India’s 2012 budget: Good on vehicle tax policy, not so much on fuel

One of the policy areas that we at the ICCT stress is how fiscal policies influence the composition of national vehicle fleets by creating (or eliminating) good or bad incentives for consumers. (The fullest recent summary of our work in this area is here.) India’s just-released budget for fiscal year 2012 offers some new examples.

The new budget increases taxes levied on SUVs and multi-purpose vehicles (MUVs) at the time of purchase. Specifically, the excise tax on small cars—defined as cars not exceeding 4m in length and with engines no larger than 1.2l for petrol/CNG/LPG cars or 1.5l for diesels—rises from 10% to 12%. For cars longer than 4m but engines smaller than 1.5l, the tax increases from 22% to 24%. And for all cars with engines greater than 1.5l (mainly SUVs and MUVs), the budget replaces the tax rate of 22% plus ₨15,000 with a flat 27% tax rate.

The FY 2012 tax schedule thus punishes gas-guzzling vehicles and strengthens incentives to cut fuel use and CO2 emissions. The previous system of new-car taxes translated into an incentive of US$33 for each gram per kilometer of CO2 emissions reduction (as detailed in our report Review and Comparative Analysis of Fiscal Policies). Under the 2012 tax scheme, the incentive becomes stronger at about US$39 for each gCO2/km reduced, primarily due to the higher tax on cars with engine capacity above 1.5l. The charts below show the change graphically; the chart on the left shows the CO2 reduction incentive of variable vehicle taxes in the 2011 budget, and the chart on the right shows the same thing for the 2012 budget.

Fig 1a 2011 budgetFig 21b 2012 budget

Of course, the tax would be more effective in terms of reducing vehicle fuel consumption and CO2 emissions if it were based directly on fuel consumption as opposed to engine size. In particular, with the development of smaller but yet powerful turbocharged engines, the Indian definition of small versus large engine may be getting outdated fast. But if taxes levied on cars at the time of purchase now more strongly encourage cleaner and more fuel-efficient vehicles, fuel taxes in the 2012 budget continue to send a somewhat different signal.

The government reports an under-recovery of ₨12.17 (US$ 0.25) per liter of motor diesel fuel to diesel fuel providers. This subsidy, combined with a number of other minor tax distortions, creates a retail price gap of ₨25 (US$0.5) per liter between petrol and diesel motor fuels.

When measured on a CO2 emission basis, the tax on petrol translates into a lifetime disincentive of US$43 per gCO2 per kilometer, while the diesel tax translates into a lifetime disincentive of US$31 per gCO2/km. For the same vehicle CO2 emission level (for example, 150 gCO2/km), a petrol car owner will pay roughly US$1,835 (₨90,000) more in fuel costs than a diesel car owner over a typical 10-year operating lifetime. Conversely, the owner of a diesel vehicle emitting 200 gCO2/km (that is, a larger, fuel-guzzling vehicle) would pay roughly the same amount in lifetime fuel costs as the owner of that 150 gCO2/km petrol car.

Fig 2: Lifetime fuel cost by car CO2 emissionsLittle wonder, then, that sales of diesel cars are skyrocketing in India. Diesel cars, SUVs and vans now account for more than 40 percent of new passenger vehicle sales in India, and the continuing fuel price gap is likely to continue the dieselization of Indian passenger vehicles. The problem, of course, is that diesel exhaust is three times or more potent in terms of emissions of nitrogen oxides, and a key source of fine particulate matter emissions. A tax policy that gives consumers incentives to buy more or bigger diesel vehicles has significant implication for public health, especially in urban areas. In order to counter perverse effects of dieselization, India needs to rationalize fuel pricing quickly, and at the same time adopt emission standards such as Euro VI that lower harmful diesel exhaust emissions.