India’s fuel tax dilemma: The fall in oil prices after the US-Iran interim agreement should not comfort New Delhi for long. Brent crude slipped to about $77 a barrel on June 18 after the deal eased fears over the Strait of Hormuz. Only in March, the government had cited crude’s jump from about $70 to $122 a barrel while cutting excise duty by ₹10 a litre on petrol and diesel. Retail prices were kept unchanged, with the benefit used instead to reduce losses at Indian Oil, BPCL and HPCL.
That sequence is the point. The price may fall. The vulnerability remains. The Strait of Hormuz carried about 20.9 million barrels a day of oil flows in the first half of 2025, around a fifth of global petroleum liquids consumption. India, which imports close to nine-tenths of its crude oil, cannot treat every oil shock as an isolated event. It is a recurring exposure built into the economy.
The usual prescription is to cut fuel taxes when crude prices rise. That is politically understandable. It is also a weak long-term answer. Cheap fuel raises consumption, weakens the signal to shift to alternatives, and cuts the fiscal revenue needed to reduce oil dependence. India should tax petroleum, but with discipline. The revenue should finance the systems that lower future dependence on imported crude.
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Petroleum tax and India’s oil import risk
India already has a large petroleum tax machine. PPAC data for 2025-26 project the petroleum sector’s total contribution to the central and state exchequers at ₹8.18 lakh crore. Within that, central taxes and duties on crude oil and petroleum products are projected at ₹3.83 lakh crore. Central excise alone is projected at ₹3.08 lakh crore. State sales tax and VAT on POL products are projected at ₹3.18 lakh crore.
These numbers are too large to be treated as routine budget support. They are a strategic resource. At present, much of this money disappears into general expenditure. That is fiscally convenient, but it wastes the logic of petroleum taxation. If fuel taxes are justified by oil dependence, pollution, congestion and import risk, part of the money should be tied to those costs.
A fixed share of central petroleum duties should flow into an Energy Security and Transition Fund. Even 10 per cent of central taxes and duties on crude and petroleum products would yield roughly ₹38,000 crore a year on 2025-26 projections. A 15 per cent share would cross ₹57,000 crore. The money should go to grid storage, public transport, EV charging, refinery efficiency, green hydrogen, solar manufacturing, and rural energy systems that cut diesel use.
The design should be simple. Parliament should define the fund. The Finance Ministry should publish annual inflows and project-wise outflows. CAG should audit it. Money not spent in a year should remain in the fund, not lapse into general revenue.
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State fuel taxes need purpose
State fuel taxes vary because petrol and diesel remain outside GST. This gives states flexibility, but it also creates large differences in pump prices and revenue. PPAC’s state-wise data show Maharashtra collecting ₹38,742 crore in sales tax and VAT on POL products in 2025-26, Uttar Pradesh ₹32,772 crore, Gujarat ₹28,913 crore, Karnataka ₹26,357 crore, and Tamil Nadu ₹25,883 crore. The all-state total is projected at ₹3.18 lakh crore.
States will resist any arrangement that threatens this revenue. That is why the answer is not a sudden GST shift that leaves states anxious. A better route is a compact. States keep their fiscal space, but a declared share of incremental petroleum VAT goes into state-level energy funds.
Maharashtra could use it for suburban rail, buses and charging infrastructure. Uttar Pradesh could use it for city bus fleets and rural feeder electrification. Karnataka could use it for Bengaluru’s public transport and grid upgrades. Tamil Nadu could use it for industrial electrification. The point is not uniformity. The point is that fuel tax should buy lower future fuel demand.
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Windfall tax should return in oil spikes
India has already used windfall taxation. In July 2022, the government imposed a Special Additional Excise Duty on domestic crude production and duties on fuel exports after global prices surged. The initial levy on domestic crude was ₹23,250 a tonne. A Rajya Sabha answer later put estimated SAED collections at ₹25,000 crore for that financial year.
The case for such a tax is strongest when price rises come from war, sanctions or chokepoint disruption. ONGC, Oil India and private producers may gain from international prices without adding reserves or efficiency. Refiners may gain from export margins when domestic consumers and oil marketing companies face pressure. The government should capture part of that surplus.
The windfall tax should not be arbitrary. It should have a published trigger based on the Indian crude basket and product cracks. It should be reviewed fortnightly, as earlier. The revenue should go entirely into the Energy Security and Transition Fund. That makes the tax easier to defend. Companies can object to the rate, but not to the principle that crisis gains should help finance energy security.
