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July 31, 2011

Page: 8/44

Home > 2011 Issues > July 31, 2011

Bad economics, worse politics

By Adhitya Srinivasan

A few weeks ago, Union Minister for Petroleum and Natural Gas, Jaipal Reddy had announced that fuel prices would be increased.Subsequently diesel price was increased by Rs 3; kerosene by Rs 2 and LPG by Rs 50. The Petroleum Minister supported this policy on grounds of continuing the policy on deregulation of fuel prices, saving the oil companies from huge losses and reducing the government’s subsidy burden. This was the first time that the government had deregulated the prices of diesel and kerosene. Fuel prices have always been a sensitive issue in Indian politics and when managed poorly, it has invariably invited a fair deal of criticism.

During the course of this announcement, Jaipal Reddy also hoped that the states would reduce taxes on fuel products so that the consumers would have some relief. Shortly thereafter, the Union Finance Minister, Pranab Mukherjee wrote to the Chief Ministers of all states, urging them to reduce levies on diesel, kerosene and LPG. Most Congress-ruled states and some BJP-ruled states such as Uttarakhand and Himachal Pradesh reduced VAT on fuel. Some other states such as Madhya Pradesh have not reduced VAT on fuel. This is the point at which politics took over. The Congress protested against BJP governments which had not reduced VAT and accused the BJP of neglecting the woes of the aam admi.

The Congress-led UPA has accomplished the unique feat of messing up both the politics and economics of fuel prices. In fact, if one were to take the following analysis to its logical conclusion, the economic aptitude of this government becomes questionable. At another level, the policy announcement coupled with the Finance Minister’s written request and the irrational protests by the Congress are attempts to clamp down on the federal structure that was envisaged by the authors of the Constitution. The State of Madhya Pradesh, currently ruled by the BJP, is the perfect illustration of all these effects.

The brand of federalism enshrined in the Constitution leans heavily in favour of the Centre. The Centre is empowered to collect tax revenue in a host of areas including income, corporate profits and services. On the other hand, the State’s ability to collect tax revenue is limited to a few areas such as agricultural income and sale of goods. Consequently, the states become dependent on the Centre for finances. In a purely equitable system, the Centre would release sufficient funds to the states. But party politics often scuttles every notion of equitable and just distribution of finances to the states.

The Centre’s directive to reduce VAT on fuel products is in the nature of an indirect tax on the states. Just as producers pass on the tax burden on to their consumers, so too is the Centre passing the burden of providing relief to the common man to the States after having caused the problem! The Centre is thus able to protect its revenues but it expects the states to bear the brunt of the fuel price hike by lowering its taxes. This is the worst kind of hypocrisy.

This hypocrisy turns into downright immorality when one considers the facts and figures. Out of the total tax revenue for Madhya Pradesh for the year 2011-12, the State’s own taxes amount to 23,118 crore rupees whereas theState’s share in Central taxes is only 17,029 crore rupees. For the year 2010-2011, the tax revenue stood at 18,670 crore rupees (State’s taxes) and 11,047 crore rupees (State’s share in Central taxes). The figures were 17,273 crore rupees and 11,077 crore rupees for 2009-10 and 13,614 crore rupees and 10,767 crore rupees for 2008-09. In other words, the major source of revenue for the State is the revenue generated by its own taxes. The Centre has consistently made a paltry contribution. Despite this, the Centre expects the states to reduce VAT and thereby lower its ability to generate revenues!

There are at least two possible fallouts of reducing VAT. Firstly, the State government, in view of lower revenues, is unable to fully implement its welfare programmes. For instance, in Madhya Pradesh, a number of important programmes such as the Ladli Laxmi Yojana, Kanyadhan Yojana and Janani Suraksha Yojna have caught the imagination of the people. These programmes cannot be implemented if State’s revenues decrease. Secondly, in order to make up for the depreciated revenues, the State government will increase taxes on other commodities. Either way, the common man will suffer. The UPA in its short-sightedness might have believed that reducing VAT would help the common man. On the contrary, it will compound his problems manifold.

None of this would have arisen had it not been for the UPA government’s decision to hike fuel prices. So it becomes important to evaluate the need for such a policy. Decontrolling fuel price might be a desirable policy. But for a government that claims competence in economic affairs, the timing of the fuel price hike was terrible. There is no sense in hiking fuel prices in an inflationary economy. Diesel is a universal intermediate and a hike in diesel price would trigger a rise in the prices of other commodities. Perhaps, the government could have increased fuel prices by small amounts on a periodic basis as opposed to knee-jerk hikes so as to give consumers some leeway for management.

But does this really solve the problem? In a 2006 an article written in The New Indian Express, (Petrol at Rs. 30 a litre? Possible, but …) S. Gurumurthy identifies an incorrect exchange-rate management policy as being responsible for the high fuel prices in India. He argues that despite the appreciation of the rupee in real terms, the Finance Ministry and the RBI have constantly intervened to keep the value of the rupee below its real value. Crude oil is imported from abroad in dollars but is sold in India by way of refined petrol and diesel in rupees. This means that if the rupee were allowed to reflect its real value, the import cost of crude would be significantly lower and consequently the fuel prices in India would be lower. This would not only bring genuine relief to the common man but also allow the government to fully decontrol fuel prices. Perhaps, the government should learn to think differently.

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