Reforming fuel taxes

Context: Addressing the chief ministers of the states recently, Prime Minister said that the Union government had reduced excise duty on fuel last November, but pointed out that some states had not followed this lead.

States raised several objections to his statement. They pointed out that the Union government has earned windfall gains on fuel production and taxation in recent years. Moreover, even without a VAT cut, fuel taxes were lower in several of the states mentioned by the PM.

What are the issues associated with the taxation of fuel?

Failure to incorporate fuel into the goods and services tax (GST) regime. Petrol and diesel have been kept out of the GST net, which means that consumers are not given the advantage of being able to set off their costs as input credits.

Further, there is no uniformity in the tax system. The GST has a pre-determined sharing formula built in, and therefore such disagreement about relative tax rates will no longer occur.

What is the way forward?

Bringing fuel under the GST will mean that overall taxes on petrol and diesel will have to be reduced to conform to the GST slabs. But in order to maintain revenue neutrality, an additional levy can be charged to the extent that current collections are higher than what they would be under the lower GST rates. This additional levy can be a special excise duty. It can also be defined as a carbon tax in keeping with international norms.

This will also allow India to make an even stronger case internationally that it is meeting its commitments on climate change. This may not be the best solution, but it is certainly better than the present situation.

Ideally, revenue from the carbon tax should be directed towards decarbonisation or sustainability projects, and shared to this end with the states. A major point of contention between the Centre and states would thus be removed.

Source: This post is based on the article “Reforming fuel taxes” published in Business Standard on 2nd May 22.