Bihar, an innovator? A trailblazer? A champion of reform? Surprisingly, all true. Bihar is looking to introduce a revolutionary new model for administering VAT, which would seek to provide a truly simple regime for small taxpayers, and a complete e-governance solution for medium and large taxpayers. This, even as the Empowered Committee of Finance Ministers debates various approaches and options to usher in the Goods and Services Tax.

The Investment Climate Department of the World Bank has been working with the Bihar government on a tax simplification project for the past year. The purpose is to identify changes needed in tax laws, procedures, rules, forms and systems in the commercial tax department, to reduce compliance burdens for taxpayers and increase efficiencies in tax administration.

For the purpose, three diagnostic tools were used: a survey of over 1,000 taxpayers and 280 tax accountants, process mapping of the tax administration, and study of other states? laws and procedures.

The survey revealed the majority of VAT taxpayers in Bihar are small (with turnover between Rs 5-20 lakh) trading concerns, with 72% of the businesses having a turnover of less than Rs40 lakh. Less than 9% own a computer. They bear a substantially higher compliance cost?3.5% of turnover?compared to larger businesses for whom this cost is a negligible 0.2% of turnover.

In the opinion of respondents , only half of the businesses actually liable to pay VAT are currently registered. Most crucially, it was found that dealers overwhelmingly believe that the process of payment of tax is more onerous than the tax amount itself.

No wonder, then, the tax payment distribution is so skewed: 81% of the registered dealers under VAT law contribute only 0.87% to the total. These findings highlight the fact that the problems and capacities of small businesses are significantly different from those of medium and large businesses. And so, the approach to be adopted to facilitate tax compliance of small businesses should also be different.

Accordingly, the key feature of the Bihar model is to segment taxpayers in two groups: small?turnover below Rs 40 lakh; medium/large?turnover of Rs 40 lakh and above. For the medium/large taxpayer segment, the model proposes exclusively an e-governance based regime: mandatory e-filing of returns, e-payment of taxes, online issuance of C-forms and route permits, and IT-based tax administration and enforcement.

It is for the small taxpayer segment that the model is truly revolutionary. It proposes a highly simplified tax regime: a lump sum tax payment of Rs 10,000 for those in the turnover band of Rs 10-25 lakh; Rs 30,000 for those in the turnover band of Rs 25-40 lakh. It would require a simple one-time, annual return. Most importantly, no scrutiny or inspection. The main reason surveyed businesses cited for not wanting to register for tax is harassment by tax officials. This model, by specifying lump sum payment, and doing away with mandatory 100% scrutiny, takes away the discretionary power from the hands of the tax officials and reduces scope for rent seeking.

However, is a simple regime sufficient incentive for small businesses to register? Probably not. The Bihar model seeks to further incentivise small, informal, non-taxpaying businesses to register for tax and join the economic mainstream by also providing help with other critical small business needs: access to finance, insurance and market information.

The proposal is to set up Laghu Kardata Seva Kendras that would, in addition to providing tax services to small taxpayers, facilitate loans from banks and financial institutions for the businesses that register for tax. The Kendras will also help small businesses get in touch with insurance providers and avail insurance services for their businesses. It is also envisaged that other services, such as provision of market information, would also be provided by these Kendras. It is proposed that these centres be set up as a public-private partnership, with a private or non-government organisation working with the commercial tax department to establish the Kendras.

As the survey conducted in Bihar shows, it is estimated that there are as many firms not registered for VAT as there are that are registered. Given about 1,20,000 registered firms, the same number of firms have turnovers above the threshold but remain outside the tax net. If the small taxpayer scheme proposed by the model is successful in attracting new registrants, there exists a huge potential for increasing formalisation in Bihar; at least the estimated 1,00,000-odd firms that are today choosing to stay informal are potential formalisers. To the extent formal firms have greater access to finance and hold out a much greater promise for future growth, the

Bihar model for VAT administration can be a very useful instrument of industrial and economic growth and generation of employment.

The Bihar model was discussed in the Empowered Committee of State Finance Ministers on Friday, October 30. Dr Asim Dasgupta is believed to have observed that it is an interesting proposal that could be followed by other states if it succeeds in Bihar. So, Bihar is pioneering an innovative approach in tax administration that other states could one day emulate. A truly wonderful example of how dynamic political leadership can bring moribund bureaucracies to life. Hope does float.

The author is with the Investment Climate Department of the World Bank and was formerly OSD to P Chidambaram