April is the cruelest of months

Updated: Jan 22 2002, 05:30am hrs
Will there be value added tax from April 1, 2002 It seems increasingly unlikely that we will stick to this deadline. There are at least four reasons why we want VAT. First, the present indirect tax structure is non-transparent and has cost cascading effects. Second, it leads to barriers in inter-state movements. Countries are removing barriers to trade between countries. And we are not able to do it between states. Of course, all inter-state barriers are not because of indirect taxes. But, several of them are. Third, the present system makes it difficult for Indian exporters to defend against anti-dumping and anti-subsidy investigations. Fourth, it also makes it difficult to work out a World Trade Organisation-compatible system of export incentives. In the more than 100 countries that have introduced VAT, implementation has not been easy. India is no different. Fifteen states and five union territories were supposed to move to VAT from April 1, 2002, with others (including Chhattisgarh, Jharkhand and Uttaranchal) following by April 2003. This requires agreement on harmonised classification of goods (a relatively simple problem), state level VAT legislation (which is happening), systemic improvements and training within states (questionable whether this is happening fast enough) and agreement on rates (an intractable problem).

VAT will replace state level sales tax. So if states continue to vary VAT rates between states, that will make nonsense of the VAT idea and fail to eliminate the present inter-state variation in sales tax rates. We seem to have some agreement on basic principles. There will be four (or five) VAT rates. A zero per cent exemption rate will apply to agricultural products. There seems to be consensus on this, as there seems to be on the 1 per cent rate for bullion and the 4 per cent rate for industrial raw materials. The 20 per cent demerit rate on products like liquor or tobacco also seems to be agreed upon. If there is any disagreement, that is probably more about what item should be included where. The fifth rate, the so-called revenue neutral rate, is where the problem lies.

If this is a proper revenue neutral rate, there are no revenue loss implications. But since sales tax rates vary, proper revenue neutral VAT rates will also vary and this doesnt get us far on harmonisation. To ensure harmonisation, one needs to set a range for these revenue neutral rates, with a cap of 12.5 per cent and a floor of 10 per cent being suggested. States that have high sales tax rates are up in arms, fearing revenue losses, even though fears of revenue losses are probably exaggerated. This becomes a classic prisoners dilemma type of problem. While on sales tax, what happens to fiscal exemptions granted for investors They dont belong in a VAT regime. Nor will they be granted after April 2002. But what happens to those that were granted earlier Will they end in April 2002 States seem to have differing views. But they have a consensus that entry tax, octroi and local body taxes cant be looked at now.

Nowhere is the revenue fear as pronounced as in the case of Central Sales Tax. CST has a minor problem in that the CST Act only permits single-point taxation, unlike the multi-point taxation VAT requires. But the more important issue is that CST shouldnt coexist with VAT. It should be scrapped from April 2002. But states are paranoid about the Rs 10,000 crore CST brings in. So CST will not be scrapped. The rate will not be reduced from 4 per cent to 3 per cent or 2 per cent in April 2002. It will not be replaced by a Central Purchase Tax, paid by a dealer or consignee in the purchasing state. It will continue with VAT, until we have figured out the revenue implications of VAT. Meanwhile, the mess on inter-state stock transfers will continue.

This is despite states obtaining revenue from taxing services. Strictly speaking, states cant tax services. The Indian Constitution precludes it and needs to be amended, so as to move services to the Concurrent List. That takes time. Pending this, one can have a Service Tax Act. Like the CST, this will allow the centre to impose a service tax and authorise states to collect and retain the revenue. Apparently, 51 such services have already been identified, to add to the 41 that are already taxed by the centre. This list of 51 includes such diverse services as: well drilling, labour contractors, pest control, movers and packers, public address systems and florists. Imagine the hell that will break loose. As it is, services are taxed on turnover and no VAT credits are available. A few years down the line, when one argues that VAT credits should be available for services taxed by states, states will again complain about revenue losses. Incidentally, have states agreed that there wont be special duties on top of VAT rates, to compensate for assumed revenue losses

The centre seems to be just as concerned about revenue. Logically, if we are going to have VAT, the special excise should be junked and spliced with Cenvat. Instead, if we are lucky, the three special excise rates of 8, 16 and 24 per cent will be merged into a single rate of 16 per cent. Since the 24 per cent rate is applied to so called luxury items, even this will create an uproar. Scrapping special excise entirely No way. Revenue considerations will also ensure that the additional excise duty on sugar, tobacco and processed fabrics will continue. And by the way, petrol, diesel and other petroleum products are outside the purview of VAT. Understandable. Look at the windfall of Rs 2,000 crore these products brought in recently. Forget any hope that the special additional duty on customs will disappear.

There is an impression that VAT will solve problems and make life simpler. Perhaps it will, somewhere down the line. But not now. For the moment, life is likely to get somewhat more complicated. And it is increasingly likely that the deadline of April 2002 will be knocked back. Commerce ministry will have to wait for its WTO-compatible package.