By R. Suryamurthy
Strip away the political theatre around fuel price relief, and what emerges is not a story of benevolence, but of a fiscal system stretched to its limits — and increasingly out of balance. India’s latest excise duty cuts on petrol and diesel are not just a response to volatile crude prices; they are a stress test of a tax architecture that has, over the past decade, grown both dependent and distorted.
At the heart of this lies a structural contradiction: the Union government has built its fiscal resilience on excise duties on petroleum, while states have entrenched their own stability through ad valorem VAT. In times of crisis, the Centre cuts; states collect. The numbers are stark, and they tell a story policymakers would rather avoid confronting.
The excise duty cut of ₹10 per litre — bringing levies down to ₹11.9 on petrol and ₹7.8 on diesel — is expected to cost the Centre over ₹2 lakh crore in gross terms. Even after factoring in windfall taxes on diesel and aviation turbine fuel exports, the net revenue loss is estimated at around ₹1.1 lakh crore for FY27. That is not a marginal adjustment; it is a fiscal event.
This is the inevitable consequence of a strategy that, for years, treated fuel taxes as a convenient reservoir of revenue. When global crude prices were benign, the Centre steadily raised excise duties, transforming petroleum taxation into a fiscal mainstay. It was elegant in its simplicity: consumers did not feel the full benefit of falling crude, but the exchequer did. Now, the cycle has turned — and the same lever is being pulled in reverse.
The government has framed the excise cut as a shield for consumers against global oil volatility. In practice, it is something more complex — and more costly. Retail prices have remained largely unchanged despite crude surging past $120 per barrel in recent weeks, effectively severing the link between international markets and domestic pricing. This stability is not free. It is being financed.
Oil marketing companies, according to official estimates, are incurring significant under-recoveries because pump prices have not kept pace with global costs. The excise cut merely offsets a fraction of this burden, allowing the system to hold — for now. The rest is absorbed through a combination of fiscal sacrifice and quasi-subsidisation.
In other words, what should have manifested as consumer inflation has been converted into a fiscal liability. This is a deliberate policy choice. But it comes with consequences that are neither temporary nor trivial.
If the Centre’s fiscal position is deteriorating, the states’ position is, paradoxically, strengthening. Unlike excise duties, which are fixed per litre and must be actively adjusted, state VAT is typically levied as a percentage of the retail price. As crude prices rise, so does the tax base. The system, by design, rewards inflation.
SBI Research estimates that states could see an incremental ₹25,000 crore in VAT revenues in FY27, even under conservative consumption assumptions. In FY25, states had already collected about ₹3.02 lakh crore from VAT on petroleum products — a figure that continues to rise with price-linked gains. This is not opportunism; it is structural design. But the implications are politically and economically uncomfortable.
Because while the Centre is compelled to act — cutting duties, absorbing revenue losses, stabilising prices — states face no such compulsion. Their revenues expand automatically unless they choose to reduce VAT rates. And so far, there is little evidence of a coordinated response. The result is a deeply asymmetric fiscal adjustment mechanism: the Centre absorbs the shock, states capture the upside.
This divergence goes beyond accounting; it cuts to the core of India’s fiscal federalism. In theory, a federal system should distribute both burdens and benefits equitably. In practice, India’s fuel tax regime has evolved into something far more fragmented. The Centre’s revenues are discretionary and policy-driven, while states’ revenues are structurally anchored and price-sensitive. This creates a perverse equilibrium.
When crude prices fall, the Centre gains by raising excise duties. When prices rise, it loses by cutting them. States, meanwhile, gain in both scenarios — either through higher consumption or higher prices. The burden of macroeconomic stabilisation — controlling inflation, protecting consumers, ensuring energy affordability — is effectively centralised. The fiscal rewards are not.
It is little surprise, then, that calls for states to reduce VAT “in tandem” with the Centre have gained traction . But such appeals overlook the incentive structure. For states, cutting VAT is not just a policy decision; it is a revenue sacrifice with no guaranteed compensation. Why would they move first?
There is another, more troubling dimension to this story: the erosion of the Centre’s fiscal buffers. Excise duty has long served as a stable and predictable source of revenue — far more reliable than dividends from oil public sector undertakings or profit petroleum, both of which are tied to volatile global markets. As those cyclical streams fluctuate, excise provided continuity. Now, that anchor is weakening.
The ₹1.1 lakh crore revenue hit projected for FY27 comes at a time when fiscal pressures are already mounting — from fertiliser subsidies and LPG under-recoveries to capital expenditure commitments and welfare spending. Estimates suggest the net fiscal cost could approach ₹1 trillion, or about 0.3% of GDP, over a year.
This is not yet a crisis. But it is a narrowing of options. Because once excise is cut, restoring it is politically difficult. And if high oil prices persist, the losses become structural, not episodic.
All of this inevitably circles back to a familiar, unresolved question: should petroleum products be brought under GST? In theory, doing so would harmonise taxation, reduce cascading effects, and align incentives across the Centre and states. In practice, it would require states to relinquish a significant and reliable revenue stream — one that has only grown more valuable in recent years.
The reluctance is understandable. But the cost of inaction is becoming harder to ignore. India is effectively operating with a dual tax regime for one of its most critical commodities — one that amplifies fiscal asymmetries and complicates macroeconomic management. Each oil price shock exposes the fault lines a little more clearly.
What we are witnessing is not just a policy response to a global oil shock; it is the slow unravelling of a fiscal compact.
The Centre’s role as the primary shock absorber is becoming increasingly unsustainable. States’ reliance on VAT, while rational from their perspective, reinforces the imbalance. And consumers, for now shielded from price volatility, are indirectly paying through future fiscal tightening. The danger is not immediate collapse, but gradual brittleness.
A system where one tier of government consistently bears the cost while another accrues the benefit cannot remain stable indefinitely. Either the incentives realign — through coordinated tax adjustments or structural reform — or the pressures will eventually force a more abrupt correction.
For now, the numbers offer a clear verdict: the Centre is bleeding revenue to buy price stability, while states are quietly booking gains from the same crisis. That is not fiscal federalism. That is fiscal drift. (IPA Service)
