The Hindu Business Line : States opting for VAT may not get full compensation

STATES that opt to shift over to the value added tax (VAT) regime are unlikely to receive full compensation for revenue shortfalls as demanded by them.

Official sources said that instead, most of them were expected to receive substantially lower amounts than sought. Under the compensation proposal by the Centre, States were promised a full compensation in the first year, 75 per cent in the second and 50 per cent in the third year. However, the budgeted provision for such compensation in the Union Budget for 2005-06 was only Rs 5,000 crore.

So far only Karnataka has decided to shift to VAT regime. The shortfall estimated on account of the shift over to VAT in Karnataka was estimated at Rs 2,160 crore or about 44 per cent of the provisions in the Union Budget. Accordingly, the VAT compensation provision in the Central Budget was sufficient to meet the needs of a handful of States, the sources said.

For meeting the requirements of all the States or even a majority of the states shifting to VAT, the provisions would have to be enhanced substantially, the sources said. This was especially since the States such as Andhra Pradesh and Maharashtra have much larger revenue bases than Karnataka. Both these States have own tax receipts that are larger than Karnataka by at least 50 per cent and 70 per cent respectively. Consequently, their shortfalls were expected to be considerably larger.

However, meeting the compensation of all the States would lead to fiscal deterioration at the Centre, they said.

Full compensation to the States, on the estimates of shortfalls made by the respective States would imply a considerable escalation in the Centre's non-plan expenditure. This would in turn push up the fiscal deficit way beyond the estimated 4.3 per cent of GDP.

Consequently, the sources said the States shifting over to VAT would receive only compensation considerably less than what has been demanded. VAT compensation was expected to be made on the basis of a formula by the Centre.

Tax buoyancy would have a considerable weightage in determining the compensation, the sources said. Tax buoyancy implies the incremental growth in revenues for every percentage point rise in the gross state domestic product (GSDP).

But, fear of shortfalls in revenues has prevented many States from shifting over the VAT regime. States such as Tamil Nadu, whose revenue base was large, were still reluctant to shift to VAT, fearing that revenue shortfalls, would lead to fiscal deterioration. In fact, for States that are attempting to conform to zero revenue deficit target, as prescribed in the Fiscal Reforms and Budgetary Management Act, shifting to VAT would mean an escalation in the revenue deficit, the sources said. It would also imply that some of them may not find revenues even to support their targeted revenue expenditure.

As a result some of the States have preferred to wait till such time the formula for VAT compensation itself became transparent or look for alternative revenue raising methods before switching over to VAT.

Such revenue raising methods included introduction of entry taxes, a practice adopted only by a few States.

Article E-Mail :: Comment :: Syndication :: Printer Friendly Page