How complicated is fuel taxation in India?

It is quite complicated. The final retail price of petrol and diesel purchased at a petrol pump has multiple components. The base price of the auto fuel, including the freight, accounts for 56 per cent of the final selling price for petrol and 60 per cent for diesel.

The Centre charges excise duty on the base price accounting for 26 per cent and 23 per cent of the final price of petrol and diesel, respectively. The excise duty is charged at a fixed rate per litre and has various components (discussed below). The dealer’s commission amounts to another 4 and 3 per cent of the selling price of the two petroleum products.

The States levy value-added tax (VAT) on the cost of petrol and diesel, including excise duty and dealer’s commission. Now, States have been given a free hand in structuring and taxing fuel in their States. Many States/UTs such as Arunachal Pradesh, Delhi, Odisha and Telangana charge just VAT at a certain rate applied to the cost of the petrol. Since VAT is an ad-valorem tax, it will go up and down with the market price of the fuel.

Many States have tried to address the resulting volatility in tax collection by adopting a hybrid model wherein they charge a lower VAT on the fuel and apply a flat charge per litre of petrol and diesel. Tamil Nadu, Maharashtra, Andhra Pradesh and others have this hybrid model of taxing fuel. The other States and UTs apply other innovative charges, including road development cess, employment cess, pollution surcharge etc.

What is the recent row over the Prime Minister’s remarks on fuel taxes?

With international crude oil prices rising from the last quarter of 2021, pressure began building on the Centre to cut taxes on fuel to cool inflation and give relief to consumers.

The Centre cut central excise duty by ₹5 on petrol and ₹10 on diesel last November. It also asked States and Union Territories to follow suit by reducing their taxes. The many States complied with the Centre’s diktat.

Uttar Pradesh, Gujarat, Karnataka, Haryana, Madhya Pradesh and Goa reduced the State tax on petrol by ₹7 per litre. Punjab made the largest cut, slashing petrol taxes by ₹10 and diesel tax by ₹5 per litre.

The States such as Bihar (₹3.2), Himachal Pradesh (₹2) and Odisha (₹3) made minor cursory cuts. The Prime Minister is now admonishing the opposition ruled States for not reducing fuel taxes.

Why are the opposition ruled States upset about the Prime Minister’s remark?

The Prime Minister has pointed explicitly to Maharashtra, West Bengal, Telangana, Andhra Pradesh, Tamil Nadu, Kerala and Jharkhand, saying their unwillingness to cut taxes is burdening consumers.

The States are pointing out that the Centre needs to forego its revenue by cutting its fuel taxes further before asking them to do so. They are also not happy with how the Centre is using the cess and surcharge on fuel taxes to keep a larger portion of taxes with itself.

They also think that the Centre is being unfair in asking them to forego revenue from an important source when the economy is still grappling with the effects of the pandemic. Taxes on fuel and alcohol form an important part of States’ own tax revenue.

Why are States against Centre levying cess on fuel?

Cess is a tax charged over the basic tax liability, and it is levied for a particular purpose, such as education cess, infrastructure development cess etc.

More important, since the cess collected has to be spent only for a specific purpose, the Centre need not share the collection with States.

Now, if we look at the excise duty charged by the Centre, it comprises four elements — basic excise duty, special excise duty, additional excise duty (road and infrastructure cess) and agriculture and infrastructure development cess. The Centre has to share only the amount collected under basic excise duty with States as other components are either cesses or bucketed under surcharge.

Basic excise duty accounts for just 4.2 per cent of the amount collected by the Centre as fuel taxes. Once 41 per cent of basic excise duty is shared with the States, the Centre retains over 98 per cent of the tax collected on petrol and diesel. The Opposition-ruled States are crying foul over how the Centre has structured the fuel taxes, cheating them of their share.

Would it not be a lot easier to bring fuel under GST?

That is the right way to go and will help in multiple ways. One, it will ensure that consumers across the country pay the same rate of taxes. Currently, prices of petrol in Maharashtra are above ₹120 per litre whereas it is ₹15 lower in Delhi. Such a disparity will cease once the fuel is moved under GST as all States will be subject to similar taxes.

Two, the Centre will have to give States their rightful share of taxes collected as the complicated central tax structure will go under GST.

Three, tax rates on fuel may come down once it moves under GST. The current tax rate on petrol and diesel (Centre and States combined) amounts to a whopping 75 per cent, much above the higher GST slab applied for sin goods.