Understanding the Impact of Taxation of Petroleum Products in India

Sacchidananda Mukherjee R. Kavita Rao

National Institute of Public Finance and Policy (NIPFP)

Structure of Presentation
Introduction Administered Pricing of Petroleum Products Environmental Impacts of Petroleum Products Revenue Generation from Petroleum Products Methodology Results Conclusions

Introduction
Taxes on petroleum products generate substantial revenues to the Central and State Governments The contribution of tax revenue from petroleum products varies across the States depending on their consumption & production base and the prevailing tax rates on petroleum products States keen to keep petroleum products out of GST base contributes to cascading could limit growth (?) Two separate factors drive taxation of petroleum products revenue considerations (easy to tax) environmental considerations The tax on petroleum products and corresponding change in prices generates both direct and indirect impacts across the sectors Understanding on the economy wide impacts of changes in prices (or taxes) of petroleum products is limited Policy dialogue, therefore not driven by such analysis

Administered Pricing of Petroleum Products

Prices of petroleum products are administered in India, the oil companies (mostly under PSU) cannot change prices in response to volatility of international crude oil prices and/or their other costs of production Domestic market price does not necessarily reflect either the international crude oil prices or the costs of production Frequent adjustments of domestic market prices are carried out to compensate the loss incurred by the oil companies followed by tax cuts to protect consumers. Concerns of inflationary pressures. The response of tax cut and corresponding loss to the government exchequer is mainly due to reduce inflationary pressure in the domestic market Taxes, therefore do not represent the only government intervention in this sector. Ideally, the combined effect needs to be assessed.

Environmental Impacts of Petroleum Products

Combustion of petroleum products (gasoline, diesel etc.) generates a cocktail of pollutants which are the main source of ambient air pollution for cities and towns in India From environmental and public health stand point, petroleum products are seen as sin products With growing income and improved standard of living, the demand for clean air will grow across Indian cities and towns Combustion of fossil fuel also generates green house gases like carbon monoxide and carbon dioxide, therefore to meet international environmental commitments, it would be necessary to reduce emissions of green house gases in future

Environmental Impacts of Petroleum Products

Instruments to Control Vehicular Pollution Emissions (CO, HC, NOx, SOx, PM)

Fuel Choice (Electric car, CNG, LPG, Gasoline, Diesel)

Fuel Standard (low sulphur, low lead, high octane/cetane number)

Engine Standard  Fuel efficiency standard  Compliance with Emission standard (e.g., Euro IV, III etc.)  Physical features o f vehicle (e.g., size, weight, engine capacity etc.)

Exhaust

Emission Control Devices (e.g., Catalytic Converter)

Figure I: Environmental Dimensions of Taxation of Petroleum Products

Revenue Generation from Petroleum Products

Central Government exchequer: excise duty, corporate tax, customs duty, cess, tax on dividend and service taxes State Government exchequer: sales tax, royalties, octroi and other duties Excluding dividend from oil companies under PSU, the contribution of tax revenue from petroleum products to the Central Government exchequer has gone up from Rs. 58,789 crore in 2002-03 to Rs. 96,486 crore in 2007-08 Sales tax payments made by the oil companies to State Governments contribute on an average 20.7 per cent of own tax revenue of the States (averaged over 2000-01 to 2006-07). Presently in the range of 30%.

Revenue Generation from Petroleum Products (contd.)

Contribution to Exchequer from Oil Companies (in Rs. Crore) Estimated Contribution Exchequer 2002-03 2003-04 2004-05 2005-06 2006-07 2007-08 2008-09 (P) Central Exchequer Cutom Duty 7,953 9,552 11,697 9,157 10,043 12,625 6,299 CESS 5,213 4,766 4,891 4,884 6,899 6,924 6,758 Excise Duty 32,964 35,364 38,150 47,180 51,922 54,761 54,117 Royalty 1,738 1,620 2,181 2,306 2,794 3,064 3,146 Corporate Tax 10,249 10,038 11,180 10,896 12,153 16,318 12,031 Tax on Dividend 269 1,110 1,513 1,315 1,362 1,850 1,077 Others (includes service tax) 403 425 439 347 666 944 870 Sub total 58,789 62,875 70,051 76,085 85,839 96,486 84,298 State Exchequer Sales Tax 29,166 32,080 38,935 46,667 56,115 56,445 63,349 Royalties 1,654 1,643 2,251 3,199 3,568 4,184 2,451 Dividend to State Governments 10 18 21 19 22 28 20 Octroi, Duties (includes Electricity Duty) 1,253 1,032 1,313 2,211 1,891 1,683 1,941 Others (includes service tax) 74 408 734 157 525 1,105 525 Sub total 32,156 35,181 43,254 52,253 62,121 63,445 68,286 Total Contribution 90,945 98,056 113,305 128,338 147,960 159,931 152,584
Source: Compiled by Authors from Various Sources

