Why is the State Government in India Not Reducing VAT on Fuel?
The question of why the Indian state government is not reducing VAT on fuel is multifaceted, involving complex economic and political factors. While it might seem counterintuitive for a government to keep raising taxes on a product that is already contributing to inflation and economic strain, there are compelling reasons for this decision.
A Revenue Stream for Balancing Fiscal Deficits
The core reason lies in the financial necessity. The revenue from VAT on fuel serves as a critical source of income for the state government. When crude oil prices drop, the state government uses the extra revenue to cover its fiscal deficits. This practice ensures that the government does not have to make additional cuts in other areas, thereby maintaining public spending levels. As a tax on a universally used commodity, the government can collect substantial amounts even with small increases in the fuel tax. For example, a 5 pence rise in fuel price brings in a 1 pence increase in tax per litre, making it a reliable revenue generator.
The Economic Principle of Higher Prices, Higher Taxes
The classic economic principle is that higher taxes lead to higher revenue, which is precisely what the government is leveraging. This is particularly evident in the UK, where a 57.95 pence per litre tax, plus 20% VAT, means that a small increase in fuel prices translates into a significant increase in tax revenue. With over 40 million vehicles on the roads, the cumulative effect is substantial, providing a financial cushion for the government.
How Industry Responds to Tax Reductions
Another factor that must be considered is the behavior of the fuel industry. Whenever there is a reduction in taxes, the industry tends to capitalize on the consumer's perceived fixed costs. This is because many businesses operate under the assumption that consumers are accustomed to paying higher prices due to previous taxes. By reducing tax but keeping the price the same, the industry can still increase profits. This strategy ensures that customers do not notice the change and that the industry can still meet the demands of its shareholders for increased profits. Studies have shown that consumers often do not notice small changes in prices, making such strategies effective for maintaining profit margins.
Lack of Public Pressure
Additionally, there is minimal pressure from the public for the state government to reduce fuel prices. In many cases, the general public does not explicitly demand lower fuel prices. The stress is more on maintaining services and infrastructure, which the current tax rates support. Many citizens are willing to accept higher fuel prices without protest, given the perceived necessity of the services and infrastructure that these taxes fund. Without vocal demands from the public, the government sees no immediate need to change its policies.
The Role of Central Government and Revenue Sharing
Lastly, the state government’s inability to reduce fuel VAT is also influenced by the central government. While states have the authority to impose VAT, the central government controls the major taxation policies such as excise duties. The revenue sharing between the central and state governments is often contentious, with state governments feeling that they are not getting a fair share of the total revenue. As a result, states may be reluctant to reduce VAT even if their counterparts in other states have done so. The delay in mandatory revenue sharing further complicates the situation, making it difficult for states to take independent fiscal decisions without the support of the central government.
In conclusion, the decision by the Indian state government not to reduce VAT on fuel is rooted in a combination of financial necessity, the economic principle of higher prices leading to higher taxes, the industry's predatory behavior, and the lack of public pressure. Until these underlying factors change, it is unlikely that there will be a widespread reduction in fuel VAT by the state governments.