The decision by the Uttar Pradesh government to introduce state value-added tax (Vat) is the last nail in the coffin of states sales tax and a good example of how good economics can be good federal politics. It also puts an end to the extensive efforts by the empowered committee of state finance ministers to bring all states within the new Vat regime, finally concluded almost three decades after it was first mooted by the LK Jha Committee. Haryana was the first state to implement Vat as early as in 2003, but the biggest gain was in 2005 when 21 states joined in after the central government agreed to compensate them for any loss in collections. Last year, five more states were finally roped in, tempted by the tax buoyancy in states that implemented Vat. In fact, state tax collections have improved by 17 basis points during the Ninth Plan to 1.09 points, and yields from Vat are expected to go up further. Though acceptance of destination-based state Vat may have been slow, the move marks a major change as states had to self-impose restraints on their taxing powers and agree to bring in at least a fair degree of uniformity in rates across the country. But they have, in return, been rewarded by a sharp acceleration in Vat revenues, which exceeded projections. The implementation of state Vat in all states now gives a big boost to efforts to introduce the goods & service tax (GST) in 2010, as planned.
But even now there are a number of anomalies that need to be corrected if the notion of a true national common market for goods and services is to be created. Some of them, like the central sales tax, are now being gradually phased out. Recently, both Punjab and Maharashtra have also shown an inclination to do away with the archaic octroi (an entry tax dating back to Roman times) to make them more investor friendly. Hopefully, this will help create a situation where controls at state borders can be abolished altogether in a few years? time. But there are larger challenges regarding the taxing powers and the sharing of revenues that the Centre and the states must work out on its road towards implementing a GST. Only a careful design of the tax collection mechanism will ensure continued buoyancy in collections and a reduction of fraud.