Revenue Generation from Petroleum Products (contd.)

Sales Tax Payments on Crude Oil Condensates and Petroleum Products made by the Oil Companies to State/UT Governments (as % of Own Tax Revenue of the Respective State) State 2000-01 2001-02 2002-03 2003-04 2004-05 2005-06 2006-07 Average Andhra Pradesh 18.4 12.9 20.7 21.3 21.3 21.5 21.0 19.6 Arunachal Pradesh 9.2 12.5 14.6 20.8 27.5 16.9 Assam 24.9 23.3 24.5 8.0 30.7 17.1 8.6 19.6 Bihar 21.0 18.5 25.0 20.6 27.2 29.1 28.8 24.3 Chhattisgarh 9.0 8.4 12.3 13.8 15.9 16.4 16.5 13.2 Goa 42.6 26.3 33.4 33.4 29.4 30.8 28.8 32.1 Gujarat 23.8 27.2 36.0 29.9 24.9 24.8 26.6 27.6 Haryana 16.6 12.8 15.0 15.1 19.2 16.8 15.4 15.8 Himachal Pradesh 10.5 8.8 11.1 13.2 13.7 13.9 19.4 12.9 Jammu and Kashmir 14.9 11.5 15.4 14.8 15.2 16.7 17.1 15.1 Jharkhand N.A. 9.4 14.0 18.2 21.3 20.7 23.3 17.8 Karnataka 15.5 12.7 15.8 16.3 15.0 15.3 14.2 15.0 Kerala 21.1 17.5 20.4 22.8 21.2 21.5 16.9 20.2 Madhya Pradesh 16.6 15.2 18.6 20.3 20.8 20.2 22.7 19.2 Maharashtra 21.1 14.4 23.5 22.9 22.8 25.0 23.1 21.8 Manipur 27.7 21.0 24.9 26.0 25.1 29.4 56.0 30.0 Meghalaya 11.6 8.0 12.8 10.4 14.7 23.9 23.0 14.9 Mizoram 23.5 26.1 34.3 34.7 35.1 32.0 30.8 30.9 Nagaland 16.1 25.9 22.6 21.9 23.7 24.6 23.2 22.6 Orissa 16.0 11.2 15.2 16.0 15.9 16.7 14.7 15.1 Punjab 15.6 13.4 15.3 16.3 17.2 15.2 19.0 16.0 Rajasthan 19.2 15.6 22.6 22.7 23.1 23.1 22.3 21.2 Sikkim 9.3 9.1 9.3 10.2 12.5 12.0 96.1 22.6 Tamil Nadu 19.3 14.6 18.8 19.1 19.3 18.8 16.6 18.1 Tripura 10.8 12.5 13.4 12.9 13.9 13.0 12.7 12.7 Uttarakhand 16.0 13.7 16.1 16.2 17.5 171.7 20.7 38.8 Uttar Pradesh 19.0 17.4 18.8 19.3 19.9 20.2 17.8 18.9 West Bengal 16.1 11.9 16.1 15.7 18.4 19.3 17.5 16.4
Source: Data Compiled from RBI's State Finances Statistics and NIPFP (undated)

Methodology
Two alternative questions being asked What is the extent of cascading due to petroleum taxes Can one design GST to reduce cascading without changing revenue profile?

Methodology (contd.)

Methodology (contd.)

Methodology (contd.)

Methodology (contd.)

Methodology (contd.)