Other economies have used similar instruments. The European Union adopted a solidarity contribution on surplus fossil fuel profits for 2022 and 2023. The United Kingdom raised its Energy Profits Levy to 35 per cent and extended it. India does not need to copy their rates. It needs a clear trigger and a clear use of proceeds.
Fuel tax should not punish the poor
The strongest objection to high fuel taxation is distributional. Poor households spend a larger share of income on transport, LPG and goods moved by diesel. A high fuel tax that funds general expenditure is regressive. A high fuel tax that funds targeted transfers and public transport need not be.
India has the machinery to do this. PAHAL showed that LPG subsidy could be moved into bank accounts and that bogus connections could be cut. Government figures put savings under PAHAL at ₹59,599 crore up to March 2019.
A share of petroleum tax revenue should fund direct transfers to the bottom 40 per cent of households when crude prices breach a defined band. This should not be a universal fuel subsidy. Universal subsidies reward higher consumption. A direct transfer protects poorer households while keeping the price signal intact for richer consumers, car owners, airlines, logistics firms and diesel-heavy users.
The same logic applies to buses. A rupee spent lowering petrol prices benefits the owner of a large car more than a bus passenger. A rupee spent on public transport lowers fuel demand and helps the commuter who does not own a vehicle.
Carbon pricing can start inside existing taxes
India need not begin with a textbook carbon tax. It can start within the existing excise structure. Fuels with higher carbon and pollution costs should face higher levies. Cleaner substitutes should face lower levies. This can be done through excise and cess adjustments, without building a new tax administration.
Sweden offers a useful lesson, but not a model to copy mechanically. It introduced a carbon tax in 1991 and raised it gradually. In 2026, the Swedish carbon tax rate is SEK 1,520, or €138, per tonne of fossil carbon dioxide for natural gas and coal. The Swedish government says carbon pricing through tax and the EU ETS now covers more than 95 per cent of its fossil carbon emissions.
India’s circumstances are different. It is poorer, more energy-hungry, and far more dependent on imported oil. That is why gradualism matters. The starting point should be a carbon signal within petroleum taxation, not an overnight economy-wide carbon tax.
There is also a trade reason. Carbon border measures in Europe and elsewhere will punish carbon-heavy production. Indian industry will be better placed if fuel prices start reflecting carbon costs at home, with revenues used to finance cleaner power, storage and industrial fuel switching.
Norway’s oil lesson for India
Norway is often cited too loosely. It is an oil exporter. India is an oil importer. The two countries do not face the same problem. But Norway’s fiscal lesson is relevant.
Norway created the Government Pension Fund Global to shield the economy from swings in oil revenue and save for future generations. Petroleum revenue is transferred to the fund, invested abroad, and only a limited share of returns is used in the budget. The fund now holds around NOK 21,300 billion in assets. Norway’s petroleum tax system carries a combined marginal tax rate of 78 per cent.
India cannot build a Norwegian oil fund from domestic production. It can build an energy security fund from petroleum taxation. The difference is important. Norway saved oil wealth. India should use oil taxes to reduce oil imports.
That means fewer unfunded schemes and more hard assets. Battery storage. Transmission. Charging corridors. City buses. Metro systems. Rail freight. Solar pumps. Domestic solar and battery manufacturing. Green hydrogen where it can replace imported fuels in refining, fertilisers, steel and shipping.
The National Green Hydrogen Mission targets at least 5 million metric tonnes of annual green hydrogen production by 2030. PM-KUSUM has installed more than 10 lakh standalone solar pumps and solarised 13 lakh grid-connected pumps, according to the government. These programmes need steady funding, not annual uncertainty.
Tax the barrel, but spend honestly
The case for petroleum taxation is not that fuel should be expensive for its own sake. It is that India pays a large strategic cost for oil dependence, and part of that cost should be recovered at the pump and from windfall profits.
The bargain should be explicit. Consumers pay fuel taxes. The government uses a defined share to cut future oil dependence. Poor households receive direct transfers when crude spikes. States use part of VAT revenue for public transport and electrification. Oil producers and refiners pay windfall taxes when war or disruption raises margins.
The alternative is familiar. Cut taxes in a panic. Hold pump prices through opaque under-recoveries. Let OMC balance sheets absorb the shock. Watch crude fall. Then wait for the next Strait of Hormuz scare, the next OPEC cut, the next war, the next sanctions cycle.
India cannot control the barrel. It can control what it does with the tax collected on it.
Dr Vijyapu Prasanna Kumar is Assistant Professor, Jindal School of Banking & Finance, O.P. Jindal Global University.