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Reducing taxes to tackle rising oil prices is a sham - Views on News from Equitymaster
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  • Mar 21, 2000

    Reducing taxes to tackle rising oil prices is a sham

    Well thatís what noted economist Paul Krugman has stated in a recent article in New York Times. Mr. Krugman was commenting on the proposal by a President hopeful that entailed a cut in taxes in an attempt to lower the price of petroleum products.

    This is what Mr. Krugman had to say:
    Even if the cut in taxes on petroleum products were to be passed onto the consumers in the form of lower prices, it is unlikely that consumers would benefit for long. This is mainly due to the fact that the higher demand (resulting from lower prices) would once again drive up prices. What about supply? Currently, the OPEC has put a lid on the output and even if it open its taps further, there will be a lag of a couple of months before the crude actually reached the US (therefore the supply in the short term is fixed). Therefore the mismatch between the demand and supply will continue in the near future. This will almost surely lead to an upward revision in prices. Mr. Krugman concluded that the gainers from this would be the refining companies, and not the consumers, for whom the move is intended.

    Then there is the issue of the US government budget surplus (can you believe that!). The decline in revenue from this source would lead to a cut back in government expenditure i.e. lower expenditure on roads.

    Mr. Krugman in other words did not support the cut in taxes. Instead he prefers that consumers pay for what they are getting. In the absence of this, the situation will not be sustainable.

    In India too the government has adopted a similar measure (although the structure of the Indian oil market is very different). It has proposed a cut in the import duty on crude. However, the Indian government is more explicit and has stated that the move is aimed at giving some breathing space to refining companies. This is mainly due to the fact that product prices of key petroleum products in India are still regulated. Therefore, even as the oil prices surged, there was no commensurate revision in prices, leading to a burgeoning oil pool deficit.

    The government's move is at best a temporary reprieve for domestic refining companies that would continue to be exposed to the movements in the price of crude as key product prices are still controlled by the government.

    So whatís the solution. Free pricing and rationalising of duties. This will result in an upward revision in prices (resulting in lower demand) while the rationalisation of duties would ensure that the government continues to derive revenue (and also protect the interest of the sector). More importantly, consumers will be paying the right price for what they are getting. And the refiners, will finally be paid for what they are selling (they would no longer have to rely on subsidies from the government). Equally important fallout would be the reduction of the governmentís subsidy bill.



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