At current rates, these add up to 2.5% of GDP, so there will be a big impact on deficits, the rupee and bond yields
With retail prices of both petrol and diesel rising rapidly each time crude prices harden or the rupee weakens—often both happen on the same day—it is easy for the man on the street to get swayed by the Congress party’s campaign to slash Central government levies on both fuels; juxtaposing the fall in crude oil prices since their UPA highs with the rising retail prices makes for a powerful picture, and the Congress party has highlighted this well. And, in parallel, senior Congressmen have also started talking of the need to bring both fuels under GST. Both, however, mean the same thing since you can’t bring them under GST without slashing the current rates of taxation—83% in the case of petrol and 56% in the case of diesel, for both the Centre and the states’ levies taken together. With 42% of all central taxes going to the states by way of tax devolution, while the centre collects Rs 14.66 on every litre of petrol, the states collect Rs 23.89; the figures are Rs 12.25 and Rs 15.5, respectively, in the case of diesel. In other words, focussing on just the Centre is even more unfair.
Right now, the highest rate of taxation under GST, however, is 28% though the GST law allows for this to be raised to a maximum of 40%. If duty levels have to be brought down to 40% from 56% for diesel and 83% for petrol, you’re talking of very large duty losses each year. Theoretically, you can add the cess to the ceiling rate, as is being done for some goods even today. But since this cess money is only used to compensate those states whose tax revenues are not growing at a certain pace, this method can’t be used to top-up the GST rates on petrol and diesel across the board.
Right now, Central and state taxes on petrol and diesel add up to around 2.5-2.6% of GDP. If even a third of this is lost due to a move to GST or by way of a cut in excise/VAT, this is a very significant loss in revenues, and the consequences of this can be even more severe. Right now, a very large part of the Central and state capital expenditure is funded from this windfall gain. Were this to be cut, the Centre, for instance, will no longer be able to build roads or expand railway capex in the manner it is right now to compensate for the fact that private investment is yet to recover from its collapse over several years. The impact of this, then, will be a slowing down of economic growth. Such a large cut in revenues, similarly, will mean a sharp increase in the combined fiscal deficit of the Centre and the states. At a time when the economy is already facing a severe shock in terms of rupee weakness and bond yields climbing steadily, a jump in the fiscal deficit will both send the rupee tumbling and make bond yields soar, with obvious consequences for both inflation as well as future investment growth. The economy is in a very delicate position and is just about coping with global volatility. It is not immediately clear if those trying to make political capital of the NDA’s higher petrol/diesel taxes realise the full import of their actions.