Column: Taxing petrol efficiently

Written by Mahesh C Purohit | Updated: Feb 21 2014, 05:53am hrs
The price of petrol is subject to factors such as refinery gate prices, the freight for carrying petrol to refineries and the commission paid to petrol pumps. Then, there are umpteen taxes levied by the central and state governments to raise resources. Thus, about half of the petrol price paid by the users goes into the coffers of the government as tax levies.

Unintegrated policy

Taxes on petrol and its users are levied by both the Centre and state governments, independently. There is no comprehensive national policy for the taxation of petrol or its road use. The Centre levies excise duty on petrol and vehicles. The levy on petrol has been restructured from being a mix of specific and ad valorem taxes into a pure specific levy. The tax component of petrol price does not increase with every increase in its retail price. State governments also levy taxes on crude oil and vehicles. Octroi and entry tax on crude oil are taxes on inputs or intermediate products. This tax burden is irrecoverable and varies from state to state and from refinery to refinery. The effective protection provided has an impact on the margins of some refineries. Taxes on petrol and on its users (via tax on vehicles) are unintegrated. In view of the dire need to arrest environmental degradation, it is essential to integrate environmental issues within the framework of the policy for taxation of petrol and its users.

Multiplicity of taxes

In addition to the levy of Union excise duty on petrol by the Centre and sales tax by states, other road user taxes are also levied by states. These include sales tax on vehicles, motor vehicles tax, and passengers and goods tax. These taxes fulfil the regulatory objective of the vehicle transport policy and are levied for mobilising resources. The fact that road user taxes play an important role in achieving a desired level of growth in the number of vehicles, and investment in roads, these taxes need to take environmental considerations.

Taxes on motor vehicles are levied at three pointsat the time of purchase; on ownership of the vehicle, i.e. when the vehicle is registered in the state; and on the use of vehicles (taxes on fuel, tolls, permit fee, goods tax etc).

Tax on purchase of vehicles

Taxes related to the purchase of vehicles, viz CenVAT, stateVAT, CST, have a strong influence on the choice of the vehicle. These taxes also have an impact on the choice of technology associated with the fuel the vehicle uses.

Most EU countries have a specific car purchase tax in addition to VAT. Existing car purchase taxes have been reformed to promote cleaner and low-carbon vehicle technologies. For example, the Netherlands has introduced a series of reforms to its original car purchase tax that has led to a reduction in registration taxes based on fuel efficiency. An ex-post evaluation of the trial that preceded the full introduction of this measure found that, as compared to 2001, the market share of the A-labelled cars in 2002 increased from 0.3% to 3.2%, while that of B-labelled cars rose from 9.5% to 16.1%. VAT being a tax on consumption, a variable rate of VAT could be levied based on fuel efficiency. Italians pay two rates of VAT; a standard 19% on cars with an engine capacity of less than 2,000-cc, and 38% for those above this.

Motor vehicle taxes

Motor vehicles taxes, also known as circulation taxes, have a significant impact upon vehicle choice rather than on its use. Most developed countries have an annual registration (or circulation) tax entitling owners to use the public highway. In many countries, the circulation tax varies according to the engine size or power of the car. But some nations have implemented reforms to address fuel efficiency or environment policy objectives. The UK has a CO2 emission based circulation tax (vehicle excise duty) for cars since 2001. In May 2009, VED in the UK was restructured into 13 narrower CO2 bands. This resulted in a shift in purchase patterns towards lower CO2 vehicles.

Other tax measures

Taxes levied on the various aspects of the use of vehicles (fuel, road user charges and parking) have a strong impact upon decisions to use a vehicle once it is purchased. These are the main taxes related to managing transport demand. Use of vehicles also raises issues related to the environment. During the last decade, the UK and many other developed nations reformed existing forms of road user taxes to address a number of transport policy goals. This led to modifications in the type of vehicle purchased for road use and in the fuel taxation policy to promote more fuel efficient vehicles, alternative fuel vehicles, cleaner fuels, and the reduction of vehicular congestion.

Policy imperatives

While looking at the role of tax on petrol and its users, it should be recognised that these tax measures are primarily to influence vehicle technology, the type of fuel used and economy in the use of vehicle fuel for environmental considerations. Thus, the existing CenVAT and stateVAT should be reformed to promote cleaner and low-carbon vehicle technologies.

Also, motor vehicle taxes at the time of registration that are levied by the states should address fuel efficiency or environmental policy objectives. Given the deteriorating environmental status of Indian cities, it is important to reform these taxes on the basis of CO2 emission. Motor vehicle taxes could be restructured on a sliding scale of a cars purchase price. This would result in a shift in purchase patterns in favour of lower CO2 vehicles and would play an important role in the uptake of cleaner vehicle technologies and low-carbon fuels. Studies indicate that the combined effect of a well established highly graded purchase and circulation tax systems in Italy and Denmark has provided for a 20% better fuel economy. It would also be useful to adopt variable VAT rates taking into account the engine capacity of the vehicle.

To compensate refineries that suffer from the burden of irrecoverable state/local taxes, the state governments/local bodies should be persuaded to withdraw such levies. States could levy a surcharge on sales tax on finished petroleum products. When octroi/entry tax is levied by local bodies, state governments could compensate local bodies out of the surcharge it collects.

In order to have a comprehensive approach towards taxation of petrol and road user taxes, the need of the hour is to put all such central and state taxes into one basket which could be looked into by an empowered group of central and state ministers on the pattern of Empowered Committee of State Finance Ministers for VAT.

The author is director, Foundation for Public Economics and Policy Research, New Delhi