Petrol, diesel prices hiked again — the curious case of oil pricing in India
“Indirect taxes are regressive and direct taxes are progressive."
This is one of the first principles which taught in economics. The reason is simple — indirect taxes affect all individuals whether they can afford to pay taxes or not while direct tax is levied on those who can afford to pay. Thus, indirect taxes should be levied only as a last resort when the direct tax collection is not enough to meet government expenditure or consumption.
This is often forgotten in many countries, including India, in order to meet their target of fiscal deficit. A poor country like India does not have a large tax-paying base and hence the need to levy indirect taxes in the form of customs duty, excise, VAT and now GST. A developing country like India does need huge investments in infrastructure, education and healthcare. There is no escape from direct and indirect taxes.
However, the question is the amount of tax that is to be levied so that it causes minimum distortions in the economy. The government has also to ensure that it runs an efficient administration and there are minimum leakages and waste in its own expenditures. This unfortunately has not been the case for the past 40 to 50 years.
The government in its wisdom levied income tax to the ridiculous levels of 70 per cent to 90 per cent in the 1970s. There is no doubt that the first source of government income has to be direct taxes, but the rate has to be such that a majority of the tax payers comply. This ham-handed approach caused most of the income to go underground and the black economy flourished in connivance with a pliant bureaucracy. The same approach was followed in regard to indirect taxes with very high excise duty and sales tax rates. This caused clearance of goods from factories without invoices.
Wisdom dawned on the government in the 1990s and reasonable rates were applied. This immediately resulted in greater compliance and the tax base widened yielding higher revenue for the government.
A notable exception has been the oil sector. Here, the whimsical policies of taxation have continued. Galloping oil prices from 1990s made the governments nervous. They realised that oil could become a political hot potato. But at the same time they realised that increasing demand for oil could yield a large tax collection for the government. So a bizarre policy was followed. The government forced oil-producing companies to keep an artificially low price with subsidies in the form of oil bonds while levying high taxes in the form of excise duty, customs duty and sales tax. This kept the official fiscal deficit under control while the oil pool deficit kept on increasing or decreasing according to the international oil prices. Creative accounting at its best.
Let us now look at the present scenario. Post-2014, oil prices slid for almost four years in a row. It was a bonanza for the government. The government in its wisdom decided that instead of passing on the benefits to the consumer, the government should increase its tax collection and increase government investment. The excise duty has been increased from around Rs 9 per litre to Rs 21 per litre which has been now made Rs 19 per litre.
Similarly, excise duty on diesel has been hiked steeply. The total central tax collection has increased from Rs 88,000 crore to Rs 2,53,000 crore in 2016-2017. It is a steep increase of Rs 1,65,000 crore. The states collect about Rs 18,000 crore as VAT. Thus, the total collection is in excess of Rs 4,00,000 crore.
No government would like to give up such a bounty. Understandably, it has been kept out of GST since GST rates cap at 40 per cent while the present arrangement results in a rate of around 100 per cent. This has resulted in India having about the highest oil prices in the world. Let us now look at the impact of this whimsical method of oil pricing.
An artificial price of an important input in today’s economy bears no relation to the cost. It is either artificially lowered or increased depending on government finances. Thus, our freight costs are either low or high as compared to the rest of the world.
Presently, with prices higher than the rest of the world, it affects us competitively and reduces our exports. It also reduces private consumption because of lower disposable income. The government may argue that they are using the money to increase government consumption and investment. That may well be true. But we all know that private consumption is always more efficient than government consumption. There is also a basic tenet of economics involved. Let the costs reflect the prices of the inputs. This always results in an efficient economy.
The government may find it difficult to meet its fiscal deficits. They have to get down to putting their own house in order. Our bleeding public sector units are a huge drain on our economy. Air India has an accumulated loss of over Rs 50,000 crore. There are many such public sector units which have to be pruned. These are not politically easy things to do and hence the easy option of milking the oil sector continues. The government can also look at its own bloated administrative expenses and become more lean.
We keep on talking about India being the fastest growing economy in the world and compare ourselves to China. But China is five times larger economy and its base is five times larger. Thus our growth of 7.3 per cent as compared to their 6.8 per cent is no big deal. We need to grow at 10 per cent for a decade and it is possible if we stop looking at easy options.
This 10 per cent growth will take care of all our problems, including eradication of poverty, fiscal deficits and government investments. Let us make our economy more efficient and we would have arrived at the world stage as a mighty power. There are no easy options.
Also read: Modi government's fuel price hike is taking the steam out of achhe din