Methodology for Estimation of Total Tax Liability

We consider a model for three sectors to understand the degree of cascading of taxes on crude petroleum and petroleum products. The sectors are crude petroleum, petroleum products and other goods and services. The model is extended to cover 46 sectors of the economy. Pc = a11Pc + a21 Pp(1+t) +a31 Po (1+ ) + Vc Pp = a12Pc(1+ ) + a22Pp + a32Po (1+ ) + Vp Po = a13 Pc(1+ ) + a23Pp(1+t) + a33Po + Vo Where
Pc: Producers price of crude petroleum Pp: Producers price of petroleum products Po: Producers price of other goods and service aij: to produce 1 unit of output in the jth sector, input requirement from ith sector : tax on crude petroleum (i.e., excise duty, custom duty, royalty etc.) t: tax on petroleum products (e.g., excise duty, custom duty, sales tax, additional surcharges, entry tax etc.) : tax on other goods and services (e.g., excise duty, VAT etc.) Vc: gross value added per unit of output of crude petroleum Vp: gross value added per unit of output of petroleum products Vo: gross value added per unit of output of other goods and services

When , t and are positive, it provides a case where there are non-rebatable taxes on all these sectors. When, only t is positive, it would imply a regime with excise only on petroleum products

Methodology for Estimation of Total Tax Liability (contd.)

Methodology for Estimation of Total Tax Liability (contd.)

According to national accounting framework, the output (Y, final demand) or Total Final Use is determined by Y (or F) = C+I+G+(X-M) Where, C: Private Final Consumption Expenditure (PFCE) G: Government Final Consumption Expenditure (GFCE) I: Gross Fixed Capital Formation (GFCF) X: Export M: Import Therefore, value of sales could be proxied by multiplying (scalar) P (prices) with F (final demands) and therefore R=P x F We consider three scenarios as follows: Baseline scenario (BL): is 0.0%, t is 0.0% and is 0.0%, which implies that tax credit is available for all the sectors Scenario I: is 15%, t is 35% and is 20%, when tax credit is not available for any of the sectors Total Tax Liability = RS-I - RBL Scenario II: is 0.0%, t is 35% and is 0.0%, when tax credit is available for all goods and service except from petroleum products Total Tax Liability = RS-II - RBL

Methodology for Estimation of Total Tax Liability (contd.)

Estimation of Scenario III We estimate the revenue neutral rate of tax on petroleum products (t) such that RS-II RS-I becomes zero. We found that at t = 62% difference between Total Tax Liability between scenario II and scenario I vanishes. Scenario III: is 0.0%, t is 62% and is 0.0%, when tax credit is available for all goods and service except on petroleum products Total Tax Liability = RS-III - RBL

Methodology for Estimation of Direct Tax Liability

Data Sources
Total Expenses (adjusted) = Expenses (total) - Compensation to employees (total) - Indirect Taxes (total) - Amortisation (total) - Writeoffs (total) - Expenses capitalised (total) - Expenses transferred to DRE (total) - Prior period and extra-ordinary expenses (total) We estimate the c vector which is the average of expenses on Power & fuel as percentage of Total Expenses (adjusted) for 46 sectors I-O Coefficient Matrix for 2006-07 provides information for 130 items. However, these 130 items are clubbed under 46 sectors PROWESS database provides information on expenses on Power and Fuels together, however to separate the power and fuel expenses, we have taken the help of I-O coefficient matrix

Results
The direct impact shows the tax incidence of the sector. Sectors having high direct impact implies that a percentage point change in tax rates on power and fuel will have substantial impact (direct) on the sector The difference between total and direct impact shows the cascading impacts of the sector Sectors having high difference (total direct impact) as percentage of direct impact, are the major sectors which are affected by cascading impacts

