Petroleum Secretary S Sundareshan, while addressing a press Conference on Friday, announced the government’s decision to deregulate prices of petrol. Petrol prices shall now be subject to periodic revisions based on fluctuations in market prices. An immediate hike of Rs. 3.50 per litre has already been affected. Prices of diesel shall be deregulated in stages while those of kerosene and LPG shall continue to be regulated by the government. For the moment, diesel has been hiked by Rs. 2 per litre, kerosene by Rs. 3 per litre and LPG by Rs. 35 per cylinder. Crude to retail: Pricing and under-recoveries India imports about 80% of its crude oil requirement. Therefore, the cost of petroleum products in India is linked to international prices. The Indian barrel of crude cost $78 in March 2010. Once crude is refined, it is ready for retail. This retail product, is then taxed by the government (both Centre and State) before it is sold to consumers. Taxes are levied primarily for two reasons: to discourage consumption and as a source of revenue. Taxes in India are in line with several developed nations, with the notable exception of the US (See Note 1) Before the current hike, taxes and duties in Delhi accounted for around 48% of the retail price of petrol and 24% of the retail price of diesel. (Click Here for details) Ideally, the retail prices of petroleum products should then be determined as: Retail prices = Cost of production + taxes + profit margins However, in practice, the government indicates the price at which PSU oil companies sell petroleum products. Since these oil companies cannot control the cost of crude (the primary driver of the cost of production) or the taxes, the net result is an effect on their profit margins. In cases where the cost of production and taxes exceeds the prescribed retail price, the profit margins become negative. These negative profit margins are called ‘under-recoveries’. When international crude prices rose above $130 in 2008, under-recoveries reached an all-time high of Rs. 103,292 crore. Even at much lower prices in 2009-10 (averaging at $70 per barrel), under-recoveries totalled Rs. 46,051 crore. (See Note 2) The latest move is an effort to reduce these under-recoveries. The government cited the recommendations of the Kirit Parkih Committee while announcing its decision (Summary - Kirit Parikh Committee report). Any alternatives to price hike? As is evident from above, under-recoveries can also be reduced by decreasing taxes. In fact, one might argue that by both taxing the product and offering a subsidy, the government is complicating the situation. Usually whenever subsidization coexists with taxation, it serves the purpose of redistribution. For example, taxes might be collected universally but subsidy be granted to the weaker sections only. However, this is not the case in the current situation. What needs to be noted here is that these taxes are a very significant source of revenue. In fact, the total taxes paid by the oil sector to the central and state governments were around 3% of GDP in 2008-09 (See Note 3). Reducing taxes now might make it difficult for successive governments to raise taxation rates on petroleum products again. Moreover, though taxes are levied both by the Centre and the States, the subsidy is borne only by the Centre. Hence, the current arrangement is beneficial to the States. Possible future scenarios The opposition has voiced concerns that the hike in prices is likely to lead to even higher inflation and will further burden the consumer. The Chief Economic Advisor to the Finance Ministry, Dr. Kaushik Basu, however, told the media that these changes would have a beneficial effect on the economy. According to him,
"The (decontrol of petrol prices), coupled with price increase for LPG (cooking gas) and kerosene, will have an immediate positive impact on inflation. I expect an increase of 0.9 percentage points in the monthly Wholesale Price Index (WPI) inflation".
However, he added, that since the hike in fuel prices would push down fiscal and revenue deficit,
"they will exert a downward pressure on prices… More importantly, from now on, if there is a global shortage and the international price of crude rises, this signal will be transmitted to the Indian consumer. It will rationalise the way we spend money, the kinds and amount of energy we use, and the cars we manufacture. It is an important step in making India a more efficient, global player”.
It remains to be seen how the actual situation pans out. Notes 1) Share of tax in retail price (%)
| Country | Petrol | Diesel |
| France | 61% | 46% |
| Germany | 63% | 47% |
| Italy | 59% | 43% |
| Spain | 52% | 38% |
| UK | 64% | 57% |
| Japan | 48% | 34% |
| Canada | 32% | 25% |
| USA | 14% | 16% |
| India (Del) | 48% | 24% |
Source: Petroleum Planning and Analysis Cell, PRS (Data as of Feb, 2010) 2) Under-recoveries by oil companies (Rs Crore)
| Year | Petrol | Diesel | PDS Kerosene | Domestic LPG | Total |
| 2004-05 | 150 | 2,154 | 9,480 | 8,362 | 20,146 |
| 2005-06 | 2,723 | 12,647 | 14,384 | 10,246 | 40,000 |
| 2006-07 | 2,027 | 18,776 | 17,883 | 10,701 | 49,387 |
| 2007-08 | 7,332 | 35,166 | 19,102 | 15,523 | 77,123 |
| 2008-09 | 5,181 | 52,286 | 28,225 | 17,600 | 103,292 |
| 2008-09 | 5,151 | 9,279 | 17,364 | 14,257 | 46,051 |
Source: Petroleum Planning and Analysis Cell, PRS 3) Contribution to Central and State taxes by Oil Sector (2008-09)
| Category | Rs (crore) |
| Sales tax | 63,349 |
| Excise duty | 60,875 |
| Corporate tax | 12,031 |
| Customs duty | 6,299 |
| Others (Centre) | 5,093 |
| Other (State) | 4,937 |
| Profit petroleum | 4,710 |
| Dividend | 4,504 |
| Total | 1,61,798 |
Source: Petroleum Planning and Analysis Cell
In the past few months, retail prices of petrol and diesel have consistently increased and have reached all-time high levels. On September 24, 2018, the retail price of petrol in Delhi was Rs 82.72/litre, and that of diesel was Rs 74.02/litre. In Mumbai, these prices were even higher at Rs 90.08/litre and Rs 78.58/litre, respectively.
