Rise of excise duty on Petrol and Fiscal stance of government

Synopsis: The rise in excise duty on petrol is in contradiction with the fiscal stance adopted by the government in the Economic Survey 2020-21. The new fiscal stance requires the government to borrow more instead of increasing taxes.

Background:

• The COVID-19 has brutally impacted the economy due to which the fiscal deficit has risen to 9.5%. This is 2.7 times higher than the expected 3.5% fiscal deficit. 
• Further, there is a drastic fall in receipts of revised budgetary estimates in comparison to original estimates.
• Thus, the government increased excise duty on Petrol and Diesel. It resulted in an increase in the prices of petrol and diesel for the consumer.
• However, a rise of Rs. 94000 crore rise was observed in estimates of excise duty. 
• This is the traditional approach that calls for increasing taxes rather than borrowing to improve the economic situation of the country.

Rationale behind such move:

• An increase in sales tax/ excise duty can be fruitful in improving revenue collection.
• This occurs as demand for products like petrol, diesel, tobacco, etc. is inelastic (not changing significantly with a change in price).
• Further, a rising fiscal deficit is not desired. The Fiscal Responsibility and Budget Management Act (FRBM) restricts its rise to 3.5%.
• It is believed that fiscal deficit automatically transforms into government debt. Such high debts coupled with their interests can create a debt trap. It is a situation where present borrowings keep increasing to repay past borrowings and service charges.
• This in turn reduces the scope of spending on judicious activities and also decreases the creditworthiness of the government.

However, rising excise duty didn’t prove to be fruitful.

Impact of rising excise duties:

• Revenue from an increase in duty could not compensate for the shortfall in other revenue resources. Thus, the fiscal deficit has increased to 9.5%.
• Further, these duties have been increased on final and intermediate goods which would increase the inflation level in the future.
• The estimation of a 7.7% output decline simply means loss of employment. This along with rising price levels would enhance inequalities in society. 

What is the New approach given by Economic Survey?

1. The survey of 2020-21 calls for adopting the approach of Professor Olivier Blanchard who has given a counter view to FRBM act. As per him, debt-financed fiscal spending can increase growth.
2. It may not necessarily reduce the inequalities but can definitely help in the overall growth of the economy.
3. Professor’s approach doesn’t focus on increasing the tax on the rich to augment expenditure and reduce inequalities.
4. Further government’s fiscal expenditure has a stronger multiplier impact during recessions compared to booms. This happens as:
   • When the economy is in a boom, the private sector is willing to borrow more. But it may get crowded out if interest rates are increased due to more government borrowings.
   • When the economy is in recession, the private sector is unwilling to borrow due to uncertain long-term expectations. Higher government borrowings in this situation are desired for boosting the confidence of the private sector.
5. The adoption strategy requires the GDP growth rate to be higher than the sovereign rate of interest. It would prevent the creation of a future debt trap. 
6. The survey pointed out that India’s average interest rate and growth rate over the last 25 years (leaving out FY 2020-21) has been 8.8% and 12.8% respectively. This satisfies Blanchard’s condition. 

As the condition got satisfied, it is difficult to ascertain why the government deviated from the recommendations of the economic survey. The only reasonable argument could be higher interest rates than the growth rate in 2020-21.

Qrious Project: Why petrol price is increasing in India? How and why should India achieve “End of oil-age”?