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Any such cut will certainly provide a fillip to consumption in the economy and will also help control inflation. But the government must take into consideration whether they have the fiscal space to absorb a cut in fuel tax.
Currently, fuel taxes constitute approximately 37% of the standard retail price of petrol in the country, with approximately 21% attributed to central excise duty and 16% to State Value Added Tax (VAT). During the pandemic when the crude oil prices had dipped sharply, the Centre had increased the excise duty on petrol and diesel by Rs 13 per litre and Rs 16 per litre respectively. Subsequently, these hikes were rolled back in 2021. Some of the state governments also followed suit and announced cut in VAT.
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Hence, we saw the share of fuel tax in retail petrol price fall from as high as 56% in 2021 to 37% currently. However, this number remains high and hence the clamour for further cut in fuel tax.The cut in excise duty on petrol/ diesel that the government had done last year was mainly in response to the spike in global crude oil prices. Since the peak of US$ 120/bbl touched in mid-2022, global crude oil prices have fallen by 50% to current level of US$ 80/bbl. Going forward, with global demand remaining feeble, a sustained spike in global crude oil price is unlikely, unless there is any major disruption in supply. Despite no immediate concerns around the spike in global crude oil prices, the government should consider some further cut in fuel tax rate. This will enable the consumers to get some benefits from the recent fall in global crude oil prices.
The demand for petrol/ diesel is quite inelastic, hence any reduction in fuel tax will increase the disposable income in the hands of people, which in turn will help boost consumption of other items. Fuel tax is supposed to be regressive in nature as it broadly impacts all income categories. In India, while a large section of the households may not own private vehicles, but they are reliant on public transport and hence they do get indirectly impacted by high fuel prices.
Given that currently we are worried about broad-based consumption recovery, a fuel tax cut could provide some fillip to consumption. It will also help contain inflation and inflationary expectations. While CPI inflation in India has moderated but food inflation remains high. Reduction in fuel taxes will not just directly reduce fuel inflation, but it will also help reduce prices of other essential items by reducing the transportation cost.
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Any cut in fuel taxes would have implications on the Centre’s as well as state government finances. Hence the moot point is whether the government has the fiscal space to accommodate fuel tax cut. A cut in excise duty on fuel by Rs 1/ litre is estimated to result in the revenue losses of around Rs 125-140 billion for the Centre. Even if the state governments’ do not cut the VAT, their revenue will get adversely impacted, as the state VAT on fuel is levied on base price inclusive of centre’s excise duty.
Talking about the fiscal headroom, the direct tax and GST collection has been healthy and that has helped to mitigate the fall in excise duty collection in the current fiscal. With economic growth momentum improving, the robust tax collection is likely to continue in the ensuing fiscal. Assuming a tax buoyancy of 1.2, we expect the gross tax revenue to grow by 12% in FY25 compared to the budgeted number for FY24.
We expect the overall expenditure to grow by 6% (YoY), with capex to expenditure ratio maintained at 23% in FY25 (around same as that budgeted for FY24). This leaves limited scope for a sharp reduction in fuel tax. However, the government can cut the excise duty on petrol and diesel by a marginal Rs 2/ litre and still achieve a fiscal deficit of around 5.2-5.3% of GDP in FY25 and move towards its glide path of 4.6% for FY26.
While the Govt has been focussing on capex in the last few budgets, a small tinkering of fuel tax will help provide the much-required indirect boost to consumption. It will also improve consumer sentiments and improve inflationary expectations.
The author is Chief Economist, CareEdge
