Tax on luxury cars will help no one, not even inflation

Last week, inflation touched 8.75% confirming that inflation has perhaps crossed 9% and if you factor in the June 4 petroleum product price hikes, it will cross 10%. Everyone seems to be predicting that by November’08, the base effect will kick in and reported inflation will come down. Still, if the direction in which prices are moving does not change, it does not bode well.

A government that is preparing for elections less than 12 months down the line cannot face an electorate with a hole in its pocket. To show that it is acting, it can behave irrationally at times. So far, it has banned futures trading in some items, banned exports of food items and imposed export duties on items like steel. And, more came last week. A kind of a luxury tax on cars has been imposed by the government. Careful not to offend first time car buyers who will buy a small car, higher duties have been levied on cars with an engine rating of more than 1500cc. That would target all the so-called medium end and premium car segment. The logic seems to be to make these cars more expensive so that demand goes down. Or it hopes to garner additional revenues from these customers and use that elsewhere.

If it aims to lower demand for fuel, then it should tax small cars more because the small car market will be a much larger consumer of fuel. But then, touching them will offend the middle class populace. Of the million odd cars sold in India, more than 70% comprises small cars, ones like the 800, Alto, Santro, Wagon R, Spark and the like. Among the rest, in the mid-size category, there are cars with an engine rating of below 1500cc too while most of the upper end segments will fall under the 1500cc and 2000cc and above category. The move will affect cars in the A3 and above segments. This segment has been gaining as car owners upgrade.

Maruti Suzuki’s A3 segment sales have grown by 42.1% in the first two months of 2008-09, chiefly due to the launch of its sedan version of the Swift, Swift Dzire. In 2007-08, sales grew by 66% driven by the SX4. The Swift Dzire will not get affected as it has a 1300cc engine while the SX4 will, as its engine rating is 1586 cc. The press release says that it aims to target the affluent society only. An unintentioned victim will be the Ambassador, as it runs on a 1800cc engine.

There are other anomalies as well. The Honda City Zx for example which has an ex-showroom price of Rs 713,000 hardly qualifies as a budget car, but it has an engine capacity of 1497 cc, which exempts it from the levy, it would seem. That’s why it is futile to make any precise calculations on the revenue earning potential for the government. Cars with engine capacity of 1500cc to 1999cc will pay Rs 15,000 extra while those above 2000cc will pay Rs 20000 extra.

About 18% of cars sold would be in the A3 and plus segment, and about 4% in the A4-A6 segments. Then you have the multi utility vehicles and sports utility vehicles to add to this, which are not counted among the cars. The logic of the move is not compelling. When the government announced a favourable duty structure for small cars, many car manufacturers who were not meeting those standards, tweaked their models to come under its umbrella.

A repeat of that situation is likely in the current situation too creating distortions in the marketplace. The only exception will be in the super premium segment, where neither the owners nor the sellers will care about issues such as an Rs 20,000 levy. A neater solution would have been to eliminate differential excise treatment given to small cars and then impose a specific duty on all cars, as a temporary measure till crude prices and inflation both cool down. That may be drastic but it will at least not create weird distortions in the auto market.

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