Atanu Dey On India's Development

Fuel Surcharge for Private Cars

In a piece I had written for the Indian Express (see “How we subsidize the rich“, Feb 15, 2008), I had advanced a tentative solution to the problem of how fuel subsidies benefit those rich enough to afford cars at the expense of the poor. Here I will address a few objections raised against the idea.

But first, here’s the recommendation:

But those subsidies have to be reduced, if not totally abolished overnight. A start could be made immediately to reduce the subsidy to the rich while continuing it for the poor. A mechanism for doing so would be to impose a tax on car owners which would reflect the full cost of the petrol they use. Depending on the size of the engine and average fuel consumption, an annual fee could be assessed which has be paid to maintain registration. So if a particular make and model of car typically consumes, say, 1,000 litres of petrol a year, the tax could be Rs 10,000.

Veeru in a comment on a Pragmatic Euphony post objected saying in essence that the scheme will penalize car owners who drive less than the average number of miles (for a particular make and model) and subsidize those who drive more than average. In short, there will be a cross-subsidy. He made his case using a hypothetical Maruti van owner who only uses it for the occasional family weekend outing, as opposed to another owner who uses his Maruti van extensively for business.

Sure, in a world where it would be costly to figure out exactly how many liters of subsidized fuel every car driver uses (and then impose a tax calculated to negate the subsidy), one is forced to go with averages, and that immediately forces a cross-subsidy. But here’s the point: if you know that you are a low mileage user, knowing that you are subsidizing others will enter into your calculation on whether to keep that car or not. It is up to you whether you wish to keep the infrequently used car which on average is used extensively by others.

Imagine that I like to drive the tractor of an 18-wheeler once a year for 100 kms just for kicks. So I own one. But, on average those tractors rake up 100,000 kms a year and (suppose) that the annual fuel surcharge is Rs 20 lakhs. It is up to me to decide I want to belong to that club.

One cannot base policy on outliers.

S Karthik makes a point that is somewhat related to Veeru’s point. He says that since a car owner who drives lower than average miles is forced to pay the same fixed cost of the average annual surcharge for that make and model of car, that fixed payment is a sunk cost and therefore will not enter into the calculus of how much he will drive. Karthik thus concludes that this will not reduce the number of miles driven.

The flat per-car tax that Atanu proposes will have no negative impact on the amount that people drive. It is a fixed cost every year. Thus, at the margin, the driver doesn’t know the true cost of the extra kilometer he drives. Thus, he will tend to drive more than what is optimum from the point of view of subsidies, etc.

Another problem with Atanu’s plan is that it creates perverse incentives. Light users of the road end up subsidizing heavy users of the road. Yes, there is still a substantial cost of driving which prevents a “true” tragedy of the commons from occurring. Still, this kind of incentive is likely to only increase the amount that people drive.

A plausible argument but not correct.

Fixed costs do not enter in the picture ex post but do enter ex ante. If the flat-tax is imposed on me after I have bought the car, it will not substantially change the number of miles I drive. But note there is an “income effect” — by paying that fixed cost, I have less money and therefore I will drive a little less.

Nor will my decision to buy or to buy a particular car (or even any car at all) be affected if I did not know that such a flat-tax may be imposed. However, if I know before hand that I will be paying a flat-tax as a fuel surcharge, it will affect my decision to buy or not, and also affect how much I actually drive. The last thing I would do is to increase my driving so as to creep as close to the average miles driven: it would be akin to cutting off my nose to spite my face.

A Larger Issue

Car owners in India today not only get subsidies for the fuel they use, they also impose substantial negative externalities. These externalities negatively impact those who have nothing to do with cars. Cars emit pollution. The driver benefits from the engine running the car and the airconditioner but the (literally and figuratively) poor pedestrian suffers the exhaust from that engine. Roads are costly to build and maintain, and take up enormous amounts of space. Those costs are not fully paid for by car owners. In India, parking is not fully priced: I have seen car parking fees as low as Rs 10 an hour in Mumbai — where the space occupied by the car probably sells for a few lakhs and therefore the correct parking fees should be around a hundred rupees.

I like the solution that Singapore has. (What else is new?) They have a huge upfront tax on cars. I believe that cars there cost approximately three times what it costs in the US. This discourages people from owning cars. On top of that, Singapore invests heavily in public transportation and gives people an incentive to use them by keeping prices low, frequency and quality of service high, etc.

The last time I was in Singapore, I took the train to the airport. At the start of the journey I paid S$ 5 and when got back S$ 3 at the end of the journey when I turned in the card at a smart card machine at the airport. The ride was fast, comfortable, and cheap. When I arrived at Mumbai, I took a cab from the airport. The ride was slow, uncomfortable, and expensive.

