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Wednesday, Jun 23, 2004

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Opinion - Editorials

ANOTHER ATTEMPT AT VAT

THE UNITED PROGRESSIVE Alliance Government has decided to make a new effort to get the State Governments to replace sales tax by value-added tax (VAT), a promise that was made in the Common Minimum Programme. This will be the first attempt by the UPA Government but the deadline of April 2005 that the Centre and the States have now agreed on will be the sixth since 1999. It is generally accepted that a value-added tax regime will reduce the scope for evasion, be transparent and more efficient from the economic point of view. Yet groundless fears of a loss in government revenue, a lack of adequate preparation, and the power of the trader lobby combined to stymie successive attempts to introduce VAT in the States. Learning from the past is therefore essential to make the latest endeavour a success.

State Governments have always claimed that a shift to the new form of retail taxation would, in the interim, result in a decline in revenue and that therefore the Centre should provide adequate compensation. The National Democratic Alliance Government agreed to a phased reduction of assistance — 100 per cent of any loss would be neutralised in the first year but the compensation would slide to 50 per cent in the third and final year. While the revenue effects of the introduction of a new tax are difficult to estimate with any degree of precision, a commitment from the Centre to make up for a notional loss may be necessary to win over financially strapped States. This promise Union Finance Minister P. Chidambaram has reaffirmed. There is also merit in another demand of the States that the Centre should share collections from the service tax imposed in the more buoyant sectors. To make fiscal sense, a retail VAT has to be imposed on both goods and services. But the system that has been planned makes provision for States to levy the tax only on goods, while the Centre and the States will share the powers of service taxation. The States have now asked that either the Centre hand over a part of its revenue from service tax or expand the list of services under the authority of the local governments. There have been five previous deadlines for a national switch-over from retail sales taxes. What has been lacking was confidence that traders, the tax authorities, and consumers had been sufficiently educated and prepared for the shift. This was especially true among retail traders who would be required to carry out a substantial degree of paper work.

Evasion is much more difficult when taxes are imposed on a value-added basis at the retail stage. This explains the resistance from the special interest lobby of large traders. However, small retailers do have a case for payment of a flat rate of tax rather than follow a VAT system in which they will be burdened with a large compliance cost. State Governments will therefore have to consider allowing retailers with annual sales of, say, up to Rs.5 lakhs to pay a fixed turnover tax. This is the only way to prevent large trade from using the legitimate worries of small retailers to oppose the introduction of VAT. The difficulties in changing the form of retail taxation need not be overestimated. Haryana is one State that has already introduced VAT. In the first year of operation, 2003-04, the State Government's revenue increased by 25 per cent. A simple four-rate tax structure has facilitated both collection and payment, and exemptions for traders with a low turnover have neutralised opposition from the special interest lobby. There is no reason why other State Governments cannot, with generous Central Government support, succeed like Haryana.

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