The Hindu Business Line : VAT compensation may not fully meet revenue shortfall

In fact, several of them are likely to face large shortfalls this year. Last April, at least 16 States and Union Territories in the country had shifted to VAT regime on the assurance that the Centre would compensate revenue shortfalls.

Last year, the Centre made provisions of Rs 5,000 crore in the budget for the current fiscal year.

However, the revised estimates have been scaled down by a little over 50 per cent.

In fact, the compensation estimated for this fiscal is just Rs 2,495 crore in the expenditure budget.

Revenue shortfall

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.

Karnataka is faced with a revenue shortfall for the first nine months of the current year. The State's Deputy Chief Minister, Mr P.S. Yediurappa, who holds the finance portfolio, said, "The revenue deficit so far is Rs 800 crore."

Expectations are that the revenue shortfalls would be much higher when the fiscal year ends. In the larger States, indications are that the revenue deficits are far more severe, which means that the compensation demands would be much higher from them.

However, sources said, compensation would not be paid out on the basis of revenue shortfall estimated by the States themselves. Instead the payout would be based on an agreed formula, where tax buoyancy would have a substantial weightage.

Tax buoyancy implies the incremental growth in revenues for every percentage point rise in the gross state domestic product (GSDP).

But what has also alarmed the States is that for the next fiscal year, the compensation has been reduced to about Rs 2,950 crore.

This would mean that they would have to examine alternative revenue raising methods.

To find alternatives

In fact, this revenue shortfall expectation was one of the major reasons for their reluctance to reduce sales tax levies on petroleum products, diesel and petrol that contribute a substantial chunk to the State revenues.

Besides, what has also taken out a substantial chunk of revenues from the State is the shift of liquid petroleum gas (LPG) to the Central Sales Tax.

Under the revised formula, the LPG can be taxed at 4 per cent on an ad valorem basis instead of 12.5 per cent, the maximum rate prescribed under the VAT regime.

The combined revenue shortfalls would now imply that States would have to improve the tax administration substantially and raise the tax to GSDP ratio to ensure revenues remain buoyant.

Or they must find move innovative methods of raising revenues to ensure that they meet the revenue deficit targets, as mandated in the Fiscal Reforms and Budgetary Management Act.