On the eve of Diwali, the Union government announced a Rs 5 and Rs 10 cut in the excise duty levied on petrol and diesel respectively. Since then, several states have followed suit, announcing additional cuts in fuel taxes. Taken together, these cuts are substantive and will help ease cost pressures in the economy. Considering that calls for cutting fuel taxes had been repeatedly shrugged off by the government, doing so now suggests that the timing was driven by political considerations: The cuts have come after the results of the recent assembly and Lok Sabha by-elections and ahead of assembly polls in five states, including Uttar Pradesh. Inflation, after all, is a top concern for voters.
The economic rationale for cutting fuel taxes now is threefold. First, with the government’s tax collections (both direct and indirect) growing at a fairly fast clip, the fiscal space to lower fuel taxes has been created. In the first six months of the ongoing financial year, gross tax collections were 64 per cent higher than last year, and 28 per cent higher than the pre-pandemic level. At current growth rates, economists expect tax collections to exceed budgeted targets significantly by the end of this year. This creates space for the government to reduce its dependence on fuel taxes — last year, as crude oil prices fell sharply, it had increased the excise duties on petrol and diesel by Rs 13 per litre and Rs 16 per litre respectively. As a consequence, it mopped up Rs 3.61 lakh crore as against a budgeted target of Rs 2.67 lakh crore. Second, a cut in fuel taxes eases cost pressures in the economy. With global crude oil prices firming up, the high levels of taxes add to inflationary pressures in the economy. In fact, members of the monetary policy committee have repeatedly called for governments, both Centre and states, to bring about coordinated cuts in fuel taxes to offset the inflationary pressures in the economy. According to Nomura’s estimates, the fuel tax cuts could lower headline inflation by 0.14 to 0.3 percentage points. Third, the government hopes that these tax cuts could provide a boost to consumption, increasing discretionary spending in the economy.
With economic activities gaining traction, it is likely that part of the estimated revenue loss to the government due to the tax cuts is offset by a rise in fuel demand. By the end of September, it had already mopped up 51 per cent of its budgeted target. This fiscal comfort should be used by the government to ramp up the budgeted spending in the coming months, which had remained subdued in the first few months of the fiscal year. It has picked up pace in September and this momentum should be sustained.
This editorial first appeared in the print edition on November 8, 2021 under the title ‘Festive cheer’.