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Why are petrol prices not decreasing?

Why are petrol prices not decreasing with the fall in global crude oil prices?

Why are petrol prices not decreasing with the fall in global crude oil prices?

A common refrain from most motorists is that petrol prices should have reduced considerably with the fall in global crude oil prices. Even though global prices have fallen from well above $100 per barrel to less than about $30 per barrel in the past 1-2 years, the price that we pay for a litre of petrol in India has not reduced proportionately. Are the oil PSUs fleecing the consumers and raking in super-normal profits by buying low and selling high? Not quite.

Firstly, it is extremely important to understand that petrol prices in India is highly regulated and controlled by the government. The individual firms (be it private or government) have little say in fixing petrol prices.

Also, it should be noted that global crude oil prices is just one side of the coin. All oil imports are priced in dollars, which makes the exchange rate of the rupee with the dollar extremely important. The rupee has been depreciating continuously against the dollar and this affects the price of petrol as well. Let’s assume that the price of 1 barrel of crude oil is $30. At an exchange rate of Rs.60/$, it would be Rs.1800, where as it would jump to Rs. 2100 per barrel, if the exchange rate jumps to Rs.70/$ (where we are inching towards).

Second, only about 40% of the price you pay is for the actual price of petrol. The rest of it is taxes. The cost of a basic litre of crude oil is around Rs.13.5. Then, of course, the crude oil has to be refined and there are various costs involved in this. At the first level, there is entry tax, refinery processing, margin and landing cost from refinery to the Oil Marketing Companies (OMC). Then, there are costs which the OMCs have to bear such as transportation, freight, landing to the dealers and finally, their own margin. All of this put together adds Rs11 to the price of oil, of which the OMC margins are less than Rs.2 per litre. The petrol pumps takes a commission of about Rs.2.25 per litre.

Then comes the first of the big taxes – the excise tax. The excise tax charged on one litre of petrol by the Union government is close to Rs.20 (which was hiked recently by the government). Thus, the dealer (the petrol pumps) pay about Rs. 45 for one litre of petrol . Then, there are a flurry of state taxes and cesses. Around 33% of what you pay for one litre of petrol goes towards state taxes, of which, state sales tax accounts for 25%, state entry taxes account for about 5%. All of this broadly falls under the state VAT. Additionally, there are other various cess that are levied both at the centre and the state. (Karnataka levied a monorail cess in the 1980s and though the project has been shelved in the early 1990s, the cess continues to this date).

Petrol Prices Breakup

One question that can always be asked is why does the government charge such a high rate of excise duty? The simple reason is to balance its fiscal books. Excise duty on oil is one of the major sources of revenue for the central government. When faced with a scenario of an impending fiscal deficit, the central government tends to raise excise duty. By a recent hike of excise duty by 75 paisa, the government hoped to raise Rs.17000 crores in revenue for the purpose of infrastructure. The government aslo used revenues from these taxes to cross-subsidize other fuel costs (diesel). Further, the PSU oil companies understand that they are in this for the long term. When prices were high, many oil companies witnessed significant losses and petrol prices were subsidised by the government. When oil prices fall, the government does not quickly pass the benefit to the consumer, instead it prefers to allow the oil companies to build a cash reserve for the next hike in prices.

Now, back to the question at hand. With the paying nearly 60% of the price towards taxes and nearly 35% towards operating costs, there is not much room to cut prices. The only way that the price that consumers pay for petrol can come down is when the government reduces the taxes it levies. For that, its budget has to be in a much better shape than what it is now. And for the budget to be in a better shape, it has to decrease its spending on the myriad of welfare schemes and subsidies: it can remove the LPG subsidy and decrease the price of petrol, but not many would favour that either.

Anupam Manur is a Policy Analyst at the Takshashila Institution and tweets @anupammanur

Note: Figures are approximate and keep changing with the change in oil prices, as taxes are a percentage of the price.

Tax rates and calculations derived from: Know how fuel cost is computed to Consumer.


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Deadly Taxes

The high ‘sin tax’ on liquor drives people to look for cheaper and unfortunately, fatal alternatives

It is that time of the year again where another hooch tragedy has occurred, the dead are counted, state compensation is given to the kin, few are arrested, political blame game ensues with no real consequences, and we move on till the next time the cycle repeats itself. The death toll this time has gone up to 97 and the opposition is demanding Maharastra Chief Minister Mr. Fadnavis’ resignation. An inquiry has been set up, the police claim that they have caught the main culprits and that justice will be meted out. Those caught will be tried and prisoned and within no time, others will take their place. The makers of hooch are suppliers of a commodity that is high in demand. This high demand for the illicit liquor makes it a profitable venture to produce the commodity. So long as the demand is high, the supply will exist.

The real question to ask then is regarding the cause behind the high demand for illicit liquor. One of the main reasons why the poor decide to drink illicit liquor is because they cannot afford to buy packaged, manufactured and regulated alcohol. There are different categories of alcohol available in India: the most expensive are the imported ones, which attract heavy import duty and other taxes, then, there is the Indian Made Foreign Liquor (IMFL), country liquor and finally, illicit liquor.

The customary police raid and destruction of illicit liquor bottles after the tragedy.

The customary police raid and destruction of illicit liquor bottles after the tragedy.

While the imported liquor and IMFL are firmly out of reach of the daily labourer’s budget, he often cannot afford even country liquor and it might not be easily available. Country liquor is produced in cottage industry type of setting and was recently brought into the regulatory fold. Many southern states have completely banned country liquor and others are beginning to impose strict regulation and taxing it heavily.

Like a typical patronizing welfare state, heavy taxes are levied on alcohol to prevent people from over-consuming the substance and thereby, prevent health hazards and societal evils. While the intention might be good, the outcome, as is the case more often than not, has not been desirable. A look at the Maharastra tax structure on liquor reveals the extremely high rate of tax levied on regulated alcohol. The excise duty on IMFL is 300% of manufacturing cost and on country liquor, the excise duty is upto 250% of manufacturing costs. It is these high tax rates that explains why large factories which enjoy significant economies of scale produce liquor which is more expensive than home-made liquor produced in small quantities.

The high rates of tax is levied by the government in order to make the relative price of alcohol higher than other products, which, in theoretical economics, should reduce the product’s demand. However, it is a known fact that high taxation on alcohol and tobacco products does not deter people from its consumption. Instead, they move to cheaper alternatives. Of course, the other reason for high taxation is that it continues to be a strong revenue earner for the various state governments. Nearly 10-15% of state government revenue comes from excise duty on liquor and another huge chunk from the tax on tobacco products.

While the government might feel that it is its moral obligation to levy a ‘sin tax’ on harmful products to prevent its use, it might not realize that its morality is driving people to illicit liquor and consequently, death.

P.S: For an excellent discussion regarding the ineffectiveness of using taxation to influence public consumption behaviour, read Catalyst’s post on “Taxing our way to better health“.

Anupam Manur is a Policy Analyst at Takshashila Institution. He sporadically tweets @anupammanur

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