A significant surge in crude oil prices and rising domestic demand for motor fuel is expected to offset the impact of cuts in central and state levies on petrol and diesel implemented between November 2021 and May 2022, keeping sales tax collections for states from this source¹ flattish at ~Rs 2.4 lakh crore this fiscal.

Moreover, the unchanged collections will come on the back of a strong ~20% on-year growth last fiscal, which was driven by a rebound in volume, rising crude prices, and elevated central and state taxes.

Sales tax collections would have grown by 5-6% on-year had the central government not reduced the central excise duty on petrol by Rs 8 per litre and on diesel by Rs 6 per litre on May 21, 2022.

Says Anuj Sethi, Senior Director, CRISIL Ratings, “Due to the recent excise rate reduction on motor fuel, while the Centre is expected to forego revenue of Rs 0.9-1 lakh crore, the potential loss of collections by states is estimated to be upwards of ~Rs 16,000 crore² this fiscal. But in the larger scheme, a healthy growth in Goods and Service Tax (GST) collections is likely to help make up for this loss, for states.”

The way it works, states levy sales tax³ on the taxable value of petrol and diesel. This value - or ad valorem - is a function of crude oil price, foreign exchange rate, refinery processing cost and margins, freight cost, central excise rate, and dealer margin. The retail price is the sum of the taxable value and state sales tax.

With the ongoing Russia-Ukraine war-related trade and supply shocks, the price of Brent crude oil is expected to average $94-99 per barrel in the current fiscal, an increase of ~25% on-year. This will result in a rise in sales tax collections, as typically, a $10 increase in the crude oil price translates to an additional Rs 1-1.1 per litre of fuel (petrol and diesel) sold, to the state exchequer.

Another positive driver of sales tax collections is the expected growth in sales volume of petrol and diesel, owing tothe rebound in economic activity, inducing an uptick in vehicular traffic. We expect 5-7% volume growth presumes an expected real GDP growth of ~7.3% this fiscal and no further pandemic-necessitated lockdowns.

Hence, it is mainly the reduction in central excise that would cause state sales tax collections to remain flat, as that brings down the taxable value of petrol and diesel for the state levy. We estimate the lowering of excise duty between November 2021 and May 2022 would reduce the tax collection of states by ~Rs 3 per litre of fuel sold.

Says Aditya Jhaver, Director, CRISIL Ratings, “In addition to excise revision by the centre, some states also cut sales tax by Rs 4-7 per litre in November and December 2021. Despite this, about half of the top 18 states in terms of gross state domestic product may still achieve mid-single-digit growth in collections this fiscal driven largely by higher off-take and as they only reduced their rates marginally, or not done so at all”.

Sales tax on petroleum products contributes a sizeable ~15% to the own-tax revenue of states. We expect higher GST collections and central tax devolution to help augment state finances despite flat collections from fuel taxes this fiscal. GST collections were already up 20% on-year in April 2022, and we believe a continuation of this momentum would help support credit profiles of states.

¹ Forms ~90% of sales tax collections from petroleum products
² In case states decides to cut sales taxes in the near term, the revenue loss can inch upwards. For instance, a Rs. 1/litre reduction in sales tax by all states can result in additional revenue loss of ~ Rs. 12000-13000 crore.
³ State tax rates varies across states and are either: 1) ad-valorem (proportion to the estimated value of sales), 2) fixed value (in Rs/litre), or 3) max of 1 and 2. Almost 80% of the fuel consumption currently is in states with ad-valorem tax structure.