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Wednesday, June 13, 2012

Who is paying the price for oil subsidies?

It costs about the same to produce a litre of petrol and a litre of diesel. In developed countries, the price of petrol and diesel at a filling pump is almost the same. Why is it different in India?

The logic goes like this. Diesel is used by locomotive engines of goods trains. Diesel is also used by trucks for transporting goods. By keeping the price of diesel artificially low, transportation cost of goods are kept low – otherwise inflation would be even higher. Prices of kerosene and LPG cooking gas are also kept artificially low because these are fuels of everyday use by the ‘aam aadmi’ (that means: vote bank).

Government-owned oil marketing companies are dependent on government subsidies to survive. But the consequence of subsidy payments is a burgeoning fiscal deficit. Ultimately, it is you and I who will pay the price through direct and indirect taxes. In this month’s guest post, Nishit exposes the government’s faulty oil subsidy policy and suggests an alternative to level the playing field for middle-class vehicle owners.


Today, I write about Petrol and Diesel subsidies and what a rip-off the so-called subsidies are. For Petrol, the share of the taxes is about 46% and for Diesel it is 32%. This means for the Rs 76 one pays at the pump, Rs 35 are taxes and Rs 41 is the actual cost of Petrol. There are multiple levels at which the rip-off happens.

  1. Every time petrol prices are hiked by the government, the taxes are also hiked as they are a percentage of the total petrol price. If the government was so concerned about easing the problems of the common man then the tax should be a fixed amount so that the hikes would not include hikes in the taxes.
  2. The Oil companies had claimed an under-recovery of Rs 8 on every litre of petrol sold in March 2012 when crude oil prices were ruling at 125 dollars to a barrel. Since, then crude oil prices have fallen by 21% and the rupee has weakened by about 10%; which means a net drop of about 11%. If the prices in March were Rs 70 + Rs 8 under-recovery then a fall of 11% means the price of petrol should be back to Rs 70 right now whereas we are paying Rs 76.
  3. The Government claims that the fiscal deficit is increasing due to subsidy on petroleum products but the tax collection has always been more than the petroleum subsidies. For example in 2008-2009, the government collected Rs 1.45 lakh Crores as taxes and spent about Rs 1.05 lakh Crores as subsidies.
  4. This has been the story for other years as well.
  5. Diesel car sales have gone up by 15% and Petrol car sales have gone down by 11%. The government claims that only 15% of diesel is consumed by Diesel cars and SUVs. Even if it is only 15%, why should people who can afford cars worth Rs 5 lakhs and much more get subsidised fuel which the Petrol vehicle owners are not getting?
  6. LPG is being sold at Rs 400 less than its market price. In this case also, there is no limit on the number of cylinders a consumer can buy. A person who needs subsidies will definitely not consume more than 4-6 cylinders per year. A simple way to plug this anomaly is to ensure that the gas cylinders are booked only through the Oil companies and the dealers are used only for delivery purposes to avoid misuse and end the subsidy above 4-6 cylinders a year.
  7. Since it is almost impossible to enforce dual pricing of Diesel for trucks and cars, a more rational argument would be to jack up the excise duty on Diesel cars and use the same amount to subsidize petrol. This will have a twofold benefit. More people will switch to Petrol based cars and the demand for the more subsidized Diesel will fall. Currently, the break-even for buying a Diesel car is roughly 40000 Kms; by increasing the excise duty and pushing the break-even point to 60000 Kms, demand will peter out. This is because most folks replace cars every 5 years and do not drive more than 12000 Kms every year.

Thus, the issue of Petroleum subsidies is at multiple levels and the government refuses to take even simple steps to resolve it. Politically toughest is the equalisation of taxes on Petrol and Diesel. The simplest and the politically easiest would be imposing additional excise duty on Diesel cars. People buying diesel cars do not form a significant percentage of the voting population. However, small cars and two-wheelers mostly run on petrol, and their owners form a larger percentage of the voting population. Their interests are being sacrificed at the altar of political expediency.


(Nishit Vadhavkar is a Quality Manager working at an IT MNC. Deciphering economics, equity markets and piercing the jargon to make it understandable to all is his passion. "We work hard for our money, our money should work even harder for us" is his motto.

Nishit blogs at Money Manthan.)


Jitesh Singh said...

Do you think that increasing the taxes on diesel cars would have a significant impact ? What happens to the diesel consumed by old cars that are already running on the road. I think if the taxes are increased one of the major impact that seems to be missed by almost every one is that the prices of used desiel cars may rise. However the demand for the fuel may not go down significantly which in turn would continue to add to the subsidy burden. Further more, the increase in demand for diesel cars is not only because of low cost of fuel but also much efficent and better engines that we used to get just half a decade earlier. Another point of arguement could be that these cars are expensive to buy, thus even though the percentage of taxes may remain the same, the quantum amount paid is higher (something similar to what you have mentioned of increase in prices of fuel and % of taxes charged). Lastly the increase in the taxes may impact the sales of diesel vehichles which inturn may negate the impact of this policy. Lastly i beleive that the quantum of funds generated by a marginal hike in the prices of diesel may surpass the amount generated by sales of diesel cars with increased tax. my two cents...

Nishit Vadhavkar said...

The old car conundrum will always remain. If this policy is in place now at least after 5 years, there will be lesser new Diesel cars on the road. One more approach is one time tax on old diesel vehicles also. If the sale of Diesel cars is impacted even better. The whole idea of this tax is cars by consumers should run on marlet rates of fuel rather than being subsidised.