scorecardresearchPetrol Price Cut: States have limited fiscal space to lower the VAT rates on petrol
In May '22, the government cut the excise duty on petrol and diesel by  <span class='webrupee'>₹</span>8/lt (from  <span class='webrupee'>₹</span>27.9/lt to  <span class='webrupee'>₹</span>19.9/lt) and  <span class='webrupee'>₹</span>6/lt (from  <span class='webrupee'>₹</span>21.8/lt to  <span class='webrupee'>₹</span>15.8/lt), respectively.

Petrol Price Cut: States have limited fiscal space to lower the VAT rates on petrol

Updated: 22 Jun 2022, 07:54 AM IST
TL;DR.
Oil revenues account for the biggest share of tax collections for both state and central governments. Any revenue loss from these items may lead to a fiscal deficit. Excise duty on fuel makes up about 18.4% of the Centre’s gross tax revenues.

International crude prices have risen considerably from its low of US$ 19/bbl seen in Apr’20 during Covid-19 times to US$ 115/bbl in June. The volatility in international oil prices was also seen in domestic retail prices of petrol and diesel. Domestic retail prices of petrol and diesel started increasing in tune with global oil prices. Petrol prices have risen from 73/lt to 113/ltr between Apr’20 to Apr’22 and diesel prices from 65/lt to 100/lt, according to a BOB report.

Retail Prices of petrol and diesel are made up of mainly 3 components - base price (reflecting cost of international oil), and central excise duty and state tax. When the retail price of petrol rose to 109.7 as on 1 Nov 2022, the government gave relief to the consumers, for the first time in over three years by reducing the duty on petrol from 32.9/lt to 27.9/lt.

VAT also was reduced simultaneously as the base price came down. Twenty-one states, including 17 ruled by the BJP, and some Union Territories then cut VAT in the range of 1.80-10 per litre for petrol and 2-7 per litre for diesel. The revenue loss to states due to this is estimated at 0.08% of GDP, as per the RBI’s State Finances report for 2021-22.

Oil prices reached a high of $140 per barrel in March 2022, due to supply concerns caused by the Ukraine crisis.
Oil prices reached a high of $140 per barrel in March 2022, due to supply concerns caused by the Ukraine crisis.

Since then, the rate revision was paused due to elections in five states including Uttar Pradesh. After that state-owned oil firms finally ended a 137-day hiatus in rate revision on March 22. Petrol and diesel prices rose by 10 per litre between March 22 and April 6 -the highest-ever increase during a 16-day period since fuel prices were deregulated two decades back.

Recently, in May '22, the government again cut the excise duty on petrol and diesel by 8/lt (from 27.9/lt to 19.9/lt) and 6/lt (from 21.8/lt to 15.8/lt), respectively. This has led to a call for states to reduce VAT in response to the current excise duty cut by the centre.

Meanwhile, oil revenues account for the biggest share of tax collections for both state and central governments. Any revenue loss from these items may lead to a fiscal deficit. Governments will think twice before reducing the taxes on petrol and diesel.

Excise duty on fuel makes up about 18.4% of the Centre’s gross tax revenues. Petroleum and alcohol, on average, account for 25–35% of states’ own tax revenue, as per the RBI’s Study of Budgets 2020–21. for 25-35% of states’ own tax revenue, as per the RBI’s Study of Budgets 2020-21. Central tax transfers account for 25–29% of state revenue receipts, while own tax revenues account for 45–50%.

The VAT story across states

When the centre lowers the excise duty, there is an automatic transmission to the base price on which the VAT is imposed and the revenue can be affected in parallel. The countervailing force is that as the base price increases with the international price of crude going up, there is a natural upside to the VAT revenue. The net effect is what matters, said BOB in a research report.

The base price for petrol was 79.98/litre in November and after the lowering of excise by 8 in May, the base price brought to 81.01, which is higher. This is so because in this period the crude oil price has gone up, thus enhancing the cost to the OMC by 9.10/litre (the dealer commission has come down marginally).

Considering the VAT rates which are available as of April 22nd, Maharashtra, Andhra Pradesh, Telangana, Rajasthan, and Madhya Pradesh have the highest collection in terms of VAT on petrol. Andaman and Nicobar, Dadra, Nagar, Haveli, Daman & Diu, Arunachal Pradesh, Gujarat, and Meghalaya are the ones where the collection of VAT amounts is the lowest.

Limited Fiscal Space

The BOB calculation shows that 16 states have made gains of between 20 and 30 paise per litre due to the increase in oil prices combined with the cut in excise duty by the centre, while for another 12 states, the gain has been between 10 and 20 paise per litre. Therefore, it may be concluded that states have limited fiscal space to further cut VAT rates in consonance with the current excise duty cut if they have to ensure that their revenue does not decrease, said BOB

Further, the analysis shows that the fiscal space that is available to states to lower the VAT rates per litre are Telangana (36 Paise), Assam (34 Paise), Rajasthan (32 Paise), Andhra Pradesh (32 Paise), Kerala (31 Paise), Madhya Pradesh (30 Paise), Odisha (29 Paise), Nagaland(27 Paise), Karnataka (27 Paise), Manipur (26 Paise), West Bengal (26 Paise), Maharasthra (26 Paise), Chhattisgarh (25 Paise), Jammu & Kashmir (25 Paise), and Punjab (24 Paise).

It said that the states have limited scope to lower the VAT on petrol without affecting their tax revenue. In FY21, for instance, states earned 2.21 lakh crore in duties on petroleum products while the centre earned 4.20 lakh crore. In the first nine months of FY22, the states earned 2.07 lakh crore, while for the centre it was 3.10 lakh crore, 

The centre’s collections were lower post the reduction in duty in November. In these 9 months, VAT/sales tax was 1.89 lakh crore and the highest collections were in Maharashtra ( 24,886 crore), Uttar Pradesh ( 18,998 crore), Gujarat ( 15,600 crore), Tamil Nadu ( 15,291 crore) and Karnataka ( 14,182 crore).

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Petrol prices in different parts of the world&nbsp;
Petrol prices in different parts of the world