VAT is dat?

Changes needed in central and state sales tax

Value Added Tax is desirable, indeed. VAT not only makes the indirect tax structure efficient and transparent, it also makes it easier for India to defend anti-dumping or anti-subsidy investigations launched by trading partners. But what about its modalities? Ideally, one ought to have a completely central VAT, with no variation among states. But Constitutional provisions prevent this. Therefore, one has in mind a VAT chain with some taxation (wholesale, perhaps) at the central level and some taxation (up to a retail threshold) at the state level. That said, states should not have too much flexibility in choosing rates. Perhaps three centrally-determined rates, with states free to choose one of the three, should suffice. However, this model is not easy to implement. First, there is need to modify the present system of central excise, central sales tax and state-level sales tax and this is impossible without amendments to the Constitution. Second, local bodies need to have revenue generation sources. Without this amendment, local body taxes cannot be eliminated and VAT remains incomplete. Third, VAT switches taxation from manufacturing (excise) to expenditure (sales tax) and there is need to compensate states that suffer revenue losses.

Given these constraints, it is understandable that movements towards VAT aren’t swift. Central excise has been somewhat rationalised to Cenvat, but special excise still contradicts VAT principles. While changes in special excise are unlikely in the next budget, there ought to be changes in central sales tax and state sales tax. The Parthasarathy Shome committee has recommended eventual abolition of CST (from the present four per cent). But as an interim measure, it was suggested that CST be reduced in two phases, to one per cent by 2003. Compensation to states remains a thorny issue. Perhaps one will witness a first-stage reduction to three per cent, with some formula emerging for compensation. Understandably, the centre argues that buoyancy will more than neutralise expected revenue losses but several states don’t buy this. A possible quid pro quo can be in transferring taxation of some local services to states. On sales tax, the issue is one of harmonising maximum rates, now that floor rates have been unified. Harmonised classification and coding, and state-level VAT legislation are also necessary. There is a difference between steps towards VAT and full-fledged VAT. The former is possible from April 1, 2002, not the latter.