Petroleum Taxation - divergence between Centre and States

The Central Government recently reduced the excise duty on Petrol (₹5 per litre) and Diesel (₹10 litre) to reduce their surging prices and in turn to modulate inflation. The two items have a combined weight of ~2.5% in the CPI basket. The backdrop for this is that the Central government had increased the excise duty on Petrol and Diesel by ₹13 and ₹16 per litre since the start of the pandemic. Thus, even after this reduction, the excise duty is higher than before the pandemic.

The bigger picture though is that the Central government levies far more taxes on the petroleum sector than do the state governments. This is even though the State governments levy ad-valorem taxes and thus they automatically benefit from higher prices. Indeed, in FY21, the central government collected twice as much revenue from the petroleum sector as compared to the state governments.

In fact, in each of the last seven years, the Central government has collected more taxes than the state governments. And in FY21, even as the taxes collected by the Central government rose 36%, those collected by the State governments declined 1.5%. Of course, a part of the taxes collected by the Central government is shared with the State governments – although that share is much lower than other taxes given that a large part of the taxes levied on the petroleum sector is through cess which is not shared with the state governments.

In aggregate the petroleum sector contributes around 8% of revenues of the state governments (without considering devolution of central taxes). But this varies widely across states. And that means that some states can reduce the state VAT on Petrol/Diesel quite easily but for some states, a reduction in duty will leave a big hole in their finances. For example, in a state like Himachal Pradesh, the petroleum sector contributes just 3% of total revenues. In Uttarakhand, the sector contributes 4% of total revenues. These two states have amongst the lowest contribution from the petroleum sector to their revenues. At the other end are states like Gujarat and Haryana where the petroleum sector contributes almost 13% of their revenues. There thus cannot be an across the board change in the taxation of petroleum products by the States.