Taxes account for a substantial part of the governments income. Broadly, taxes are of 2 types Direct and Indirect.

. Indirect taxes are those taxes where the burden and levy of the tax are on different people. Flat rate taxes and ad valorem taxes are two types of indirect taxes. A flat rate tax is when a flat amount of tax is levied on each unit sold; such as an amount per liter/kilo. An ad valorem tax is based on the base value of goods sold, and since it is a percentage, the amount will increase as the base value increases. In this case, the government plans to implement: A flat rate tax of Rupee 1 per liter of fuel sold. An ad valorem tax of 8% on cars and 4% on two-wheelers.

Through this plan, the government aims to achieve two important long term objectives: Reducing the use of private vehicles to prevent congestion; and Popularizing public transport.

According to the Indian government, it can collect around Rs 5, 000 crore annually through this cess. With this money, the government plans to finance highway construction and urban transport infrastructure, thus subsidizing public transport by imposing taxes on private transport. The imposition of a Rupee 1 tax on auto fuel would lead to an upward shift of the supply curve, with the demand curve remaining unchanged (Figure 1). The demand curve does not shift because the quantity demanded at each price remains unchanged after the tax. However, the supply curve does shift upward by Rupee 1 everywhere. The reason is that producers will maintain supply at earlier levels only if they receive the same price (net of tax) as before. The incidence of tax on consumers and producers depends on the price elasticity of demand (PED) and supply (PES) of the product. The PED of auto fuel in this case tends to be highly inelastic as there are not any close consumer substitutes available. In my opinion, the PES could be elastic, as any increase in the price of auto fuels is likely to lead to an increase in the exploration activity and thereby increase the supply. However, in the short run, the supply curve

may be rather inelastic, especially in the present day since the world is running at close to maximum capacity. The incidence of tax on consumers is much more than the incidence of tax on producers in case of goods with inelastic demand. We will have a new supply curve SS which is parallel to the original supply curve SS and the distance between both the supply curves is of Rupee 1. The new equilibrium price is at E, where SS (new supply curve) meets DD (the demand curve).

Figure 1: effects of expenditure tax on petrol

As can be seen from Figure 1, the consumer bears most of the burden of the tax while the producers bear only a small part of the tax. Further, auto fuels, private transport and public transport are related as they are either complementary or substitutes in nature. Complementary goods are those where an increase in price of one good leads to a decline in demand for the other good. On the other hand, substitute goods are those where increase in price of one good leads to an increase in demand for the other good. However, the extent of this increase or decrease would depend on the cross price elasticity of demand.

Figure 2: demand for complementary and substitute goods

While, auto fuel and cars/two wheelers are complements, public transport and private transport are substitutes. Because of the rise in price of auto fuels (due to the imposition of a tax of Rupee 1 per liter as well as rising international crude prices), demand for both automobiles and fuel could decline in the long run. Further, the cess on automobiles could lead to a decline in the demand not only for automobiles but also for petrol. On the other hand, private vehicles and public vehicles are substitutes. As the price of automobiles rises along with that of auto fuels, the demand for private vehicles could decline. Consumers then could search for available substitutes of private transport and public transport could be the best alternative. The demand for public transport should then increase. Thus, the Indian government intends to subsidize public transport by taxing private transport. Besides making commercial sense, this could also be beneficial from a developmental angle, as this would reduce congestion and pollution levels.