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Don’t slip on the oil slick

Instead of battling crude oil prices, the Centre should lower taxes imposed on it.

india Updated: Jun 29, 2011 23:29 IST

Last week’s hike in fuel prices and the ensuing flurry of tax cuts by states in an attempt to ease the pain is a reminder to the government that it shouldn’t be subsidising energy use. And if it must, there are better ways of going about it. Trying to put a lid on oil prices is an expensive endeavour for a nation that imports two out of every three barrels it burns. When, as is inevitable, rising prices of crude oil need to be passed on to the “protected” Indian customer, it comes as a shock because incremental changes bunch up over the time the government has been trying to cushion the blow. This jolt can be avoided if transport and cooking fuel prices are freed from bureaucratic control. Then again there is a fundamental argument against price controls: these lull us into a false sense of security and we end up burning fuel faster than we can afford to.

Yet if cheap energy remains critical to Indian policy- making, we ought to be asking ourselves whether price controls serve the purpose. Artificially low diesel prices benefit the bloke riding a bus to work as well the guy driving his own car. Do we need to subsidise both? The free rider problem — as economists describe it — is inherent to any imposed ceiling, or floor, for market prices. It makes eminently more sense to free fuel prices and pay the bus rider cash if his ticket costs too much. As a country with an intimate relationship with subsidies, India needs to target them better. Cash handouts to select households will go much further than the jungle of price controls we have erected in vast swathes of the economy, arresting the invisible hand in markets as diverse as food and fuel.

The flip side of economy-wide subsidies are high taxes. Fuel is a good example. Taxes on a litre of diesel in India are much higher than the subsidy on it. In effect, the subsidy lowers the tax rate on diesel. It would be simpler, then, to lower the tax and dispense with the subsidy. The relentless rise in the price of oil is perversely steering our policy-makers to this realisation. For one, the government gets to test its ability to withstand international market forces. And it also realises the limits to lazy taxation. Dear energy in India traces its roots to high taxes as much as it does to the underlying price of crude oil. The government can fix the former instead of engaging in a futile battle with the latter. It’s time the penny dropped.