497, UPSC CSE 20214y

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Why does central government imposes specific tax on excise tax (excise duty) whereas
state government imposes Ad valorem tax?

Specific tax is imposed on any physical characteristics of a product say, length, width, weight
etc.

Ad-valorem is imposed on the monetary value of the product.

The reason Central government imposes specific tax on excise is to regulate the prices of
commodities and keep them affordable for common people while taking care of the
national wallet as well.

(Although this example relates to Custom duty, the analogy can be drawn in the case of Excise
duty as well. I chose this example to make the concept understandable as it features frequently in
the news.)

India depends on crude oil market for 80% of its requirements. The central government taxes
petrol on ‘specific’ basis i.e. Per barrel.

The state governments tax petrol on ‘Ad-valorem’ basis i.e. Total value of petrol.

It should be clear that a tax levied on a specific characteristic of a commodity (say, 10p per
barrel) would be less than if it is levied on the total value of the commdity(say, 25% per litre of
petrol)

So, a tug of war like situation arises when crude oil prices rise in international market. Who
would take the cut so that the burden doesn't fall on us, the consumers? The centre or the States?

State governments’ prime source of income is VAT. They generate around 40-50% of their total
revenue through VAT levied on petroleum and alcohol. So, they hesitate to lower VAT but, as
they tax on Ad-valorem basis, them taking the bullet will reduce the burden on consumers far
greater than if centre takes a cut on its revenues by slashing custom duty on crude oil.

VAT reduction would be ‘felt’ more than a reduction in Custom duty. But, in India, states
are independent to set VAT rates. In Maharastra, 47% is levied as VAT on petrol while in Goa
it is 17%.