Oil's new challenge for tax reforms

With the Centre increasing reliance on tax revenue from oil, the inclusion of petrol and diesel under GST can be problematic

Retail prices of petrol and diesel are in the news. In some parts of the country, petrol’s retail selling price has crossed Rs 100 a litre. International crude oil prices have been rising over the past several weeks, and the increase in retail prices for petrol and diesel is a direct outcome of that.

But the focus has understandably shifted to the share of government taxes on these petroleum products, which rose rapidly in the last few years even as international crude oil prices fell. The government of the day decided to take advantage of the softening crude oil prices and raised the excise levy to meet the gap in its finances. Since crude oil prices were falling, there was no immediate increase in retail selling prices. In fact, instead of falling in the normal course, prices stayed where they were, giving the government an oil bonanza of sorts.

For instance, excise duty on petrol and diesel was raised steeply by the Union government in March 2020 and again in May 2020. This helped the Centre mop up some extra revenue from the oil sector without any adverse reaction from consumers. But now, there is growing resentment over rising oil prices and there is a demand that the government roll back at least a part of the additional excise levy it had imposed in March and May of 2020.

Some experts believe that the Budget that was presented earlier this month has actually provided for a cushion in its excise revenue projections for 2021-22. Oil consumption and the Indian economy are expected to bounce back next financial year. Such an increase should give the government more excise revenue even if the excise rates remain unchanged.

But the Budget estimate for excise collections (a bulk of which is accounted for by the oil sector) shows a decline of about 7 per cent over what will be collected in the full year of 2020-21. In the current year, thanks to the increase in excise duty and despite lower consumption, excise collections will increase by 51 per cent over last year.

So, is the government already preparing for an excise cut on petrol and diesel? That is likely. But more important than that question is the need to understand the actual trajectory of the government’s taxation on the oil sector, which has serious implications for its tax reforms agenda.  

A quick appraisal of tax revenue collections by the Centre and the states brings to light quite a few interesting trends (See table). There is no doubt that the Centre has over the last six years (coinciding with the Modi regime) made the oil sector a significantly bigger source of tax revenue. The share of the combined indirect tax revenue from oil in the Centre’s gross tax revenue has gone from about 10 per cent in 2014-15 to over 14 per cent in 2019-20 (for which the latest numbers are available). Of course, this increase was largely driven by excise, whose share in the Centre’s gross tax revenue increased from about 8 per cent to 11 per cent in the same period.

The criticality of the oil sector for the Centre’s tax revenue efforts has also increased significantly in this period. In 2014-15, the share of the Centre’s indirect oil taxes in gross domestic product or GDP was about 1 per cent and this went up to 1.4 per cent in 2019-20. But the overall share of the Centre’s gross tax in GDP actually went down in this period — from 9.96 to 9.90 per cent. Take out the indirect tax revenue from the oil sector, the Centre’s overall tax efforts look even more unimpressive — going down from 8.95 per cent of GDP to 8.49 per cent.

This could become a serious problem if the trend is not corrected quickly. If the excise duty collections for 2020-21 and Budget estimate under this head for 2021-22 are any indication, the dependence on the oil sector will remain at elevated levels in the current year and the next — with shares of excise in GDP at over 1.5-1.85 per cent and the share of excise duty in the Centre’s gross tax revenues hovering at 15-19 per cent.

In contrast, the states have not exploited the oil sector the same way as the Centre has in the last six years. Indeed, the share of oil taxes in the states’ own tax revenues has declined quite significantly — from about 20.5 per cent in 2014-15 to 16.5 per cent. Even in terms of the share of combined state oil taxes in GDP, the states did not do well with the share coming down from 1.28 per cent to 1.09 per cent in this period.

Of course, the aggregate figures mask the performance of some states which raised taxes on oil products and did well with revenues But there are also some states which did not raise duties on oil to provide relief to their consumers. Nevertheless, the divergent trend in the Centre’s oil tax efforts and the aggregate state oil tax efforts has an important ramification for the taxation reform in the coming days. This is about the proposed inclusion of petrol and diesel under the Goods and Services Tax (GST) regime.

The challenge of including petrol and diesel under the GST regime will not arise from the high rates of excise or Value-Added Tax (VAT) that prevail. Special rates over and above the peak rate under the GST regime could be introduced for petroleum products. So, there should be no fear of any sharp reduction in the overall incidence of tax rates on oil products adversely affecting the Centre’s revenues. But what should worry the Centre is the way the inclusion of oil taxes in the GST regime would result in a sharp increase in refunds to the taxpayers at various stages of production and an increase in the amount of tax revenue to be transferred to the states under the devolution formula. A large part of the Centre’s indirect oil taxes consists of cesses and surcharges, which at present are not part of the divisible pool. Once, they come under GST even at a special rate, they too would have to be shared with the states.  

Thus, the Centre’s increasing dependence on the oil sector for its tax revenues has serious implications for the GST reforms agenda. In contrast, the states will have to worry far less on this count. In other words, collections under central GST will take a bigger hit than those under the state GST, if petrol and diesel were to be included under the GST regime. This is because in any case, the states are not as dependent on the oil sector for their tax revenues as the Centre is. Conservatism on oil taxation efforts will strengthen the states’ demand for inclusion of petrol and diesel under the GST regime, just as the Centre will be a little reluctant. Expect, therefore, yet another round of tough negotiations from the states with the Centre on the question of including petrol and diesel under the GST.