Adopt a sliding scale formula for excise duties and sales tax

India just had one of the steepest increases in the prices of two crucial petroleum products - petrol and diesel. It is often stated that the reason for this increase is high international crude oil price. However, the price rise is also an outcome of the cascading effect of taxes.

Taxes are one of the major sources of revenue available to the government for financing its welfare and developmental programmes. They are also a tool in the hands of the government for promoting efficiency and affordability of various products. In the light of these, one needs to see if the present taxation system has been able to achieve any of the above objectives.
The petroleum sector accounts for nearly 40% of the total central excise revenues, with petrol (32%) and diesel (36%) being the biggest contributors. There is high incidence of taxes in the price build-up of these fuels; as a matter of fact, taxes account for around half of the total price in case of petrol and a third in case of diesel. Despite such high taxes, consumers have not shifted to a more efficient mode of transportation.

The Indian transportation sector is characterised by a skewed modal mix; 70% of freight and 85% of passenger traffic travels by road, primarily because of poor service facilities and high freight charges of the Railways. In short distances and intra-city travel, too, not many substitutes are available. Further, there is no public transport infrastructure system set up in any of the cities, making it difficult for consumers to shift from personally-owned vehicles to public transport.

As a result, the consumption of petrol has increased. In fact, in 2005-06, even with high oil prices, there was a 5% rise in the sale of petrol compared with the previous year. Taxes in the petroleum sector have also been used by the government to increase access and affordability of households to cleaner and better fuels-kerosene and LPG. Both these products do not attract any excise duty and the sales tax is also marginal in comparison to diesel and petrol.

But this taxation policy has not been able to achieve any of the aims it was set for. Kerosene, which is often referred to as the poor man's fuel, is sparingly used for cooking purposes. Around 40% of it is siphoned off and a majority of this is used to adulterate diesel. The price disparity between diesel and kerosene is the foremost reason for this malpractice.

In case of LPG, consumption is restricted to only urban areas and to the richer classes. In these testing times of high crude oil volatility there is an increasing need to share the burden of high oil prices among all stakeholders equally.

In the present situation, oil companies are reeling under huge under recoveries and consumers are bearing a substantial portion of taxes. The taxation policy has not been able to promote either conservation of these fuels or provide cleaner fuels to the masses. The government can rationalise its taxation policy, which would dampen the effect on the consumers. However, this would not impact the returns to companies.

To correct these distortions in the taxation system, the government can adopt a sliding scale formula for excise duty so that not only does its revenue expectation remain untouched with changes in international crude and petroleum prices but the consumer, too, doesn't bear the burden of high tax incidence.

A similar approach can be adopted by state governments. An encouraging step towards this rationalisation of taxes is the recent adjustment of sales tax by some state governments to dampen price rise impact on the consumer.

Finally, there is an urgent need to change the subsidy delivery mechanism, especially for kerosene, wherein the subsidy is being provided to the entire distribution chain rather than the end consumer. Options, like introduction of smart subsidy cards can be adopted to ensure that benefits reach the targeted.