Preparing for VAT

THE FINAL REPORT of Karnataka's Tax Reforms Commission comes as an addition to the existing body of literature on India's moves to switch over to Value-Added Tax (VAT), to begin with, at the State level. Attempts to prepare the States for VAT over the past years have not yet resulted in a building up of the required confidence levels. In addition is the backdrop of the not-so- successful attempts by the Centre since the mid-1990s to cajole States to move away from counter-productive rate wars, which could trigger a race to the bottom. The Karnataka document, which comes at a time when policy-makers at the State level are engaged in charting out mechanisms to move to VAT, should serve the purpose of building a consensus. Given the States' fears about VAT, the Report merits serious attention on two counts: the detailing of the tasks ahead - at both the State and the Central levels - and its discussion of the impact of VAT on State revenues. It is reflective of the apprehensions at the State level on possible revenue losses as much as it is indicative of the extent to which a State will go to ensure that the mechanism takes root. The magnitude of changes required to be made to usher in VAT make it, as the Commission rightly points out, ``the most significant event in fiscal federalism since Independence''.

Managing this transition is going to be hard for States, especially given the uncertainty over the status of revenues from their own sources. The Commission's analysis of emerging scenarios of VAT on commodities as well as services requires broader debate and serious study. Among the several tasks remaining to be done before the April 2002 deadline agreed upon for the State-level VAT, an important one is that of rationalising the various levies - taxes on sales, purchases, turnover, entry and infrastructure - into a single VAT. That there is little preparedness on this front raises serious doubts on the possibility of effectively and successfully meeting next year's deadline. In the long run, the mismatch between the efforts taken in the past in sensitising States to the need for reform and the concurrent reform of Central excise should be a cause for concern. This uncertainty is likely to dampen the efforts by the States in bringing in reforms within. Moreover, as the Karnataka report shows, little has been done at the State level in terms of administrative and departmental preparedness to move towards VAT.

By emphasising the importance of the need for clarity on such corresponding reform, the Report's observation that the prevailing situation could cause distortion is a serious one that requires correctives. It is equally important to strike the right balance between harmonising tax policies and procedures and fiscal autonomy at the State level. Interaction between States, yet another issue dealt with in the Report, is also an urgent requirement to avoid tax exportation. The larger issue of a review of the taxation powers of the Centre and the States under the Constitution is also required as the steps towards introducing VAT at the State level are but a prelude to a national-level VAT. The more apprehensive the States are about the possibility of their revenue sources being diminished, the less likely they are to move towards fiscal reform. While these issues remain to be addressed, it is equally important to address the opposition expressed by trade bodies across the country, which had resulted in some early-bird States - Maharashtra, Tamil Nadu and Andhra Pradesh, for instance - withdrawing the proposed reform measures.

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