You shouldn't change excise duties because of price changes in the underlying commodity By TomTheHand - Own work, CC BY-SA 3.0,

Moody’s, the ratings agency, is telling India that cuts in oil excise duties aren’t a good idea – not unless spending gets chopped too. And that’s the political difficulty, isn’t it? Cutting taxes is popular, cutting spending isn’t.

It’s also true that cutting such duties just because oil is expensive at the moment isn’t a good idea either.

Rating agency Moody’s has sounded a note of caution that any reduction in excise duty on petrol and diesel would adversely affect fiscal deficit unless it is matched by a commensurate cut in expenditure.

That does sound pretty obvious, doesn’t it? If you take in less revenue but keep spending in the same manner then you’re going to end up with deficit problems, no?

According to government estimates, every rupee cut in excise duty on petrol and diesel will result in a revenue loss of about Rs 13,000 crore.

Even in a place and economy as large a India that’s real money.

Pressure has been mounting on the government to cut excise duty on petrol and diesel to bring down their prices which have gone up following a spike in crude prices in the international market.

But there is indeed that political pressure and there’s speculation that they might give in.

However, they shouldn’t, and not because of the deficit question. Rather, people really need to use petrol and diesel – at least, anyone who uses it at all pretty much must keep using them. That’s why they’re great things to tax.

As we all know taxing something raises the price, meaning that fewer people use or buy it. How much this is so is the elasticity of that thing. Inelastic means that price and usage changes little with respect to price, elastic a lot. Such changes in use are distortions from the free market ideal created by the taxation. We’d prefer to have less distortion in the economy than more, while we’d also like to have our tax revenue. Thus we should tax things that are inelastic. And, usefully, if demand is inelastic then we can get lots of tax with few distortions precisely because people don’t change their usage much in response to price changes.

Oil and diesel are inelastic by our usual measures – thus we can and should tax them highly. Precisely because people must use the stuff we get lots of revenue with few distortions.

None of this is changed by the manner in which the international oil price has risen in recent months. Nor by how it is falling back in recent weeks.

We can and should tax oil products highly because people must use them.