Reform of the oil sector is long overdue. The problems in the sector emanate from the structure of central taxes and the system of price subsidisation. Solutions to the problems need to address both tax and subsidy aspects simultaneously. The social losses from this problem are many; misuse of scarce petroleum resources, diversion, adulteration, improper substitution between products, tax arbitrage, distortion of consumer preferences and input choices of industries, and international cross hauling of petroleum. Nearly all these loses arise not because of subsidisation per se, but due to the use of varying retail prices that are used to subsidise. Tax reform – viz casting all taxes in the form of value added taxes has not taken place in the sector despite the passage of nearly 15 years since such reform was put in place in nearly all other sectors of manufacturing. Complete deregulation of the sector allows oil producers, oil refiners, marketing companies, and integrated operators to price their products as they deem fit. Recasting central indirect taxes into a value added tax, as for any other product., i.e., allowing input credit for all registered intermediate users of petroleum products is overdue. Central government revenues can be protected by working out a revenue neutral value added tax rate. Such a tax regime would also be neutral to the degree of vertical integration and remove the biases in the use of products. The Public Distribution System (PDS) is not necessary and ought to be dismantled. Kerosene as well as  LPG would then be sold in the open market for all consumers. The second best proposal involves the recommendations as before but additionally creates a “Crude Price Stabilisation Fund” (CSF) that allows crude prices to be moderated, so that the pass through is influenced by the managers of the CSF. It is important that CSF be set up as an independent body and insulated from the government and governed by strict and automatic rules. A fund of $40 billion (Rs. 200,000 Cr) envisaged as a credit line would work in most situations. The fund would operate with strict limits on the quantum of the credit line used to pay out stabilization. To ensure that such crude stabilisation measures do not affect the competitiveness of the industry, exports of product shall be taxed when crude is subsidised, and subsidised when crude is taxed. Appropriate conversion factors would apply. 

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