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States seek more Central aid for VAT switchover

C. Shivkumar

One of the major factors ensuring buoyant State Government revenues is the cascading effect of the current ad valorem method of taxation.

Bangalore , July 1

STATE Governments have sought greater financial support from the Centre for migrating to the value-added tax (VAT) regime for offsetting potential revenue losses.

Sources said here that unless the Centre was prepared to make such support through increased grants for the States in the Budget, the 2005 deadline would be difficult to adhere to.

The proposal involved shifting sales/commercial taxes to VAT sales tax realisations comprise about 75 per cent of State Governments internal revenues.

In fact, the States would have migrated to VAT in 2003 itself if the Centre had committed on this kind of compensation. However, in 2003, the budgetary provision for Central support to States on account of VAT shortfalls was Rs 700 crore. The States though had sought a budgetary provision in excess of Rs 3,500 crore, which was not accepted. This year, however, the figures were likely to be higher. This was in view of the 8 per cent GDP growth in the last fiscal, which translated to greater tax realisations.

Few States were prepared to accept a reduction in these tax revenues without any compensation. At present, one of the major factors ensuring buoyant State Government revenues is the cascading effect of the current ad valorem method of taxation.

Under this method, the tax is levied as a per cent of the value of the goods/services. A transition to VAT would, therefore, imply that the actual revenues would come down, since the tax incidence under VAT applied only to the value addition at each stage.

The fear of a revenue loss was also high because few States fulfilled the criteria of a high tax coverage ratio. Tax coverage ratio is measured by the tax to gross State domestic product (GSDP).

In most States, including the Left-ruled States, this ratio was barely 5 per cent of the SDP. Only in Maharastra, Gujarat and Tamil Nadu, the tax coverage ratios were higher implying greater compliance. In fact, in these States, the ratios were closer to about 8 per cent, about the same level as the Centre's. As a result only these States were expected to be VAT ready by the prescribed deadline, the sources said.

One major reason for the low tax-GDP ratio was that few States were prepared to tax farm incomes. In fact in all the States where the tax to GDP ratios were low, contribution of agriculture to the GSDP was close to about 60 per cent. But none of the States were prepared to levy agricultural income-tax. Tax on agriculture is a State subject under the constitution. Actual collection of agricultural income tax for the last fiscal was a piffling Rs 110 crore.

The Left parties are now in the forefront for taxing "rich farmers," incomes in the Budget to be announced on July 8. But even in Left-ruled States such as West Bengal, farm tax realisation was just Rs 16 lakh in 2003-04, according to figures in the RBI survey on State finances.

Most States, the sources said, would prefer to have farm incomes collected by the Centre and then apportioned to the States. This would, however, involve amendment to Article 270 of the Constitution. Therefore, amendment of the article required the concurrence of all the States.

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