Few economic debates in India are as politically loud — and analytically shallow — as the debate on fuel taxation. Petrol prices are routinely cited as evidence of fiscal excess and governmental insensitivity. Yet, much of the debate rests on selective comparisons, nominal arithmetic, and flawed economics. Once inflation, externalities, fiscal federalism, and energy security are properly accounted for, the narrative changes fundamentally. Far from being excessively taxed, fuel in India actually remains under-taxed relative to its true social cost.
Myth 1: Petrol prices have dramatically risen under the present government.
The most common political comparison is that petrol prices in Delhi were around Rs 71-72 per litre when the UPA government left office in May 2014 and are now around Rs 98 per litre. Inter-temporal price comparisons without inflation adjustment are economically misleading.
Once adjusted for general inflation, petrol prices prevailing in 2014 translate to roughly Rs 123-125 per litre. In real terms, therefore, petrol in Delhi today is substantially cheaper than it was in 2014. The same logic applies to fuel taxation itself. In May 2014, the Union excise burden on petrol was approximately Rs 9.5/l. Today, including cesses and surcharges, it is roughly Rs 19.5/l. But after adjusting for inflation, the 2014 levy itself would be equivalent to roughly Rs 16.5-17/l. The real increase in taxation is therefore far smaller than headline nominal figures suggest.
This distinction matters because Union fuel taxes are largely specific levies denominated in rupees per litre, whose real value steadily erodes with inflation. A nominal increase over 12 years therefore largely reflects inflation adjustment rather than any dramatic escalation in the effective tax burden.
Myth 2: India excessively taxes petroleum products.
Once externalities are properly priced, India is actually under-taxing fuel. Internationally, fuel is subject to both corrective excise and value-added tax-type consumption tax. Fuel consumption imposes enormous social costs in the form of pollution, congestion, accidents, carbon emissions, and dependence on imported crude oil. Corrective taxation is intended to align private consumption decisions with these broader social costs. International studies on efficient fossil-fuel pricing suggest that the appropriate corrective levy on petrol and diesel in countries like India is about Rs 60/l (excluding VAT). Against this benchmark, the present Union levy of roughly `19.5/l appears not excessive but inadequate.
The macroeconomic implications are equally significant. India imports nearly 85% of its crude oil requirement. Persistently underpriced fuel encourages higher vehicle usage, faster growth in consumption, and greater exposure to oil shocks. It also weakens India’s transition towards electric mobility by diluting the operating-cost advantage of electric vehicles over petrol and diesel vehicles. India thus subsidises electric mobility through FAME schemes and GST concessions while simultaneously undermining the transition by keeping fossil fuels underpriced — a textbook case of bad public policy.
Myth 3: Indian fuel prices are exceptionally high by global standards.
This claim collapses once international comparisons are introduced. As of May 18, the average global petrol price is approximately Rs 148/l compared to roughly Rs 105/l in India according to GlobalPetrolPrices.com. Consumers in several advanced economies routinely pay the equivalent of Rs 160-270/l despite much higher per capita incomes. Countries with high fuel prices are not merely raising revenue; they are pricing pollution, congestion, and energy-security externalities into fuel consumption decisions. India, despite severe pollution and import dependence, continues to price petroleum relatively cheaply.
The principal objection of opposition parties and civil society to higher fuel taxation is that it will burden poor households by raising transportation and input costs. This concern is legitimate but does not justify underpricing fuel for the entire economy, including affluent consumers. India already has a sophisticated direct benefit transfer infrastructure. Part of the additional revenue can therefore be returned to vulnerable households through direct cash transfers without weakening the price signal necessary to moderate fuel consumption.
A transition towards full corrective taxation would undoubtedly produce a one-time increase in prices. However, this would largely represent a level adjustment rather than a sustained inflationary spiral. Once the new equilibrium is absorbed, inflation would normalise. If vulnerable households are protected through targeted transfers, such a transitional shock should not constitute a serious macroeconomic concern.
Higher corrective taxation could also strengthen India’s fiscal resilience. As revenues rise, states will gain fiscal space and become less dependent on borrowing. Over time, this could permit a gradual reduction in state borrowing limits from 3.5% of GSDP to 2%, rebuilding buffers against increasingly frequent global shocks and commodity-price disruptions.
Myth 4: State governments are major beneficiaries of fuel taxation.
Ironically, states are not the principal beneficiaries of fuel taxation but among its largest fiscal losers. The present structure of petroleum taxation deprives them of revenues that would ordinarily accrue through constitutional tax devolution.
More fundamentally, under-taxation of fuel itself deprives states of the much larger tax devolution that would have accrued had corrective fuel taxation been imposed through ordinary Union excise duties. Further, had fuel taxation been imposed primarily through ordinary excise duties forming part of the divisible pool, 42% of the revenues would ordinarily accrue to states. Instead, of the roughly Rs 19.5/l collected by the Centre on petrol, nearly Rs 18 is raised through cesses and surcharges lying outside the divisible pool. The consequence is that the Centre appropriates almost the entire revenue while states are denied their legitimate share.
The distortion extends further. State VAT on petroleum products is largely ad valorem and imposed rightly so, on an excise-inclusive base. Consequently, under-taxation at the Union excise level also suppresses the VAT base available to states.
Artificially lowering fuel taxes for everyone benefits not only vulnerable households but also affluent vehicle owners who account for a disproportionately large share of fuel consumption. Such generalised price suppression is fiscally wasteful, environmentally destructive, and economically distortionary. India’s fuel-tax debate is ultimately a classic case of bad economics camouflaged as pro-poor policy. What is not a myth, however, is the public policy sin of under-taxing a sin good and leaving future generations to bear the cost.
The author is Former Member, CBDT, former Senior Economist, IMF, and Senior Visiting Research Fellow at XKDR
Disclaimer: The views expressed are the author’s own and do not reflect the official policy or position of Financial Express.