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States must reciprocate: Dithering on auto fuel tax cut may be good politics, but bad economics

The reluctance of states to do their bit stems from deep-rooted grievances. They believe the Centre keeps them out of their fair share of tax collections by imposing cess on various items, including auto fuels.

The reluctance of states to do their bit stems from deep-rooted grievances.

Not a single state has so far followed the Centre in cutting duties on auto fuels by trimming the value-added tax (VAT) or the sales tax. Last week, the Centre lowered the levies on petrol and diesel by Rs 8 per litre and Rs 6 per litre, respectively, by reducing the road and infrastructure cess. While a couple of states like Maharashtra and Rajasthan have claimed they have pruned duties, the reality is that the lower prices are the result of the adjustment to prices post the cut in the central excise duty. States may forego some revenues, but that is purely due to the ad valorem nature of the duty structure, not because the states have cut the VAT.

The reluctance of states to do their bit stems from deep-rooted grievances. They believe the Centre keeps them out of their fair share of tax collections by imposing cess on various items, including auto fuels. Therefore, they hold that sharing only 41% of the divisible pool isn’t an equitable distribution of the spoils, even if this is mandated by the Finance Commission. The relations have become more strained since it was clear that the Centre will no longer be compensating them for any shortfall in GST revenues below the 14% threshold.

The states have a point when they say the Centre reaped a bonanza by raising duties on auto fuels between FY14 and FY17, when crude oil prices fell from about $105 per barrel to $47 per barrel. This boosted excise revenues from Rs 78,000 crore in FY14 to Rs 2.43 trillion in FY17. Moreover, duties were raised thereafter too and, by FY21, revenues had hit Rs 3.73 trillion. For FY22, they are pegged at Rs 4 trillion post the revenue foregone of Rs 45,000 crore due to the cut in duties in November 2021. But the states were also beneficiaries of the duty hikes. The share of cess and surcharge shot up to 96% for petrol and 94% for diesel, respectively, of the total central levies, by March 2021. In FY18, these shares were about 56% for petrol and 35% for diesel. Post the two cuts, the shares have dropped, but remain elevated at about 93% and 89%, respectively. There’s no denying, therefore, that cess and surcharge do account for a disproportionate share of the total levy.

Be that as it may, it is not entirely true that the high prices at the pump are the result of the incidence of central taxes. As former chief economic advisor Krishnamurthy Subramanian has argued, the Maharashtra government’s levies are about 30% higher than those of the Centre given that it levies a VAT of 26% on petrol (Rs 31/per litre), as also a fixed charge of Rs 10.12/litre. The central tax, calculated as the difference between the pre-VAT price and the price charged by the dealer was Rs 24 per litre as on May 22. The difference may not be as wide for other states, but many including Andhra Pradesh and Telengana do impose high duties on petrol.

It may be true that states are concerned their revenues could fall short of their needs and are, therefore, conserving resources. But they should not forget that the Centre has bailed them out on their colossal discom losses, on more than one occasion. In FY21, the Centre had allowed the states to access more resources to the tune of Rs 4.28 trillion by raising the net borrowing cap from 3-5% of GSDP, subject to certain conditions. The war against inflation needs to be fought together and states must sink their political differences over the Centre’s past approach to taxing fuels. After all, states also have to realise that the best way to safeguard the revenue is to ensure that the growth momentum in the economy as a whole is supported.

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