Fuel prices and oil bonds: The convenience of false equivalences

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Recently, I came across an interesting article about the petrol prices in India where the author argued that low corporate tax rates are responsible for the high petrol prices. This is not a one-off occurrence as many people have drawn inferences regarding the corporate tax cuts without looking at the overall data. There is a consistent attempt to paint a view that the corporate tax cuts are responsible for the high taxes – whether direct or indirect.

However, such a view is problematic for various reasons. For starters, it ignores the rationality associated with the corporate tax cuts. Refer to the joint article with Surjit S Bhalla where we highlighted using the distribution of prevailing corporate tax rates that the optimum rate was at 22%. Therefore, a reduction in corporate taxes was to align our corporate tax rates with that of our competitors. This must be viewed as a necessary condition for companies to consider operating within a taxation jurisdiction. Add to this the fact that lower corporate taxes could also serve as an incentive for companies viewing to diversify their supply chains and the tax cut could eventually prove to be revenue positive in nature.

Many have been quick to dismiss the tax cuts even as they have ignored the fact that ever since the corporate tax cuts, the economy has been subject to various exogenous shocks in the form of a pandemic. Thus, one has to be patient to see the extent of impact that the tax cuts will have on both tax revenues and economic growth. Moreover, it makes limited sense to revert to the high tax rates for corporates at a time when the Indian government is wooing private sector to come and set their manufacturing plant in India.

Also Read: Reduce prices without further ado

But the issue at hand is not of corporate taxes — but of high petroleum prices. There are questions regarding what constitutes as an appropriate level of tax on the consumption of petrol and diesel. By any standards, the appropriate level will be lower than the present level of taxation. That taxes on petroleum products should be reduced is something that everyone would agree with. However, this is a normative statement that ignores the complex contextual scenario which has led to the high taxes on petroleum products.

Bevy of taxes

In India, petroleum products are taxed by both the state and the central government. The state governments levy VAT while the central government levies the excise duty. However, somehow the focus by many analysts has been solely on the central government — and not on the VAT increases by state government. Keep in mind, that the central government has already taken the entire expenditure on Covid–19 pandemic which includes the cost of vaccination. Moreover, it has provided fiscal support through various schemes to people as an attempt to cushion the impact of the pandemic. The states on the other hand have issued support to varying degrees — while many have even chosen to not offer any relief thus far. In fact, most states hiked VAT last year due to fear of tax shortfalls, however, even as tax collections have improved, they are yet to reverse the VAT hikes. It has been long argued by me that state governments are better placed to slash the VAT rather than the central government cutting excise given the present economic situation. Ideally, we should have a moderation of VAT and some moderation in excise tax rates to help lower the retail price of fuel.

That most state governments have not yet reduced the VAT even as they did not provide much support to their respective economies is very telling as it reveals the problem associated with commentariat. The commentariat ignores the state governments or its handling of the economy even as it continuously dissects the decisions or at times the lack of them by the union government. Such dissection is welcome but it should be extended even to the state governments so that even they are pressurised to revisit their public finances and focus on revival of their respective growth rates. After all, India’s economy consists of the economies of various states and therefore, we need all the states to register robust growth for the country to do well.

No headroom 

In fact, the commentariat has conveniently ignored — despite repeated reminders — that the central government virtually assured states of a 14% revenue growth under the GST compensation clause. What this means is that if the indirect tax revenues of the state government do not grow by 14% annually, the central government will compensate them by the amount of tax shortfall by levying the compensation cess. Essentially, states are guaranteed a return of 14% on their indirect tax collections irrespective of their domestic economic conditions.

Objectively speaking, there is a case for the state governments to revisit their taxation on petroleum products. The same is also true for the union government, however, given the extent of expenditure required to tide over the pandemic, there is limited space with the central government for an excise cut.

Oil bonds

The situation is made more difficult by issuance of the oil bonds by the previous regime. Those bonds artificially kept the oil prices low even as they pushed the liability to pay them off to future generations. Moreover, the borrowing was done in a discrete manner to hide it from the genuine public and understate India’s fiscal deficits during UPA. This was confessed by a former Finance Minister in a tweet where he talked about the need to ‘mentally add’ the oil bonds to the overall fiscal number.

The present Finance Minister has and rightly so put an end to the practice of reporting fudged numbers achieved through creative accounting. Thus, she has brought back the sanctity of our fiscal figures by openly admitting the extent of the deficit in the pandemic year. This is correct as it sets the record straight and will help potentially revert to a prudent public finance policy that should help our growth aspirations.

On the fuel prices, there is a need to look at states and the available fiscal space with them. Ultimately, relief will have to come from a cut in VAT given the limited expenditure by states in the Covid year. However, if commentariats continue to ignore the state governments & their policies, then perhaps consumers will have to wait for another few months until oil prices start moderating to see a reduction in their monthly fuel bills. Till then, the generally low CPI inflation should be viewed as a silver lining — as we all expect (and even hope) that the CPI moderation will continue well during the second half of the financial year.