The Hindu Business Line : VAT: There's value in the design

In a country like India which has a limited income-tax base or depends mostly on indirect taxes that have a pronounced volatility, value-added tax can be a reliable source of revenue. The Centre must speed up its implementation with a carrot-and-stick approach.

IN A functioning democracy, any policy anarchy is a travesty especially when the issue under study has implications for the welfare of the people at large. The introduction of the value-added tax (VAT) from April 1 has brought several concerns to the fore, defeating the very objective of evolving seamless movement of goods across the country with little harassment to the ultimate consumer or detention of goods any where.

VAT is a simple, transparent, multi-stage levy with input tax credit that eliminates cascading and no resultant price escalation. It is beneficial to the common public.

The Empowered Committee of State Finance Ministers decided that a number of State-level levies on purchase or sale of goods such as sales, turnover, purchase, and entry taxes would be subsumed in VAT.

That is, a single tax would replace a plethora of levies. The Committee finalised the VAT design after much deliberation and full consideration of gains offered by the system and taking into account the concerns of all the stakeholders.

The Empowered Committee of State Finance Ministers decided to continue with the Central Sales Tax in its present form in 2005-06. It would review the levy later and advise the Centre accordingly. Under the VAT system, about 550 goods would be covered and there would be only two basic VAT rates of 4 per cent and 12.5 per cent plus a specific category of tax exempted goods and a special VAT rate of 1 per cent.

Under the exempted category, there would be about 46 commodities comprising natural and unprocessed products in unorganised sector. Under the 4 per cent category, there would be about 270 goods comprising items of basic necessities and declared goods including drugs and medicines. Gold, silver, bullion, precious stones would be taxed under one per cent VAT rate category while the remaining commodities would attract 12.5 per cent rate.

Only 21 States joined the VAT, with all the BJP-ruled States such as Rajasthan, Gujarat, Madhya Pradesh, Chattishgarh and Jharkand and others such as Uttar Pradesh and Tamil Nadu not willing to put in place the regime.The contention of these States is that the existence of CST along with VAT and also the local sales tax (LST) would leave the traders at sea in compliance practice, which would erode their margins besides pushing up the prices of the products.

For the Centre, the coexistence of VAT with the CST is no confusion because "VAT... is a State level tax which shall be levied only on intra-State sales. Central Sales Tax shall be levied, as usual, on inter-State sales of goods between VAT and non-VAT States".

Even as the yields of the CST is shared among the States which average Rs 15,000 crore a year, the CST has the advantage of tracking the movement of goods across the States so that no tax is evaded. Presumably, the new VAT had a design flaw in tracking movement of goods across the borders in the event of elimination of CST so much so that there were worries that traders in many States might misuse this to avoid payment of VAT.

If VAT is what its advocates say in glowing terms, why is it that traders are fuming over its introduction?

First, they are sore over the retention of CST/LST alongside VAT, creating confusion and escalating their transaction cost.

Second, even after a month and half of its introduction, State VAT Acts and Rules are not available, leaving consumers to the mercy of merchants. Even as the VAT votaries contend that it will replace the extant system of inspection, the VAT Acts of various States stipulate a number of provisions that allow inspectors to visit dealers with this process even being proposed at the time of taking the registration number.

For instance, traders in Delhi with a turnover of less than Rs 5 crore are expected to file at least four assessment returns even as the VAT law had dispensed with the trader-savvy safety nets against arbitrary directions of the Sales Tax Authorities.

Taking a dig at the VAT's simplified form of returns, the Confederation of All India Traders maintains that the States VAT Acts not only consolidate inspector raj but the returns forms are so designed that they cannot be filled up without the assistance of chartered accountants and tax parishioners.

No doubt the introduction of VAT provides a chance to rid the system off cobwebs and revamp a considerable part of the rickety tax administration that has not shown a modern mind-set to collect tax with maximum efficiency and minimum trouble.

That is why the Finance Minister, Mr P. Chidambaram, goes rhapsodic over the inherent virtues of VAT. As he remarked: "the ongoing effort on VAT, which should ultimately yield a single national market and a symmetric treatment for goods and services, is a supremely important project through which India will achieve a modern tax system".

An IMF study in 1991 on VAT said it is not designed to correct for income or wealth inequalities. "Perhaps, combined with the introduction of VAT, income-tax collections should be strengthened to ensure that the progressive rates legislated are actually collected."

On the issue of VAT's regressive and iniquitous nature, the IMF study said that instead of resorting to simplistic use of exemptions and zero rating by trying to amend and distort the VAT, its strengths should be used to generate revenue that will enable the government help the poor in more effective ways.

"This is probably a more positive way to tackle the issue of regressivity than throwing out the VAT or manipulating the new tax until its merits are eroded," so argues the IMF, implying the importance of this crucial form of destination-based tax that provides due credit to inputs used at every stage.

In a federal set-up the direction of the Centre and its use of budgetary allocations for providing Plan assistance are significant levers, which could be deployed to bring in a progressive piece of legislation. Instead of chorusing that it is only "a facilitator" and the actual groundwork and launch of VAT are vested with the State governments, the Centre should act now before any precious time is lost. If the Centre is not able to persuade all the States to come on board to implement VAT, the experiment would remain so with little efficacy.

In a country like India which has limited income-tax base or depends mostly on indirect taxes that have a pronounced volatility, VAT is a reliable tax source. It is a pity that not much spadework has been done in evolving an easy and replicable design for the VAT system to succeed. Such tasks as registration and taxpayer identification, invoicing and bookkeeping requirements and collection, including the role of electronic data processing must have preceded the launch of VAT.

A recent report by the National Council of Applied Economic Research (NCAER) estimates that an electronic payment mechanism will save time and transport costs and other costs equivalents, which will equal 1.06 per cent of the gross domestic product (GDP).

The NCAER paper states that if VAT is introduced in computerised format, it will not only widen the tax base, it also enhance the level of collection, by plugging the leaks that are inherent to the current paper-based system.

As the goal is to have a national level VAT which would reduce distortions with favourable effects on investment and exports, Mr Chidambaram should have a carrot and stick policy to ensure the smooth functioning of the VAT system.

In November 1999, Dr. Manmohan Singh, as Finance Minister, had initiated the debate on VAT introduction, replacing the sales tax systems of the States.

Perhaps, Mr Chidambaram can take guidance of Dr Manmohan Singh so that VAT is taken to the next logical step of implementation by his Government itself.

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

Stories in this Section
`Powerless' in Maharashtra

VAT: There's value in the design

The yin and yang of business

Ending the testing times for students

The changing face of banking

Stress testing and Basel accord

Hope and frustration in Afghanistan — Mr Jean Mazurelle, World Bank's country manager in Afghanistan

FDI in retail