Unfortunately, the introduction of a Value Added Tax (VAT) is likely to be postponed beyond April 1, 2003 because of impending elections in about 12 states next year. Besides electoral reasons, the states fear of revenue losses has also been a driving force behind the postponement as is evident from meetings of the empowered committee of state finance ministers. The goal of a national VAT involving the Centre and states thus looks a distant dream, if not a chimera. Both the Centre as well states must do some soul-searching if VAT is to become a reality. It is not difficult to nail the misconception that this tax regime is inflation prone. The challenge essentially lies in designing a revenue neutral VAT that should not cause inflation since no additional revenue is being collected. While this is fine in theory, at the practical level VAT may affect some commodities with higher rates than others with lower rates. It is also observed that some traders hardly, if at all, pass on any tax benefit through the chain of production and distribution. That is why any beneficial price effect on these commodities gets neutralised and the possibility of inflationary impulse from VAT looms on the horizon. But this is largely an issue of monitoring and can hardly be an excuse for postponing it. Many countries have in fact followed such a method to keep an eye on price movements after the introduction of VAT.
The states feeling of revenue loss is compounded by the fact that their own revenues have lost buoyancy of late. The Union finance minister therefore has to come out with an alternative formula to compensate the states in this regard. That will convince them of the Centres sincerity. One way would be to extend the residual tax powers of states to tax services. VAT itself needs some revamping. The origin-based VAT where revenue accrues to the state that exports a good to another state should be changed to a destination-based one where revenue accrues to the importing state for VAT is a tax on consumption. The Centre can compensate states that lose from the shift by assigning selected services for taxation. Some lessons can be drawn from Brazil that has successfully implemented VAT since 1960 and over 100 countries that have VAT at the central level. The challenge in India lies in implementing VAT at both levels in a federal structure. Political expediency should not stonewall its implementation.