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Phasing out Central Sales Tax

The phasing out of the Central Sales Tax (CST), recently agreed upon by the empowered committee of State Finance Ministers, is a step long overdue and should help in refining the State-level value-added tax system (VAT). In fact the continuance of the CST after a majority of the larger States decided to adopt VAT in 2005 was an anomaly that went against the basic tenets of the new tax regime. Besides, it has been an obstacle to the emergence of an all-India common market, one of the laudable objectives of the VAT regime. Under VAT, as it has evolved so far, each State provides tax credits to manufacturers for inputs sourced from within its borders but not for those coming from outside. The Centre continued to levy a tax of 4 per cent on such goods and distribute the proceeds among the States. Evidently, the inability of the present system to capture all transactions occurring within the boundaries of a State, regardless of where the goods come from, has necessitated the continuance of the CST. It follows that the case for continuing with the CST will disappear if the States move towards a totally harmonious system under VAT. Although some progress has been achieved here, the goal is still elusive. The other major shortcoming was the less than universal coverage of the scheme, when it was introduced less than two years ago. With Tamil Nadu having joined in, Uttar Pradesh is the only large State still staying away. The timing of the moves to taper off the CST — initially it will be brought down to 3 per cent from the present 4 per cent — seems propitious.

However, despite the consensus among States, there are a number of practical difficulties in compensating the States for the loss of revenue consequent on the reduction in CST rate. It is only after the forthcoming budget season that the details of the compensation package will be fully known. However, it seems certain that the Centre will transfer to the States the entire tax revenue in respect of certain services and provide budgetary support for any shortfall. Besides, in a move that has major implications for other aspects of public finance as well, States might also be empowered to tax certain services on their own. Critics may find fault with the relatively long time frame of four years fixed for bringing down the CST to zero. Still, an initiative that pre-dates the formal introduction of VAT requires considerable political will and a reasonable consensus before it could be implemented. The phasing out of the central sales tax, though not a radical step in terms of the time frame, will certainly smooth out the VAT system.

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