June 2012

CRISIL Opinion

TAX

Will additional taxes on diesel cars help?

CRISIL Opinion

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Will additional taxes on diesel cars & UVs help reduce petroleum subsidies?
In the 2012-13 Union Budget, the government has set stringent targets to contain its subsidy bill, of which petroleum subsidies form a third. The options being considered include imposition of a one-time tax on new diesel cars & UVs sold or an annual usage-based levy on existing diesel cars and UVs, which are aimed at reducing the preference for these vehicles and thereby bringing down diesel consumption. CRISIL Research, however, believes these options will not bring down the subsidy significantly or will be difficult to implement. Furthermore, diesel cars & UVs account for just over a tenth of the diesel consumption. To bring about a sustainable reduction in the subsidy burden, the government will have to hike diesel prices, and ensure that in future also, diesel prices move in accordance with crude oil prices.

Petrol prices hikes alone cannot contain subsidy burden

The recent Rs 5-plus hike in petrol prices has again turned the spotlight on petroleum subsidies, which account for nearly a third of the Rs 2,200 billion subsidy bill in 2011-12. In the Union Budget 2012-13, the government has targeted to contain its petroleum subsidy bill at Rs 436 billion, about 40 per cent lower than in 2011-12. In 2011-12, petroleum subsidies shot up by almost 80 per cent to Rs 680 billion as crude oil prices rose and the rupee weakened. Within petroleum subsidies, diesel alone takes up about 60 per cent. Under-recoveries on diesel are at an all-time high of Rs 14 per litre at current diesel prices. Thus, hiking petrol prices alone would not make any difference to the petroleum subsidy burden of the government.
Rising share of petroleum subsidies in total subsidies
( R s billio n) 2,500 2,000 23% 1 ,500 1 ,000 500 2005-06 To tal go vt subsidy 201 1 0-1 P etro leum subsidy 201 -1 1 2 201 3B 2-1 6% 22% 32% 35% 30% 25% 20% 1 5% 1 0% 5% 0%

P ro po rtio n o f petro leum subsidy to to tal subsidy (%) (RHS)

Note: Other major components of the subsidy bill include food and fertilisers
Source: CRISIL Research

CRISIL Opinion
Imposing additional taxes on cars and UVs offer limited benefits
Given the political compulsions that prevent major hikes in diesel and LPG prices, the government is evaluating other options to discourage diesel consumption and reduce subsidies. The options being discussed include levy of a one-time tax on all new diesel cars and utility vehicles (UVs) sold and collecting an annual tax from all diesel cars and UVs based on usage. CRISIL Research believes that these moves will not bring down the subsidy burden significantly or will be difficult to implement. Moreover, other vehicles like trucks and buses, which consume more diesel, remain untaxed. Of the total diesel consumed in 2011-12, cars & UVs used up only 12 per cent, a third of what trucks and buses consumed. (CRISIL Research has derived the share of diesel use by cars & UVs, based on an estimated population of 3.6 million diesel cars in India as of March 2012. This formed about 23 per cent of the total population of cars and utility vehicles. Of this, we have estimated that 47 per cent of the cars are for personal use, and the remainder, for commercial use.)
Diesel consumption mix (2011-12E)
( pe r c e nt ) Others, 26 Cars & Uvs (P erso nal), 7 Cars & UVs (Co mmercial), 1 9 Ro ads, 48 Railways, 3 Industry, 5 Trucks and buses, 74

A griculture, 1 8

Source: CRISIL Research

In the following two paragraphs, we have presented our analysis of the options being discussed by the government: Collections from a one-time tax (estimated at Rs 90,000-Rs 140,000 per car depending on fuel and vehicle use) on all new diesel cars and UVs sold would almost equal the subsidy borne by the government over the life of the vehicle. This tax would form 16-20 per cent of a typical diesel cars price. However, since such a one-time tax would be levied on only new vehicle sales, the government will be able to collect only Rs 58-60 billion annually which forms only 12-15 per cent of the total diesel subsidy bill (estimated for 2011-12). Secondly, as the life, mileage and distance travelled would be different for personal-use and commercial-use cars and utility vehicles; levying a common tax would be difficult.

An annual usage-based tax on all diesel cars and UVs would, as per our estimates, amount to an additional 2 per cent of the vehicle price annually for personal-use cars and 5 per cent for commercial-use cars. However, for collecting an annual tax, the government would have to rely on RTOs, which are fragmented and not so well-equipped. Thus, it would be difficult to collect taxes regularly and monitor nonpayments, which renders this option unviable too. Moreover, Indian car and utility vehicle buyers already pay 26-30 per cent of the vehicles retail price as tax, as compared to a 16-20 per cent tax in Korea and Germany and an 8-12 per cent tax in Japan (excluding scrappage and carbon tax which are annual in nature). Additional taxes on cars & UVs would, therefore, only burden consumers further.

Diesel price hike of 10-15 per cent inevitable

To contain under-recoveries on diesel at last years level of Rs 9 per litre, the government would need to hike diesel prices by at least 10-15 per cent. This would reduce petroleum subsidies by about 25 per cent in 2012-13, and also curb the rising share of diesel in petroleum subsidies. However, such a hike in diesel prices would also stoke inflation. All fuels together have a weightage of about 15 per cent in the wholesale price index (WPI). Diesel alone accounts for close to 5 per cent in the WPI. Hence, a 10 per cent increase in diesel prices will directly result in a 0.5 per cent increase in inflation. A hike in diesel prices will also indirectly impact inflation, pushing up input costs for manufacturing, which would be passed on to consumers through higher commodity prices. The extent to which prices are passed on would depend on demand.

Deregulating diesel prices - the only long-term solution to cut subsidy burden
While fears of high inflation, lower GDP growth and political compulsions had restricted the government from hiking diesel prices so far, the need to keep diesel prices regulated, even as subsides keep mounting, is also being increasingly questioned. Globally too, petrol and diesel prices do not vary much. In most countries within the EU and in the US, diesel and petrol prices are similar the difference between the two is not more than 15 per cent. By contrast, in India today, petrol prices are close to 2 times higher than diesel, reflecting both higher subsidies and higher taxes on petrol. (Taxes on petrol in India are at about 45 per cent of the selling price as compared to less than 20 per cent on diesel). CRISIL Research believes that biting the deregulation bullet and ensuring that diesel prices moves in line with crude oil prices would bring about a sustainable reduction in the subsidy burden, which will also provide the government funds for other development activities. Discouraging diesel consumption by imposing additional taxes on private and luxury diesel vehicles would only minimally cut down petroleum subsidies.

(Please note that the views expressed here are those of CRISIL Research and not of CRISILs Ratings division. CRISIL Research operates independently of and does not have access to information obtained by CRISIL's Ratings Division.)

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