VAT could trip

Updated: Jan 19 2005, 05:30am hrs
The long-awaited white paper on VAT is a well thought-out document. However, on a few important issues, several compromises have been made. Some of these may prove harmful.

VAT needs to be levied on all goods and services. However, for the time being, some important commodities like petrol and diesel are being kept outside this system. Another compromise allows tea-producing states an option to levy VAT at 12.5%, or at 4%. Similarly, an either/or provision is made for foodgrain: a 4% levy or full exemption. If such options are given, this may lead to an interstate tax war, or to disparities among various state VAT laws. Another compromise is on allowing tax incentives. Such schemes are not conducive to successful implementation of a VAT system. The chain will get disturbed.

The white paper claims to have a two-tier rate system. But there are actually four rates: 0, 1, 4 and 12.5%. The last rate, with excise and other local levies, would raise effective tax incidence to 25-30%, not conducive for growth. Continuity of other taxes is undesirable. The white paper should distinguish between zero-rated goods and exempted goods.

A commendable step is the raising of VATs threshold from Rs 40 lakh to Rs 50 lakh for traders. This will reduce administrative and compliance costs.

To widen the tax base, the service sector needs to be brought under VAT. A constitutional amendment has been passed allowing the Centre alone to levy service tax, but it has yet to be notified. And, the existing CST is a major deterrent to the success of VAT in the Indian federation. There is need for a clear roadmap to phase it out.

The author is professor and head, economics unit, Institute For Social and Economic Change, Bangalore