The Hindu's Advice to Combat Rising Oil Prices

Today's editorial and op-ed by K.Venugopal are a study in contrast. The editorial prevaricates on how the government can adjust oil taxes to ensure 'revenue-neutrality':

Two key issues need to be addressed clear-sightedly. Who should bear the subsidy burden? Secondly, how can the subsidy bill be brought down? The answer to the first question is obvious: the OMC losses must be borne by the Central budget, not by PSU balance sheets. The answer to the second question is more complex.

Right now, about 40 per cent of the retail sale price of petrol and diesel consists of excise and import duties. Sales tax constitutes another 15 per cent to 25 per cent depending on which State one is in. Reducing these levies, while moderating the increase in retail prices, will improve the bottom line of the OMCs. Nearly a quarter of Central tax revenues come from levies on oil products but given the other positive trends in the economy, it should be possible to calibrate an excise-cum-subsidy adjustment that is broadly revenue-neutral. Over the medium-term, a prudent tax policy will require a widening of the revenue base away from excessive dependence on petro products. With the average oil price predicted to hit $150 and even $200 a barrel in the months ahead, the slack provided by excessive indirect taxation will eventually be exhausted. Protecting the poor by subsidising kerosene is one thing but there is no reason why the owners of private vehicles, for example, should be protected from global price trends. The real longer-term answer is taking energy conservation seriously. This means a strategic policy of targeting the present energy inefficiencies, reducing the energy-intensity of the economy, expanding public transportation, and sending out the right price signals towards this end.

Venugopal's plain-speaking demolishes these ideas. He points out two things. The first is that even entirely eliminating the oil tax will only address 40% of the need. So this excise-cum-subsidy adjustment essentially relies on the Laffer curve (less tax = more revenue because of buoyancy of economy) which is strange given that the Hindu had decried precisely the very same idea as 'unproven' when the NDA government applied it in their budget proposal.

To keep consumer prices where they are, the Opposition parties have suggested that the Centre reduce taxes on petroleum so that the oil companies can keep more of the consumer rupee. On the face of it, this appears a reasonable suggestion but it could be both inadequate and unfair. The Centre collected about Rs. 71,000 crore in excise and import duties on petroleum in 2006-07, which means that even if the duties were forsaken entirely, they would provide just 40 per cent of the need. On the other hand, without such revenue the budget would be weakened leading to spending cuts on many a social programme. While petroleum is used in the production of most goods and even services, not every one in the population enjoys it in equal measure. Just one third of the country’s households, for instance, use LPG in the kitchen. Of course it is much the cleaner fuel, and every attempt must be made to make it more accessible. But as things stand, the less fortunate in the population, who make do with firewood and farm residue, gain nothing from a stable LPG price. It would be a rather unjust denouement if a reduction in any government social programme should impact this section of society.

For all the talk in the editorial about reducing consumption and developing alternative sources to also reduce climate change, note that it does not offer any policy proposal to make this transition. Venugopal correctly indicates that the best way to incentivize these alternatives is to expose the consumer to market prices. That way, higher prices will force consumers to cut back on their driving, use of private vehicles and reduce consumption. Keeping prices artificially low by subsidizing them is the best way to prevent this change.

Having worked its creative accountants to the full, the government may claim it has won the battle, but it will lose the war. The proper response to a doubling in the oil price would be to ensure a more efficient use of the resource that the world knows is limited and exhaustible.

...On their own, consumers do respond appropriately to price signals; they know how to moderate consumption when the purse is pinched. If the government insists on shielding its consumers from global price changes, then it must take on the role of modulating consumption. Some one will need to bear the pain.

As Venugopal points out, the government may once again hike petrol price by Rs.2-5, diesel by Rs.1-2 and leave kerosene alone while making up the rest by issuing oil bonds. The continuing subsidy will continue to discourage greater efficiency while the increasing difference between petrol/diesel and kerosene prices will end up incentivizing adulteration. The Hindu does not appear to have thought through its advice before giving it. It appears from what I have seen that it simply echoes the CPM line.