Table 2: Direct and Total Impacts of Power and Fuel Expenses across Sectors Direct Impact: Average Expenses on Power and Total Impact (Cascading Difference as Percentage Impact): Power and Fuel Fuel as Percentage of Description of the Sectors of Direct Impact (%) (c*') Total Expenses (adjusted) (%) (c') 2007 2008 2007 2008 2007 2008 3.58 3.87 3.94 4.18 10.04 8.10 Agriculture and allied activities (incld. Fishing) 10.85 9.56 13.54 12.05 24.85 26.06 Mining of coal and lignite 0.35 0.80 0.88 1.30 148.52 62.98 Extraction of natural gas 0.31 0.69 10.07 9.60 3200.86 1294.39 Extraction of crude petroleum 15.75 14.61 22.41 20.68 42.31 41.53 Pulp and paper products 2.51 2.00 3.64 3.03 44.85 51.61 Publishing and printing 2.35 1.32 14.18 12.94 503.27 883.89 Mfg. of coke, refined petroleum pdts. 7.03 6.53 8.77 8.22 24.77 26.02 Mfg. Chemicals 5.40 5.46 8.01 8.27 48.36 51.37 Rubber and plastic products 17.53 16.55 18.28 17.26 4.27 4.26 Non-metalic minreal products 8.31 7.37 10.74 9.52 29.18 29.10 Mfg. base metals 4.68 4.65 5.99 5.82 27.86 25.17 Fabricated metal products (excld. machineray) 2.80 2.32 3.51 2.96 25.29 27.56 Mfg. of machinery 2.91 2.58 3.39 3.03 16.61 17.28 Mfg. of electrical machinery 2.87 2.52 4.09 3.68 42.45 46.13 Mfg. radio, TV, and comm. Equipments 4.56 4.32 5.58 5.23 22.19 21.21 Mfg. motor vehicles 4.96 2.67 5.37 3.01 8.25 12.89 Mfg. transport equipments 1.11 1.02 2.77 2.83 150.87 177.94 Mfg. furniture & others manufacturing n.e.c. 2.23 2.73 12.59 12.54 464.27 359.85 Electricity, gas etc. supply 1.68 5.38 2.17 6.44 29.36 19.78 Water supply 2.52 1.83 3.02 2.89 19.55 58.24 Construction 2.31 2.21 17.93 16.80 675.68 659.61 Retail and wholesale trade of motor vehicles 10.37 9.18 11.94 10.70 15.08 16.65 Hotels and restaurants 14.46 11.42 21.49 18.06 48.66 58.24 Land transport 22.32 29.72 22.52 29.90 0.88 0.60 Air transport 2.74 3.60 6.25 7.08 128.14 96.53 Post and telecommunications Financial intermediaries, Banking and financial 663.85 648.67 1.18 1.13 8.99 8.45 services Source : Computed

Table 3: Direct and Total Impacts of Fuel Expenses across the Sectors Direct Impact: Share of Expenses on Fuel as Percentage of Total Expenses (adjusted) c' 2007 2.85 4.41 0.13 0.22 0.64 1.74 4.23 2.32 8.90 3.15 2.12 1.28 1.18 1.07 1.21 2.35 0.47 0.53 0.12 1.29 1.96 4.89 9.11 7.66 21.75 0.53 0.89 0.94 2008 3.08 3.89 0.30 0.51 0.51 0.97 3.92 2.34 8.40 2.79 2.11 1.06 1.04 0.93 1.15 1.27 0.43 0.64 0.37 0.93 1.87 4.33 7.20 9.12 28.96 0.44 1.17 0.90 Difference (Fuel) as Percentage of Direct Impact 2007 7.13 25.74 184.34 2746.21 74.52 420.05 23.13 74.71 4.24 32.09 27.32 25.52 18.69 44.90 35.32 10.52 240.36 889.40 158.00 14.18 411.73 18.12 40.56 2.43 0.42 42.99 201.50 390.50 2008 5.79 26.68 76.91 1140.48 88.13 771.42 25.20 84.81 4.14 31.69 24.69 27.69 19.99 49.61 33.54 17.44 303.07 675.89 66.08 26.22 412.96 21.67 50.20 1.97 0.29 48.98 160.67 380.34

Description of the Sectors

Total Impact: Fuel (c*')

Agriculture and allied activities (incld. Fishing) Mining of coal and lignite Extraction of natural gas Extraction of crude petroleum Publishing and printing Mfg. of coke, refined petroleum pdts. Mfg. Chemicals Rubber and plastic products Non-metalic minreal products Mfg. base metals Fabricated metal products (excld. machineray) Mfg. of machinery Mfg. of electrical machinery Mfg. radio, TV, and comm. Equipments Mfg. motor vehicles Mfg. transport equipments Mfg. furniture & others manufacturing n.e.c. Electricity, gas etc. supply Water supply Construction Retail and wholesale trade of motor vehicles Hotels and restaurants Land transport Water transport Air transport Other transport activities Post and telecommunications Financial intermediaries, Banking and financial services Source : Computed

