With Sri Lanka currently facing a Balance of Payment crisis due to foreign institutional investors exiting from the domestic Government Securities market, a plausible revenue option is to increase the tax on diesel, a top analyst advocated last week. According to the CEO of JB Securities Ltd. Murtaza Jafferjee, Diesel is presently being taxed at a lower level at 16% than most other goods (approximated taxes as a proportion of their final price) while Petrol in comparison is being taxed around 50%.

“Currently diesel has taxes totalling around Rs.15.50 per litre – customs duty of Rs.9 (actual duty is Rs.15 but there is a waiver of Rs.6), PAL @7.5% – Rs.3.50, Excise duty of Rs.3.00.”

“In comparison, petrol has taxes totalling Rs.65.50 per litre – customs duty of Rs.35 (no duty waiver), Excise duty of Rs.27 and PAL @7.5% – Rs.3.50,” Jafferjee said.

According to his analysis which is based on the current VAT rate of 11%, three-wheelers are taxed at 65%, two-wheelers at 45%, Hybrid cars – 51%, Raw material– 23% and Intermediate goods at 28%.

“Unfortunately, although the evidence is clearly in favour of increasing taxes on diesel, successive governments have politicised fuel pricing,” Jafferjee charged.

He pointed out that if one uses the rate applicable on intermediate goods, i.e. 28% then the tax on Diesel should be Rs. 27 instead of the current Rs.15.50 per litre.

According to end 2014 statistics, Sri Lanka had consumed approximately 200 million litres of Diesel a month with the pre-correction post-tax subsidy being Rs.28 billion.

Meanwhile, on the government’s perspective, some of the reasons sighted for under-taxing of diesel are that it will reduce inflation, it encourages public transportation since buses run on diesel and that higher taxes on diesel are regressive.

However, Jafferjee argues that inflation is a continuous increase in prices and hence a one-off price increase, will only have a transitory effect unless there are factors like wage-indexing that causes it to be persistent.

“As per the CCPI basket, the passenger transportation has a weight of 4.26% of which the fuel cost would be a smaller component­—this is a direct effect and I would estimate a similar weight for indirect effects. As per out estimates, fuel retailers are making a healthy profit on diesel compensating them for the losses they are making on petrol. CPC’s volumes on Diesel are 2-2.5 times more than Petrol.So the net benefit to them is greater. If fuel taxes are revised, the pass-through to the consumer would be modest.This would be an ideal time to do it since reported inflation is in low single digits although it is expected to trend up, if the VAT is increased from 11% to 15%,” he said.

On the second argument that keeping diesel taxes low would encourage public transportation, Jafferjee says based on a back of the envelope calculation, a 5 kilometre journey will cost Rs.15 for bus travel, Rs. 50 for a 2-wheeler, Rs. 75 for a 3-wheeler (owner driven) while driving a small car like an Alto would cost Rs. 130.  Hence, since fuel cost represents around 40% of the cost of a bus journey thus even if diesel prices are increased by Rs.27 per litre, the pass-through cost for the said journey is around Rs.4.

“The economics yet favour public transportation by a significant margin but will not stop the demand for private transportation,” he said.

Coming back to the final argument that higher taxes on diesel are regressive, Jafferjee opines that the International Energy Agency (IEA) has estimated the distribution of subsidies globally according to Quintiles and therefore one may have to calibrate their figures for Sri Lanka.

Murtaza Jafferjee
Murtaza Jafferjee

No sight of fuel price formula
Although it has been 15 months since the new government assumed power pledging in its Presidential election manifesto to implement a fuel pricing formula, it is disappointing that it has not been implemented yet, analysts said last week.

“Fuel prices should NOT be a vote buying tool for its an imported commodity – by incorrectly pricing fuel through post tax subsidies we are transferring wealth to oil exporting countries due to excess consumption, reducing the incentives to develop alternate energy sources and depriving the treasury of much needed revenue to spend on social investments like health and education and/or contribute towards fiscal consolidation,” CEO of JB Securities Ltd. Murtaza Jafferjee said.

According to him, on 19 January Brent oil touched a low of USD 28.0 a barrel and it has been rallying ever since and is currently trading at USD 41.5 – one is not sure where it is heading.

“This is a once in a generation opportunity to implement the promised fuel pricing formula under benign market conditions and depoliticises fuel prices. Now or never!,” he said.