Third Dimension - Automobiles - Annual tax on diesel cars may resolve subsidy conundrum::Edelweiss,

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Rising dieselisation of cars fuelling subsidy woes

The price differential between petrol and diesel has surged to INR25 from INR10 since petrol price deregulation. This has led to a shift in buyers’ preference in favour of diesel vehicles as the required kilometers to recover the extra cost for diesel vehicles have dipped 50% (refer table II on page 2). Overall, dieselization has doubled in the past one year and car models with diesel variants now account for 80-85% of demand in that segment. While diesel car sales surged 64% in November 2011, petrol car sales dipped 19%. All petrol cars have high discounts on offer while diesel variants have a waiting period. Amidst this craze for diesel vehicles, diesel subsidy has touched INR377bn in H1FY12, a fact hard to ignore by the government, even though total passenger vehicles (including taxi) account for 7% of total diesel consumption.

Demand for levying tax on diesel passenger vehicles

Press reports suggest that the government is considering raising excise duty on diesel passenger vehicles while it may lower the same on petrol cars. The Kirit Parikh Committee has also suggested different fuel prices for personal and commercial vehicles, which is difficult to implement.

Annual diesel tax a feasible option

In our view, the government should also explore the option of levying a recurring annual diesel tax. It should be a fixed percentage on the value of the car which the owner will have to pay every year in lieu of the subsidised fuel he enjoys. In our estimate, the total number of diesel passenger vehicles is 4.5mn units; levy of 4% annual diesel duty could fetch the government INR71bn in tax. This should be the preferred option over increase in excise duty for the following reasons:

·         Increase in excise duty punishes new buyers though old buyers will continue to enjoy subsidised fuel.

·         Our interactions with dealers suggest that there is an element of irrationality in purchase of diesel vehicles. Buyers do not mind paying higher cost even if break even period for diesel vehicles is more than five years as they are more concerned about regular running costs. Hence, an annual tax is a better deterrent than an one time higher excise duty.

·         It is akin to having differential fuel pricing. Commercial vehicles should be spared from this tax as it could be inflationary.

Insurance agencies could collect tax

Implementation of such an annual diesel tax is the tricky part as users may prefer not to pay it and rather pay fines or bribes as is the case currently with pollution certificates. To protect against this:

·         The job of tax collection could be entrusted to an insurance agency which anyways collects mandatory insurance premiums

·         This would ensure compliance as the car owner is more than willing to renew insurance due to accident coverage.

·         A part of the proceeds could be used to cover the deficit that these insurance companies are running.

Though flipside is demand destruction

Amidst a general slowdown in car demand, surge in demand for diesel cars is the only bright spot. Ergo, any hike in duty on diesel vehicles could destroy this demand while not necessarily spurring demand for petrol cars. Another limiting factor is fixing the duty rate as it may punish buyers who travel less whereas heavy users will still benefit from subsidised fuel.