The difference in retail prices in the two cities is because of the different tax rates levied by the respective state governments on the same products. This blog post explains the major tax components in the price structure of petrol and diesel and how tax rates vary across states. It also analyses the shift in the taxation of these products, its effect on retail prices, and the consequent revenue generated by the central and state governments.
What are the components of the price structure of petrol and diesel?
Retail prices of petrol and diesel in India are revised by oil companies on a daily basis, according to changes in the price of global crude oil. However, the price paid by oil companies makes up 51% of the retail price in case of petrol, and 61% in the case of diesel (Table 1). The break-up of retail prices of petrol and diesel in Delhi, as on September 24, 2018, shows that over 45% of the retail price of petrol comprises central and states taxes. In the case of diesel, this is close to 36%.
At present, the central government has the power to tax the production of petroleum products, while states have the power to tax their sale. The central government levies an excise duty of Rs 19.5/litre on petrol and Rs 15.3/litre on diesel. These make up 24% and 21% of the retail prices of petrol and diesel, respectively.
While excise duty rates are uniform across the country, states levy sales tax/value added tax (VAT), the rates of which differ across states. The figure below shows the different tax rates levied by states on petrol and diesel, which results in their varying retail prices across the country. For instance, the tax rates levied by states on petrol ranges from 17% in Goa to 39% in Maharashtra.
Note that unlike excise duty, sales tax is an ad valorem tax, i.e., it does not have a fixed value, and is charged as a percentage of the price of the product. This implies that while the excise duty component of the price structure is fixed, the sales tax component is charged as a proportion of the price paid by oil companies, which in turn depends on the global crude oil price. With the recent increase in the global prices, and subsequently the retail prices, some states such as Rajasthan, Andhra Pradesh, West Bengal, and Karnataka have announced tax rate cuts.
How have retail prices in India changed vis-à-vis the global crude oil price?
India’s dependence on imports for consumption of petroleum products has increased over the years. For instance, in 1998-99, net imports were 69% of the total consumption, which increased to 93% in 2017-18. Because of a large share of imports in the domestic consumption, any change in the global price of crude oil has a significant impact on the domestic prices of petroleum products. The following figures show the trend in price of global crude oil and retail price of petrol and diesel in India, over the last six years.
The global price of crude oil (Indian basket) decreased from USD 112/barrel in September 2012 to USD 28/barrel in January 2016. Though the global price dropped by 75% during this period, retail prices of petrol and diesel in India decreased only by 13% and 5%, respectively. This disparity in decrease of global and Indian retail prices was because of increase in taxes levied on petrol and diesel, which nullified the benefit of the sharp decline in the global price. Between October 2014and June 2016, the excise duty on petrol increased from Rs 11.02/litre to Rs 21.48/litre. In the same period, the excise duty on diesel increased from Rs 5.11/litre to Rs 17.33/litre.
Over the years, the central government has used taxes to prevent sharp fluctuations in the retail price of diesel and petrol. For instance, in the past, when global crude oil price has increased, duties have been cut. Since January 2016, the global crude oil price has increased by 158% from USD 28/barrel to USD 73/barrel in August 2018. However, during this period, excise duty has been reduced only once by Rs 2/litre in October 2017. While the central government has not signalled any excise duty cut so far, it remains to be seen if any rate cut will happen in case the global crude oil price rises further. With US economic sanctions on Iran coming into effect on November 4, 2018, India may face a shortfall in supply since Iran is India’s third largest oil supplier. Moreover, Organization of Petroleum Exporting Countries (OPEC) and Russia have not indicated any increase in supply from their side yet to offset the possible effect of sanctions. As a result, in a scenario with no tax rate cut, this could increase the retail prices of petrol and diesel even further.
How has the revenue generated from taxing petroleum products changed over the years?
As a result of successive increases in excise duty between November 2014 and January 2016, the year-on-year growth rate of excise duty collections increased from 27% in 2014-15 to 80% in 2015-16. In comparison, the growth rate of sales tax collections was 6% in 2014-15 and 4% in 2015-16. The figure below shows the tax collections from the levy of excise duty and sales tax on petroleum products. From 2011-12 to 2017-18, excise duty and sales tax collections grew annually at a rate of 22% and 11%, respectively.
How is this revenue shared between centre and states?
Though central taxes are levied by the centre, it gets only 58% of the revenue from the levy of these taxes. The rest 42% is devolved to the states as per the recommendations of the 14th Finance Commission. However, excise duty levied on petrol and diesel consists of two broad components – (i) excise duty component, and (ii) road and infrastructure cess. Of this, only the revenue generated from the excise duty component is devolved to states. Revenue generated by the centre from any cess is not devolved to states.
The cess component was increased by Rs 2/litre to Rs 8/litre in the Union Budget 2018-19. However, this was done by reducing the excise duty component by the same amount, so as to keep the overall rate the same. Essentially this provision shifted the revenue of Rs 2/litre of petrol and diesel from states’ divisible pool of taxes to the cess revenue, which is entirely with the centre. This cess revenue is earmarked for financing infrastructure projects.
At present, of the Rs 19.5/litre excise duty levied on petrol, Rs 11.5/litre is the duty component, and Rs 8/litre is the cess component. Therefore, accounting for 42% share of states in the duty component, centre effectively gets a revenue of Rs 14.7/litre, while states get Rs 4.8/litre. Similarly, excise duty of Rs 15.3/litre levied on diesel consists of a cess component of Rs 8/litre. Thus, excise duty on diesel effectively generates revenue of Rs 12.2/litre for the centre and Rs 3.1/litre for states.
