States increase petroleum tax revenue to fund COVID-19 battle; large share with the centre

The price of crude oil that India imports has declined from Rs 3,961 per barrel on 21 February to Rs 1,523 on 1 May. Prashanth Vishwanathan / Bloomberg / Getty Images
04 May, 2020

On 21 April, Assam increased the rate at which it taxes petrol and diesel. It issued a notification that in effect raised the price of petrol from Rs 71.61 to Rs 77.46 per litre and of diesel from Rs 65.07 to Rs 70.50 per litre. With the state under lockdown and economic activity effectively coming to a halt, this was one of the few ways in which Assam could raise money to pay salaries of government employees or fund health expenditure in fighting COVID-19. “The state relies heavily on taxes from petroleum and that is the reason for the increase, because there are no other sources of revenue, even in a post-lockdown scenario,” an official in the finance department of Assam, who requested anonymity, told me.

There are two ways in which Assam earns revenue from petroleum. The state is one of the few in India which has onshore oil fields. Royalties on oil drilled in Assam contribute around two thousand and five hundred crore rupees per year to the state’s revenue, according to the official, but since they are benchmarked to international crude oil prices, which have sharply fallen since the COVID-19 outbreak, this revenue stream has slowed to a trickle. The other is Value Added Tax, or VAT, on sales of petrol and diesel, which the official said used to contribute Rs 3,000 crore to the state exchequer. The lockdown has virtually dried up this revenue stream as well.

Sales tax collection—taxes from petroleum constitute a major portion of this—contributes 23 percent to Assam’s tax revenue. A collapse of almost a fourth of the tax base can be catastrophic for the state exchequer. Assam is not unique; all states in the Indian union have undergone a similar collapse in tax revenues due to the COVID-19 induced lockdown. At the same time, states have had to suddenly ramp up spending on medical infrastructure.

However, the architecture of petroleum pricing in India is such that a large part of petroleum tax revenues go to the centre. The import price of oil in India is a weighted average of two international benchmarks—Dubai and Oman, and Brent crude. Dubai and Oman is the benchmark for oil pumped in the Middle East. Brent crude is the classification for oil pumped in the North Sea. It is one of two benchmarks used for oil trading worldwide. The prices of Brent crude have crashed, from above fifty dollars on 10 February to a little over twenty six dollars as of 3 May. Consequently, the price of crude oil that India imports has also declined from Rs 3,961 per barrel on 21 February to Rs 1,523 on 1 May. 

Yet, the fall in import prices has not resulted in a fall in retail prices. “Although global crude prices have fallen, they are not reducing for the Indian consumer,” Sumit Dutt Majumdar, a former chairman of the Central Board of Indirect Taxes and Customs, an agency that formulates policy concerning customs and central excise duties, told me. “There is a mechanism for pricing petroleum through which a large part of the tax revenue goes to the central government. Global crude prices are low while Indian retail prices are high and a lot of the margin goes to the union government.”

Petroleum in India is taxed by both the centre and the states. The centre taxes the import, processing and manufacture of petroleum via customs and central excise taxes while the state governments tax the sale of the petroleum via sales tax or VAT. While the central taxes are the same, the state taxes vary. According to data from the petroleum planning and analysis cell—or PPAC—under the ministry of petroleum, the centre charges a three types of customs duty on petrol— a basic customs duty of 2.5 percent, a countervailing customs duty of Rs 12.98 per litre and an additional customs duty of Rs 10 per litre. It also charges three types of central excise amounting to Rs 22.98 per litre. On diesel, the corresponding customs rates are 2.5 percent, Rs 8.83 per litre and Rs 10 per litre and a central excise of Rs 18.83 per litre. 

Meanwhile, the taxes that states charge for petrol vary from a 16.20 percent VAT in Arunachal Pradesh to a 26 percent VAT in Odisha to a 27 percent VAT in Delhi. The state taxes on diesel vary similarly. According to data on the website of the Indian Oil Corporation, as of 1 May, petrol was sold in Delhi to dealers, after customs and freight charges, at Rs 28.27 per litre. Adding a central excise tax of Rs 22.98, a VAT of Rs 14.79 and a dealer commission of Rs 3.55, the retail price reached Rs 69.59.

A 2018 analysis of petroleum prices by PRS Legislative Research, a research institute that tracks the functioning of the Indian parliament, noted that while there was a 42 percent drop in the price of global crude oil between 2013 and 2018, during this time the retail price of petrol in India increased by eight percent and diesel by 33 percent. “In the past, when global crude oil prices have increased, duties have been cut,” the article noted. “Since 2014, as global crude oil prices declined, excise duties have been increased. As a consequence of the increase in duties, the central government’s revenue from petrol and diesel increased annually at a rate of 46% between 2013-14 and 2016-17. During the same period, the total sales tax collections of states (from petrol and diesel) increased annually by 9%.”

Data from the Petroleum Ministry’s PPAC backs this analysis. A chart on the contribution of the petroleum sector to India’s tax revenues suggests that in 2014–15 the central exchequer got 52 percent of the tax revenues while states got 48 percent. In 2016–17, the centre got 64 percent, while the states received 36 percent. In 2018–19, the division was 60 percent to the centre and 40 percent to the states. A Reserve Bank of India study on state finances found that petroleum­’s contribution to state tax revenues declined from 15.4 percent in 2016–17 to 12.2 percent in 2018–19.  

