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Tuesday, June 28, 2022

Explained: States vs Centre on fuel taxes

The Prime Minister has noted that certain states have not reduced VAT; states have attributed rising fuel prices to central taxes. How is fuel taxed, and how are collections shared between the Centre and states?

Written by Aanchal Magazine , Karunjit Singh | New Delhi |
Updated: April 29, 2022 12:02:45 pm
Excise duty and VAT on fuel constitute an important source of revenue for both the Centre and the states.

The Centre and the states are at loggerheads over taxes and duties on petrol and diesel. While the Centre feels the states are not reducing VAT in line with the Centre’s cut in excise duty, the states have expressed concerns over their fiscal cushion, especially with the GST compensation regime due to end in June.

On Wednesday, Prime Minister Narendra Modi said Maharashtra, West Bengal, Telangana, Andhra Pradesh, Tamil Nadu, Kerala, and Jharkhand have not reduced VAT, and urged “all states to work as a team in this time of global crisis following the spirit of cooperative federalism”.

From opposition-ruled states, West Bengal Chief Minister Mamata Banerjee said the state government has lost Rs 1,500 crore on account of a Re 1 subsidy it provides on petrol prices, and that the Centre owes West Bengal Rs 97,000 crore. Maharashtra CM Uddhav Thackeray issued a statement detailing the Centre and the state’s share of taxes on fuel and saying the former owes Maharashtra Rs 26,500 crore. Telangana CM K Chandrasekhar Rao said the state had not hiked fuel prices since 2014; Kerala Finance Minister K N Balagopal said the price hike was due to the cess and surcharge levied by the Centre.

As fuel prices soared in November 2021, the Centre, for the first time in over three years, cut central excise duties on petrol (by Rs 5 per litre) and diesel (by Rs 10 per litre). Twenty-one states, including 17 ruled by the BJP, and some Union Territories then cut VAT in the range of Rs 1.80-10 per litre for petrol and Rs 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.

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But the relief these moves provided was outweighed by a series of 14 price hikes in 16 days, following the lifting of a 137-day freeze after state elections in March.

Table 1: Price breakup in Delhi; Chart 1: Central excise & VAT/sales tax on petroleum products

Fuel levies as revenue share

Excise duty and VAT on fuel constitute an important source of revenue for both the Centre and the states. Excise duty on fuel makes up about 18.4% of the Centre’s gross tax revenues. Petroleum and alcohol, on an average, account for 25-35% of states’ own tax revenue, as per the RBI’s Study of Budgets 2020-21. Of the revenue receipts of states, central tax transfers comprise 25-29%, and own tax revenues 45-50%.

During April-December 2021, taxes on crude oil and petroleum products had yielded Rs 3.10 lakh crore to the central exchequer, including Rs 2.63 lakh crore as excise duty, and Rs 11,661 crore as cess on crude. For the same period, Rs 2.07 lakh crore accrued to the states’ exchequer, of which Rs 1.89 lakh crore was through VAT, as per the Petroleum, Planning & Analysis Cell (PPAC).

This compares with Rs 4.19 lakh crore (Rs 3.73 lakh crore excise duty; Rs 10,676 crore cess) collected by the Centre and Rs 2.17 lakh crore by states (VAT Rs 2.03 lakh crore) in 2020-21.

Petroleum taxes with states are shared out of basic excise duty. The Centre also levies additional excise duty and cesses on petroleum products. In 2020-21, the total central excise duty (including cesses) collected from petrol and diesel was Rs 3.72 lakh crore. The total tax devolved to state governments from the corpus collected under the central excise duty was Rs 19,972 crore.

Central and state taxes currently account for about 43% and 37% of the retail price of petrol and diesel respectively in Delhi. Credit ratings agency ICRA had noted in February that the Centre would have to forgo revenue of about Rs 92,000 crore in FY23 to restore excise duties on petrol and diesel to pre-pandemic levels. The levies on fuel and liquor have also become an important source of revenue for states as other indirect tax revenue is routed through the GST regime.

Sunil Kumar Sinha, Principal Economist, India Ratings and Research, said the switch to GST has severely curtailed the states’ flexibility to adjust revenues according to the situation. “So at the moment, the only components which they can adjust are the fuel tax and excise duty on liquor,” Sinha said, noting that this is why states are not willing to accept interference from the Centre on these taxes.

How fuel is taxed

States apply an ad valorem VAT or sales tax on the base price, freight charges, excise duty and dealer commission on petrol and diesel. Therefore, state collections also rise as the Centre hikes excise duties. Prior to the cut in excise duties on November 4, the Centre had increased excise duties by a total of Rs 13 per litre on petrol and Rs 16 per litre on diesel compared to pre-pandemic levels.

Delhi imposes 19.4% VAT on petrol while Karnataka levies a 25.9% sales tax on petrol and 14.34% on diesel. Certain other states impose an ad valorem tax in addition to a flat tax per litre. Andhra Pradesh, for instance, levies Rs 4 per litre VAT and Rs 1 per litre road development cess on autofuels in addition to VAT (31% on petrol; 22.5% on diesel).

Other states have sales taxes with a fixed floor in rupee terms on the sale of petrol and diesel but apply an ad valorem tax as prices go higher. Uttar Pradesh, for instance, charges whichever is higher between 19.36% or Rs 14.85 per litre on the sale of petrol.

While state VAT collections have risen along with higher fuel prices and previous hikes in excise duties, the states’ share of excise duties on fuel was reduced in the FY2022 Budget. It cut the Basic Excise Duty (BED) on petrol and diesel by Rs 1.6 and Rs 3 per litre respectively, cut the special additional excise duty on both by Rs 1 per litre, and introduced an Agriculture Infrastructure and Development Cess (AIDC) of Rs 2.5 per litre on petrol and Rs 4 on diesel. While reducing the states’ share, this did not impact pump prices since collections from cesses are not part of the shareable pool.

Tax revenues & price trends

The Centre’s excise duty collections moved upward during 2014-15 to 2016-17, then showed moderation for next two years, before picking up again since 2019-20 after excise duty was raised in 2019 (see Chart 1). Every rupee hike in excise duty roughly yields Rs 13,000-14,000 crore annually, conditional on global prices and consumption levels.

Oil marketing companies (OMCs) have been revising prices since last month in line with rising crude prices, after a freeze of 137 days. Ordinarily, the prices of petrol and diesel are revised daily in line with a 15-day rolling average of benchmark prices. However, OMCs had held prices constant starting from the excise cut on November 4, until the end of elections in five states in March.

Since the revisions began in March, OMCs have hiked petrol prices by Rs 12 per litre and diesel prices by Rs 10 per litre. The price of LPG too has increased: a 15 kg cylinder now costs Rs 949.50 (up Rs 50) in Delhi, and a commercial 19 kg cylinder Rs 2,253 (up Rs 250).

The price of Brent crude has increased by about $25.53 per barrel since November 4 to $106.48 per barrel. India imports about 85% of its crude oil requirements.

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