This does not seem to be a sound principle

Written by Mahesh C Purohit | Updated: Jul 1 2008, 04:50am hrs
The Indian constitution provides autonomy to the sates. It appends List II, that is, the state list, which enumerates the functions and resources of the states. The constitution also provides for setting up of the finance commission to award tax sharing and grants-in-aid from the centres kitty to the states. All these provisions are to provide an autonomous status to the states.

In the past when the government of India worked as a facilitator to help states introduce VAT it did guarantee States to compensate for the loss of revenue mainly because the VAT was a new tax.

On the contrary, when the centre took away some fiscal power of the states, the states were compensated. This happened, for example, in the case of the levying of additional excise duty in lieu of sales tax on textiles, sugar and tobacco. Hence, the states had to be compensated for the loss of their fiscal power and tax revenue.

The recent decision of the central government to hike prices of petroleum productspetrol by Rs 5 per litre; diesel by Rs 3 per litre; and cooking gas by Rs 50 per cylinder and subsequently requesting the states to reduce the rate of sales tax is not at par with the compensation given to the states for taking away a fiscal power or for VAT.

In this case, the central government has also reduced its own taxes on these products. This has been done to check the inflationary impact of the skyrocketing prices of crude in the international marketthe import duty on crude oil is reduced to nil from 5%, while import duty on diesel and petrol is cut to 2.5% from 7.5%. Also, excise duty on petrol and diesel is cut by Re 1. The reduction in tax will cost the central exchequer Rs 226 billion this fiscal year. These measures will sustain the fiscal health of oil companies and reduce the spiraling prices.

Though there has been a reduction in tariff and excise, the price of petrol, diesel and LPG has gone up in all the states. Petrol and diesel will cost Rs 50.56 and Rs 34.80 per litre, respectively in Delhi and Rs 55.51 and Rs 39.08 per litre, respectively in Mumbai. The prices of these products vary in states because of the varying rates of VAT.

To soften the impact of the new prices of these commodities, many of the states have now brought down their tax rates slightly, in some cases. It is learnt that the Empowered Committee of State Finance Ministers has opined that as a result of the cut in the state taxes on petroleum products as well as reduction in devolution of funds caused by the Centres move to reduce customs and excise duties on these products, the states stand to lose at least Rs 8,000 crore in the remaining part of 2008-09. It is, therefore, suggested that the at least 50% of this loss should be met by the central government.

This does not seem to be a sound principle of federal finance. The authority to levy state-VAT belongs to the states and they should use the power according to the best rational principles, as they are autonomous. Also, this is not a case when the centre is taking away some of their power.

The states must strive to use their own fiscal powers to mobilise resources and get the maximum tax resources as is feasible. The whole idea of the centre in suggesting reduction in tax rates to the states is to share the burden. If the centre were to be bear it alone, this could have been done directly by a further reduction in excise duty.

The time is ripe for the states to finally must understand that it is better to have specific tax on these products than an ad valorem tax so that a price spiral does not take place. Also, the states must realize that by giving away their power of mobilising resources through the imposition of uniform rates rather than floor rates for an important tax, they are scuttling their own fiscal powers as well as autonomy in the near future.

The writer is director, Foundation for Public Economics and Policy Research, New Delhi