The Goods and Services Tax, implemented in 2017, reorganised the tax structure of India. Since petroleum was one of the most important revenue earners for state governments, they were reluctant to include it in the GST and let go of their power to independently tax it. Consequently, five petroleum products—crude oil, petrol, diesel, aviation turbine fuel and natural gas—were left out of the ambit of GST while other products, such as liquefied petroleum gas and kerosene, were included in it. The reasoning was that states would continue to receive tax revenues from the non-GST petroleum products. However, a technicality in the GST design actually reduced some of the tax inflow.

Before GST, states charged a Central Sales Tax, or CST—a levy on the movement of goods between states. However, when the GST was implemented, the Central Sales Tax was abolished and replaced with the integrated GST, or IGST, a component of the GST. Since five crucial petroleum products—which had the maximum revenue potential—were kept out of the GST, the IGST did not apply on them. The states lost out on revenue because they were neither receiving the GST nor the IGST that came in lieu of the CST. 

“The loss of revenue from CST and entry tax has hurt state revenues,” Sacchidananda Mukherjee, an associate professor at the National Institute of Public Finance and Policy, a centre for research, told me. The entry tax was a levy charged by states in the pre-GST period on all goods entering their state borders. “Whatever the fall in international crude prices was capitalised by the union government by increasing the excise duty,” he added. “For the states to further increase the tax would be a political decision, because you have to pass on the increase to the consumer.”

Last year, Mukherjee authored a paper for NIPFP on tax collections from the petroleum sector in which he argued that since 2010–11, the revenue share of petroleum taxes has gone up for the union government and down for state governments. This, Mukherjee said, is a long-term trend which started in 2001 and saw some short periods of respite in between. Referring to the union excise duty, levied by the centre, the paper noted, “The fall in revenue collection from petroleum taxes during 2008-15 is mostly attributed to cut in UED on petroleum products, announced as a part of fiscal stimulus package to moderate the impact of global financial crisis.” The paper added, “However, gradual fall in international crude oil prices since July 2014 enabled the government to increase excise duties on petroleum products which resulted in higher tax collection since 2015-16. The imposition of higher excise duties on petroleum products arrested the fall in domestic prices of petroleum products. In other words, the benefit of lower international crude oil price did not passed on to the consumers in terms of lower prices of petroleum products in the domestic market. The benefits of increasing UED on petroleum products did not result in equal benefits to states’ tax collection.”

State governments have been complaining that the centre has not been transferring resources to them to fight COVID-19. On 23 April, Manpreet Badal, the finance minister of Punjab, said that his state received only Rs 71 crore from the centre to combat COVID-19. On 22 April, Amit Mitra, the finance minister of West Bengal, said in an interview to The Wire, that he had written eight letters to Nirmala Sitharaman, the union finance minister, seeking economic help, but never received a reply. One of the requests from the West Bengal government was for a nine-month moratorium on repaying loans and interest. In another letter, Mitra asked that companies be allowed to count contributions made to the Chief Minister’s Relief Fund, or any COVID-19 dedicated fund, toward their corporate social responsibility spending. Mitra said that only a small part of one of the state’s several key requests had been agreed to.

“There has been a heavy reliance on petroleum taxes both by the centre and by the states, as a result of which the consumer pays a much more than a reasonable price,” Govinda Rao, a public finance economist and member of the fourteenth finance commission, told me. The fourteenth finance commission, a constitutionally mandated body set up to evaluate the finances of the union and state governments, had recommended that tax revenue from India’s divisible pool of taxes be shared between the centre and the states in the ratio of 58 percent to 42 percent starting 2015. Rao added, “The centre has been devolving tax money, including from petroleum levies, to the states as per the recommendations of the fourteenth finance commission. Customs and central excise is also shared with the states.”

However, Rao further noted, “After the fourteenth finance commission gave the recommendation that 42 percent of the divisible pool of taxes should go to the states, the central government, in terms of any discretionary measures it took, started charging cesses so that it didn’t have to share with the states.” Cesses and surcharges are taxes levied by the centre which do not have to be shared with the states. In the 2018–19 budget, the central government replaced a portion of excise duty with a road and infrastructure cess, the effect of which would be to deprive states of revenue. Rao continued, “One of the things that happened 2014 onwards was a sharp reduction in the price of crude, and when that happened the centre increased the taxes, and in increasing the taxes it increased the cesses and surcharges. An increasing proportion of tax revenue going to the centre is because of the road and infrastructure cess that the centre charges.”

The Reserve Bank of India’s September 2019 report on state finances noted that, “The levy of cesses and surcharges by the Union, which are outside the divisible pool, neutralises the increase in tax devolution recommended by successive Finance Commissions. The proceeds of cesses and surcharges, which constituted only 2.3 per cent of the gross tax revenue of the Centre in 1980-81, has increased to 15 per cent in recent years.” A study on state finances by PRS Legislative Research found that as a result of this “states’ 42% share in the divisible pool … effectively comes down to 35.7% of centre’s tax receipts in 2019-20.”

Meanwhile, other states have joined Assam in hiking taxes on petroleum. On 30 April, Nagaland imposed what it called a “Covid-19 cess”—an additional six rupees per litre on petrol and five rupees per litre on diesel. Meghalaya also increased the price it charges for petrol from Rs 68 to Rs 72 per litre and for diesel from Rs 61 to Rs 66 per litre. On 30 April, the Haryana cabinet also increased the VAT on petrol and diesel. “Some of the states have started increasing petroleum taxes because they cannot increase GST and there are no property registrations on at the moment,” Rao added. “The only thing they can do is increase petroleum taxes.”