China’s higher fuel taxes: a step forward or more headaches for the government?

After fifteen years of debate, China’s government decided in December 2008 to raise significantly the taxes on oil products. The increases came into effect on 1st January 2009 and apply to the full range of oil products from lubricant oil and fuel oil, to jet kerosene and naptha, and to gasoline and diesel. Biofuels are exempt from these increases.


These tax rises are substantial. The tax on gasoline rises from 0.20 Y RMB/litre to 1.00 Y RMB/litre, and for diesel from 0.10 Y RMB/litre to 0.80 Y RMB/litre. Other oil products have seen similar rises to between 0.80 and 1.00 Y RMB/litre ( US 0.12-0.15/litre, or £0.08-0.10/litre). The retail prices for oil products were reduced in advance of 1st January 2009 in order that the application of the higher taxes would not cause an increase in retail prices. Pump prices in Beijing remain at around 5.45 Y RMB/litre for gasoline. Thus, fuel tax now accounts for 18% of the pump price, up from 3-4% in the recent past. At the same time the government has abolished six fees previously charged for road and waterway maintenance and management.


Though the taxes will also apply to farm vehicles, the government will increase subsidies to farmers and taxi drivers, and to the fishing, forestry and public transport sectors. At the same time, the government will seek to ensure that the oil refining companies retain a profit margin on their oil product sales.  


The government has clearly agonised long and hard before introducing this tax rise, and, in applying it now, has taken advantage of the relatively low level of international crude oil prices.  The aims of the reforms are said to be to encourage energy saving, to promote stability in the oil sector, and to assist economic reform. In the future, retail prices will be determined by market forces but, until that time, the government still plans to control domestic oil prices in order to dampen the impacts of international price fluctuations.


Given the wide range of supplementary measures introduced at the same time, it is far from clear what the impact of this tax rise will be and how the government will manage retail prices in the future.


In a market economy, such as the UK, the pump prices are determined by competition. Fuel tax accounts for a large proportion of the price, about 60% at present, with VAT adding another 15%. As a result, the pump price comprises 70% tax and 30% oil price. The government sets these the fuel tax annually, and sometimes may establish a policy of increasing the level of taxation at a set rate for a number of years. When international crude oil prices rise or fall, the tax remains unchanged, and the degree of change of pump prices depends on the behaviour of players in the domestic market. But the competition relates solely to that percentage of the price which is not tax. 


This approach has a number of advantages. The government receives a large and relatively predictable flow of revenue. At the same time, it can claim that the high tax is part of environmental policy, for the generally higher level of pump prices tends to encourage the manufacture and purchase of smaller, more fuel efficient vehicles. The relatively large proportion of tax in the pump price, together with fact that this tax is based on volume not on price, causes a considerable dampening of the impact of fluctuations of international crude oil prices on domestic pump prices. For example, a 50% rise in crude oil prices may only cause a 20% rise in pump prices. However, extreme increases in crude oil price, as we have seen in recent years, can still cause a dramatic rise in pump prices and may cause some drivers to modify their behaviour accordingly.


The disadvantage of the tax, at least as it is imposed in most countries, is that it is not set at a level sufficiently high to cause a radical change in people’s behaviour, at least not in times of ‘normal’ oil prices. The reason for this is clear. If the government really wanted the fuel tax to act as an environmental tax and to persuade citizens to leave their cars at home and use public transport, it would lose a vital source of revenue and would have to spend large sums of money expanding the public transport systems. Thus, claims that these taxes have environment protection and energy efficiency as primary objectives are without foundation.


Certainly fuel taxes can make a marginal difference by encouraging the manufacture and sale of more fuel efficient cars. But this may have an unfavourable knock-on effect, for car manufacturers can make large vehicles more efficient as well as small ones. As a result, the UK and other countries saw an explosion in the sale of SUVs (sports utility vehicles) and other large private cars during the late 1990s and early 2000s when oil prices were at modest levels and when incomes were rising. So, greater efficiency allowed people to by larger cars, rather than buy cars of the same size as they had before but with greater fuel efficiency. This phenomenon is a common result of energy efficiency policy: appliances become more efficient, but energy uses stays the same, either because larger appliances are used or because the same appliances are used to a greater extent.


A further disadvantage of the fuel tax is that, like all taxes, it is subject to political influence. In the UK the level of fuel tax may be adjusted each year, and is likely to respond to government revenue needs as much as to environmental policy. It is also open to lobbying by powerful fuel-consuming interests. For example, in the year 2000, truck drivers in the UK and in other European countries were able to bring extreme pressure on their governments to constrain or reduce fuel taxes after a sudden rise in crude oil prices. They achieved this by blockading oil refineries. Within four days the supermarkets were running out of food and the economies were coming to a halt.


So, how does the Chinese approach compare? Given that the government retains control over both the pump price and the fuel tax, the situation is quite different from that in most market economies. Indeed, as of now, it is almost impossible to say how pump prices will react to fluctuations in the international oil markets and therefore to predict what impact the tax will have on energy efficiency and the environment.


It is doubtful whether the government will receive more revenue, for it has abolished a number of existing taxes and has promised to raise subsidies to certain sectors. How it will keep its promise to allow the oil refiners to make profits is also not clear. With the oil price now forming a smaller part of the pump price, the government has little choice but to continue providing subsidies to the refiners, unless crude oil prices fall to sufficiently low levels that allow the refiners to make a profit without receiving a subsidy. If crude oil prices rise in a few months time, how quickly will the government pass these rises through to the consumer? If it decides to restrain the pump price, it has a choice of either reducing the fuel tax or increasing the subsidy to the oil refiners.


By introducing a higher fuel tax, the government may have taken an important step in reforming the market for oil products and in introducing a measure to support the energy efficiency policy. But until such time as the domestic market for oil products is liberalised, the government appears to have just given itself more decisions to make. In the past it had to decide the level of fuel price (without tax) and the level of subsidies to oil refiners and to certain oil consumers. Now it has to decide on the level of the fuel tax as well. This not only adds to the complexity of government decision-making, but exacerbates the existing ambiguity concerning future trends in domestic fuel prices in China.

Philip Andrews-Speed is Director of the Centre for Energy, Petroleum and Mineral Law and Policy at the University of Dundee, UK

Print Friendly, PDF & Email