2007 3.05 5.55 0.38 6.39 1.11 9.05 5.20 4.05 9.28 4.16 2.71 1.60 1.40 1.54 1.64 2.60 1.61 5.20 0.30 1.47 10.03 5.78 12.81 7.84 21.84 0.76 2.68 4.62

2008 3.25 4.92 0.54 6.29 0.95 8.48 4.91 4.33 8.75 3.68 2.63 1.35 1.25 1.40 1.53 1.49 1.75 4.98 0.61 1.17 9.61 5.26 10.81 9.30 29.04 0.65 3.04 4.34

Table 4: Direct and Total Tax Liability under Each Scenario

Case I: Case I: Case II: Case II: Case III: Case III: Direct Tax Total Tax Direct Tax Total tax Direct Tax Total tax Liability (Rs. Liability Liability (Rs. Liability Liability (Rs. Liability Lakh) (Rs. Lakh) Lakh) (Rs. Lakh) Lakh) (Rs. Lakh) 319,431 6,237 2,417 1,345 710,855 20,360 14,613 9,143 43,044 21,037 9,090 1,665 19,159 15,691 2,955 85,391 2,483 67,143 53,190 1,432,555 8,523 19,499 7,899 3,132,720 449,117 9,295 3,514 9,891 692,245 29,776 28,103 20,106 102,968 47,511 29,029 6,299 54,319 29,536 9,592 151,169 5,824 126,124 102,200 1,812,309 12,154 24,311 14,569 4,361,027 319,431 6,237 2,417 1,345 0 20,360 14,613 9,143 43,044 21,037 8,871 1,665 19,156 15,691 2,955 84,778 2,483 67,143 53,190 1,432,555 8,523 19,499 7,899 2,420,997 297,468 6,158 2,326 6,540 36,688 19,705 18,596 13,271 68,012 31,399 19,053 4,165 35,889 19,531 6,347 99,333 3,841 83,538 67,650 1,200,385 8,050 16,107 9,648 2,464,808 561,913 10,972 4,252 2,366 0 35,815 25,706 16,083 75,718 37,006 15,606 2,929 33,698 27,603 5,198 149,133 4,368 118,112 93,566 2,520,011 14,993 34,301 13,895 4,258,783 526,315 10,895 4,115 11,572 64,913 34,864 32,903 23,481 120,335 55,555 33,711 7,370 63,499 34,556 11,230 175,751 6,796 147,804 119,693 2,123,862 14,244 28,499 17,070 4,361,027

Description of the Sectors

Agriculture and allied activities (incld. Fishing) Forestry and Logging Mining of metal ores Publishing and printing Mfg. of coke, refined petroleum pdts. Mfg. Chemicals Rubber and plastic products Fabricated metal products (excld. machinery) Mfg. of machinery Mfg. of electrical machinery Mfg. radio, TV, and comm. Equipments Mfg. of medical instruments, watches and clocks Mfg. motor vehicles Mfg. transport equipments Mfg. furniture & others manufacturing n.e.c. Electricity, gas etc. supply Construction Retail and wholesale trade of motor vehicles Hotels and restaurants Land transport Water transport Air transport Financial intermediaries, Banking and financial services Total Tax Collected (Rs. Lakh)

Conclusions
Any change in prices (or tax rates) of petroleum products will have both direct and cascading impacts across the sectors Sectors having larger direct impacts have larger tax incidence, it implies that one percentage point change in tax rate will have substantial impact (direct) on the sector The sectors having larger cascading impact suffer significantly by hidden taxes Depending on composition of economic activities across States, different states will have different tax incidence

Conclusions (contd.)
Even under sustainable development regime, it is not clear what are those additional benefits to be obtained by not allowing for input tax credit for inputs going into the production of these fuels as well The same total revenue impact and the deterrent through non-rebatable taxes on petroleum products can be introduced without the need for cascading of the input taxes into petroleum sectors as well In this case, the extent of cascading seems to be distinctly lower, which recommends this approach even for a policy advocating sustainable development