Towards further progress on VAT

The decision of five States under the rule of the Bharatiya Janata Party, besides Uttar Pradesh, to switch over from sales tax to the system of State-level value added tax is a vindication of the front runner States which had adopted VAT last April. This leaves Tamil Nadu as the only major State yet to declare unambiguously its intention to opt for VAT. The reported increase in revenue collections, to the extent of about 14 per cent, in States that have already gone in for VAT is not surprising, considering that the VAT system widens the base of taxation and offers a built-in disincentive to fraudulent practices such as under-invoicing and fictitious invoicing, and minimises the scope for corruption. The adoption of VAT should be beneficial not only in terms of proceeds from the trade chain but also by way of providing an incentive to investment in manufacturing since it allows the set off of taxes paid on inputs, including capital goods, and the tax on inputs is itself fixed at a moderate level of four per cent. Suggestions that the input tax be raised to five per cent should be treated with caution since higher taxes would only raise the cost of production.

The Union Government had long ago made clear its intention to compensate States, on a tapering basis, for loss of revenue on account of the proposed phase-out of Central sales tax (CST). Instead of harping on the adequacy of the compensation, States would be better advised to be vigorous in seeking an early abolition of the CST, which is a levy on inter-State commerce and militates against the emergence of a competitive and single large common market. The demand of States for power to levy tax on certain services (as distinct from merely sharing the proceeds of the service tax) is unexceptionable. Once States are allowed to levy and collect tax on some of the more organised of services — leaving aside insurance, telecommunication, sharebroking, and a few other money-spinners for the Centre — the tendency among States to levy taxes in an irrational manner to garner revenue could be checked. A case in point is the imposition of "sales tax" on telecommunications, through a misinterpretation of the concept of "deemed sales" which was actually meant to cover only hire purchase, leasing, and work contracts. Also, States should appreciate the need for further devolution in favour of local bodies the power to levy a tax on certain services, especially the ones that tend to be in the unorganised sector such as cyber cafes, beauty parlours, caterers, pandal contractors, and many more such service providers who might be brought under the tax net in future. Such decentralisation would facilitate the identification of the potential assessees and also create an incentive for the populace to demand accountability and performance from local bodies in terms of their obligation to provide local infrastructure and social services.

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