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Overhaul oil and ore taxation
May, 10th 2011

In enunciating its latest policy stance last week, the Reserve Bank of India ( RBI )) was clear-cut in its appraisal that high oil and other commodity prices and the impact of attendant dearer cost of funds indicated by the monetary authority will weigh on economic growth. High oil prices do, after all, adversely affect costs and rev of inflationary expectations all round. Further, there is significant 'suppressed component of inflation', as the increase in global crude oil prices has not been passed on completely in revised, higher retail price. of petroleum products, noted the central bank. It points to the pressing need to review the high extant taxes and duties on oil products, so as to stem the price impact.

The point is that the fiscal authorities do need to rationalise taxes on oil products, which can make up over half the retail price. It is plain distorting. Worse, in a scenario of buoyant oil prices and consequent widespread expectations of hardening prices in the pipeline, the effect of high indirect levies on oil products would unwarrantedly add to the inflationary spiral.

Meanwhile, iron ore too found mention in the front pages last week albeit in the fine print, in the forest clearance for Posco's proposed mega steel plant in coastal Orissa. Quite apart from the issue of export of iron ore from captive mines, there is the need to levy excise on mining output for transparency. We must modernise tax design for commodities like oil goods and ore.

It is a fact that taxes on petro-products have traditionally amounted to a very substantial chunk of government revenues. There may have been several reasons for such tax design, especially in the pre-reform days when the scope of levying direct taxes on incomes was rather limited and indirect taxes accounted for the bulk of tax collection. Additionally, the tax base for indirect levies was also constrained, which is why much of burden of garnering taxes willy-nilly fell on oil products.Besides, collecting fuel taxes is rather straightforward: fuel demand is known to rise with income or that its demand is income-elastic.

However, in a fast-growing economy that is purposefully globalising as well, the way ahead is to broadbase taxes across goods and services, and not rely disproportionately on petroleum taxes. In any case, high taxes and duties on oil goods would merely imply high relative tariff barriers for such products. Note also that the value-added in refining crude is minimal, generally in single digit, and so, seemingly modest duty protection for the refined products would effectively imply high tariff walls for the value added.

And heightened duty protection really means continuing with a high-cost oil economy, with much scope for routine opacity, cost-plus pricing and a panoply of inefficiencies. Now, a case can well be made that oil products, given their negative externalities, do need to be appropriately taxed to discourage usage and negate the societal harm of oil pollution.

It actually suggests a strong case for acess on oil products that is earmarked for proactive environmental measures, cleaner fuels and the common good. However, a general regime of high taxes on oil products designed very much as arevenue-augmenting measure is incongruous, after two whole decades of reforms, albeit often checkered.

It is true that the more progressive tax regimes abroad do levy high taxes on petro-goods, but in such cases, there is usually a modern system of value-added taxes in operation, including for petro-products, with tax paid only on the value added and setoffs available along the value chain.

Yet, we continue with a system of cascading taxes on oil products, with its umpteen anomalies and all. The tax differential between dearer petrol and diesel has actually lead to large-scale fuel-switching to the relatively lightly-taxed fuel and almost certainly aggravated pollution levels. There are other negative implications of the warped policy of high taxes on automotive fuel, such as fuel adulteration and much faster engine wear and tear. In parallel, there is no reason why oil retailing need remain a cosy monopoly of the oil companies. Abroad, in the mature markets, independent retailers account for over half the volumes in retail oil offtake.

The point remains that ring-fencing retail oil sales would disallow room for efficiency gains and productivity improvements in a large, high-growth segment like oil.

As one of the largest consumers of oil products, with much of the crude imported, we can no longer afford runaway populism and monopoly prices in oil. It would have unsustainable monetary and fiscal implications. In tandem, we do need to levy excise duty on minerals such as ferrous and non-ferrous ore, as per the Central Excise and Salt Act, 1944, and the Excise Tariff Act, 1985. Note that minerals in their finished form are very much excisable items. But they have been merely exempt from the 'whole of the duty ofexcise leviable thereon'. The move, that would be Vattable, could put paid to large-scale illegality reported in ore mining and exports.

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