GST on petroleum products – Here’s why the idea cannot be immediately executed

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There have been many arguments which have been presented for introduction of petroleum products in the Goods and Service Tax. One of them was recently pushed by the SBI’s Chief Economist, Dr Soumya Kanti Ghosh, which suggested that brining petroleum under GST may not have much revenue implications if government does not allow input tax credit on it.

Input credit simply means that companies can deduct the tax that they have paid on petroleum products for moving their goods and services from the tax collected by them for the sale of those products or services.

There are two important issues that we must discuss. First is, should petroleum products be under the GST? The answer to this is a definite yes. Bringing petroleum products under the GST will be a good decision.

The second question pertains to whether this can be done at the moment. Unfortunately, the answer to that is perhaps no. As much as I would like petroleum products to be included into GST, we must recognise that at present it is one of the major sources of revenue for state governments – each of which levy a different VAT rate for raising revenues. Thus, a single GST rate across the country that subsumes both central excise and VAT will have revenue implications that will differ across states.

With the pandemic, and the issue of GST compensation there has already been a confrontation between states and Centre. On the issue of state finances, the lack of GST has overstretched their balance-sheet restricting the ability of states to spend their way outside of the pandemic. Most of these states have increased their borrowings at rates that are higher than the interest on mortgages at present.

Thus, taking away their power to levy taxes on an item which has an inelastic demand would be met with significant resistance. Of course, state finances should be strengthened and they must be asked to re-evaluate their expenditures, prioritise on spending for growth and getting rid of their state owned PSUs to generate additional revenues.

However, that is a slightly longer project of overall expenditure rationalisation. The key point here is that states that heavily rely on petroleum taxes would oppose the move to bring it under the GST and convincing them would require working out a compensation formula which may or may not be acceptable to them.

The GST compensation formula has been unfair to the Centre as even though we have witnessed a lower level of inflation and thus lower nominal growth, states continue to insist on GST compensation even though there is limited improvement in compliance from their side. Moreover, guaranteed revenues have allowed states to extend their expenditures without considerations of economic growth and there is a problem of moral hazard there. As is the case, high local state taxes on petroleum products are a political choice that states have to make between extending subsidies to one section of the population while generating revenues from a particular sector. Whether this is good economics or not is a separate issue as is the issue on whether this is good politics.

Additionally, building a consensus on the issue of bringing petroleum products under the GST is likely to be a challenging task as it will require a significant amount of political capital. The question is whether bringing it under the GST regime is optimal use of the political capital or it could be utilised better elsewhere.

My sense is that the latter may be a better utilisation for various reasons. To begin with, a need for overall GST reform is perhaps more important at this moment that adding petroleum under the GST. Rationalization of rates and putting maximum number of items at a single standard rate with 3 additional rates would result in what we term as an ideal GST regime.

As is the case, a recent study by ICICI Securities showed Centre has space for reducing the excise duty by approximately 8 Rs and it would still manage to generate adequate revenues to meet its budgetary estimates.

Thus, there is a case for a modest reduction in taxes from the Centre – which could result in states willingly cutting rates. That by far is a more likely outcome that will be acceptable to governments.

The overstretched public finances make it a difficult outcome to achieve at the moment – though it is a desired outcome.

Perhaps, rationalisation of rates should be prioritised while issue of GST on petroleum products could be explored once the rationalised GST structure stabilises and public finances across state governments are in a healthier situation.

(The writer is an economist and policy-researcher. Views expressed are personal)