Related post: “The price of oil and the wages of stupidity“.

  • http://www.cse.iitb.ac.in/~parijat parijatgarg

    Atanu. Somehow, this solution that you have provided, and the rationale does not feel comfortably snug with free market economics. Sure, I could decide to not buy a car at all. However, if you are living in Gurgaon and wish to commute to Delhi once in a while, it is sort of imperetive to have a car. And yet, a flat tax per car (based on model, etc) seems all but unfair.

    In any case, if the cost of petrol for the country is higher, it must be charged at the pump and nowhere else. If anything, petrol pumps could be authorized to charge more for filling up car-tanks as opposed to say scooters or mo-bikes. Of course, you’d soon have the problem of petrol-pumps refusing to carry enough inventory of “cheaper” petrol for bikes as opposed to that for cars, forcing two-wheeler owners to also get petrol at the prices for that of a car. But then, any kind of subsidy is a distortion and an incentive to cheat – you can expect nothing more and nothing less.

  • http://www.sundarmail.com Sundar

    There should be a special annual tax on private cars and even on two wheelers. This money should be used to build excellent public transport networks. I agree with the large issue you had mentioned.

    Fuel surgarge on private cars does not look practical and feasible. This will be withdrawn the moment fuel prices go down and the larger issue will be forgotten.

  • http://www.deeshaa.org Atanu Dey

    Parijat:

    I did not say that petrol at the pump should not be charged at full cost. In fact, I am arguing for it. My solution was just an intermediate step, as I clearly note in the excerpt quoted.

    Also, my solution is not anti-free-market. Free markets work. But for them to work, one of the conditions (necessary but not sufficient) is that externalities are compensated for. Imposing a surcharge is an attempt at fixing the distortion. It is a second-best solution in a second-best world.

    This whole matter of a free market and why it makes sense is a topic for an independent post. Perhaps in some time I will write more on it.

  • lurker

    Why not tax for the number of miles driven per year? That tax rate would be based on the make/model or engine capacity/power/etc.

    PS: Can we no longer register a username on this site?

  • http://www.sundarmail.com Sundar

    Lurker:
    If it is based on Miles, lots of mechanics will get busy fixing / resetting milometers.
    Any credit for negative miles? :-)

    PS: Chennai used to have autos with tampered meter to inflate the charge. Now we have more electronic meters but never switched on and flat rates charged are expensive than Cool cabs in Mumbai!.

  • dp.chalasani

    Atanu,

    Do you own a car?

  • http://www.deeshaa.org Atanu Dey

    DP Chalasani:

    No, I don’t own a car. Unlike in the US, in India I can do without a car.

    I love cars and consider myself the second best driver in the world (note, my inherent modesty in admitting that there is one better driver in the world than I.)

    Seriously, though, I’d like to know why you ask.

  • lurker

    It is obvious that any solution comes with the following caveat. The first thing that the govt should do before imposing any tax on any thing, is to build a very good public transport ( if not like in Singapore, atleast like Mumbai). Btw, good public transport in Metros and big cities is still feasible, but what about cities like Raipur, Bhopal, Allahabad, Belgaum. There are simply tooo many of them. I doubt if govt possess the resources and more importantly political, admininstrative, financial and social will in such a huge scale as to build public transport in all these cities. I am assuming its not a feasible solution. So possibly, the best solution is to increase the rates of petrol. When that happens those who cant afford to drive car wont drive, those who can drive will still drive according to their new altered budget. Possibly, thousands of people whose living depends on not increasing the fuel price will be on the streets, but what to do, if we exploit the nature, someday this is bound to happen anyways. We cant fool ourselves longer, the market has to come into a new equilibrium according to the rising fuel cost. Let market rule.

    – Pravesh Biyani

  • dp.chalasani

    Atanu,

    The reason I ask is…might owning a car bias your thinking?

    Hey, I thought I was the second best driver on the roads! You just spoiled my day!

  • lurker

    The case you are making, and the case that some have problem with being victimized, is the current case of common man. Even though he rides a bi-cycle (so to say), he still feels the heat of the oil (both literally and economically).

    On the other hand, I wonder how much can technology can solve this problem. If you wire something to the odometer that gives how many miles a vehicle has traveled, it could be possible to make everyone happy (although ppl who travel more will still crib, thanks to our ancestral attitudes). Technology (especially information technology) has the potential to solve a lot of our problems without the need for much (in)human intervention. But I am just dreaming. :-)

    -Mike