Value Added Tax (VAT) is a general indirect tax assessed and collected on the value added to goods in each business transaction. It is levied on all commercial activities involving manufacture and trading of goods and services (services are not included in India). It is charged at a uniform rate as a percentage of prices at which the goods are transacted and it is effected at each stage of transaction in the production and distribution chain.
Introduction of VAT is considered to be a major tax reform as it eliminates the cascading effect of multipoint taxation associated with the existing sales tax regime. Sales tax is levied on the gross value without allowing any set-off for taxes paid on inputs. VAT is levied only on the value added after setting off the tax already paid on the inputs. Since VAT requires computerised records it provides for greater transparency. Thereby VAT reduces tax evasion and improves compliance. In a federal set-up like India, uniform VAT rates eliminate competition among states to offer tax reduction concessions to attract investment and thereby it prevents reduction of revenues. Once VAT is implemented India will become a common market and sales between states will become totally free. Each producer will have a big common market before him. However, in a federal country like India consensus among states is a precondition to introduce VAT. In USA, another federal country, VAT has not yet been introduced. However federal states like Brazil and Canada have adopted VAT with varying degrees of success. Usually it takes a few years to streamline the administration to prepare it to implement VAT.
In India, an Empowered Committee of the Finance Ministers of the States has been constituted for the purpose of arriving at a consensus and implementing a nationwide state-level VAT as a substitute for the present sales tax which is one of the main sources of revenue for the states.
The empowered committee of state finance ministers - headed by West Bengal Finance Minister Asim Dasgupta and comprising the finance ministers of Assam, Delhi, Gujarat, Jammu & Kashmir, Jharkhand, Karnataka, Madhya Pradesh, Maharashtra, Meghalaya, Punjab, Tamil Nadu and Uttar Pradesh - endorsed the suggestion that every State law on VAT should have a minimum set of common features. At the conference of State finance ministers held on January 23, 2002, it was agreed that all the 28 States as well as the Union Territories would introduce VAT with effect from April 1, 2003. This position was reiterated during the conference of State chief ministers held on October 18, 2002 that was presided over by the Prime Minister. The commitment to introduce VAT was repeated again on January 17 this year at a conference of finance ministers of States and Union Territories. The Kelkar Committee on tax reforms has also recommended introduction of VAT in its report. Subsequently, this year’s budget announced implementation of Value Added Tax (VAT) all over the country, to be effective since April 1, 2003.
But many states subsequently dithered. Only Haryana was able to introduce VAT by the April 1, 2003 deadline. Though 16 states have agreed to introduce VAT ten of them have not even passed the necessary legislation. Most of the North Indian states have made no preparation to introduce VAT. The deadline was extended to June 1 due to differences among states. Asim Dasgupta, the West Bengal Finance Minister and Chairman of the Empowered Committee declared that VAT would be in place by June 1. Dr.Asim Dasgupta argued that the 16 states that have agreed to introduce VAT represent 75% of the country’s trading and industrial activity and it wouldn’t matter if other states did not come forward to implement it.
States which have agreed to implement VAT from June 1 are Maharashtra, Gujarat, West Bengal, Madhya Pradesh, Karnataka, Andhra Pradesh, Tamil Nadu, Kerala, Haryana, Assam, Orissa, Bihar, Jharkhand, Tripura, Goa and Meghalaya. The Union Territories of Pondicherry, Daman & Diu have also decided to go ahead with the new tax regime from June. It is mainly the northern States, including Delhi, Rajasthan, Uttar Pradesh, Punjab, Himachal Pradesh and Uttaranchal, which will not meet the new deadline. "But we expect even these States to implement VAT before the end of the third quarter of the fiscal (i.e before December 2003)", Dr Dasgupta said. According to him, the reason for the delay in implementation by the northern States was "political" and not "economic". "The Delhi Government is apparently citing elections to its State Assembly in November for not implementing VAT immediately. And since Delhi is not implementing VAT now, the neighbouring States are also hesitating", he said.
Actually, the traditionally pro-BJP traders lobby has also been vigorously opposing VAT. Madan Lal Khurana has emerged as their key spokesperson. A delegation of top party leaders met Prime Minister and asked him for deferring introduction of VAT. Subsequently, the Union Finance Minister Yashwant Singh declared that it was not feasible to introduce VAT by June 1 and stressed the need for further postponement as there is unevenness with several states clearly unprepared for implementation of VAT.
On its part, the Centre has also said that the inter-state taxes (Central Sales Tax) would be abolished only gradually after the introduction of VAT. Thus there is no immediate incentive for many states to implement VAT and for all practical purposes it has been shelved till the coming round of elections is over.
There has been opposition to VAT on several grounds. Firstly, the traders lobby is opposed to the introduction of VAT and the traders have observed an all-India strike opposing its introduction. Over 1,00,000 traders from all over the country converged in Ramlila grounds in a rally on April 8 to protest introduction of VAT. The traders lobby cites the possibility of harassment by the tax inspectors as the outward reason for their opposition. Under VAT system pucca records need to be maintained which is very cumbersome and would lead to harassment, they say. "The VAT is good for manufacturers, but bad for traders. We are protesting against the extensive procedural formalities that will have to be followed by traders under the new regime, resulting in increased transaction costs," Sanjay Sethi of the Confederation of All-India Traders said.
However the real reason is different. There is less scope for tax evasion under VAT and there will be stricter compliance. The traders lobby wants to retain the scope for tax evasion as it exists at present under the sales tax. This being the real underlying reason for their protest there can be no sympathy for their opposition. To exempt small traders from VAT the minimum turnover for VAT has been made Rs.5,00,000. But the traders lobby argues that this limit is too low.
Some have expressed apprehensions that introduction of VAT would lead to price rise. If we go by the experience of other countries only in Uruguay and Chile there have been high inflation following the introduction of VAT and in other countries the price rise has been marginal.
States are reluctant to introduce VAT because it would reduce the revenue. The Centre has acknowledged the possibility of reduction in revenue following substitution of sales tax by VAT and had offered to compensate the states for the revenue reduction for three years. Though initially there might be a fall in the revenue, after a period of time the revenue would be buoyant as the compliance would improve. Though Jaswant Singh announced in his budget that VAT would be implemented from April 1 this year he has made no allocation in his budget for this year to compensate the states for their revenue loss. This only means that the Centre was not very keen or hopeful of introducing VAT this year.
Dr. Ashok Mitra, noted Marxist economist and former Finance Minister of West Bengal, has opposed VAT because it would be a negation of the federal principle as it would concentrate more powers at the Centre and also because it is being introduced at the behest of the WTO. Recently the World Bank has also urged India to expedite the introduction of VAT as this is the best way to tax services, which now form more that half of the GDP. Some commentators have expressed concern that the benefits of VAT may not materialise if the Government keeps colluding with the trading community - a big part of the currently formal economy may turn informal - to avoid paying any tax at all. Giving automatic input credit to dealers and manufacturers under VAT without proper computerisation is like giving blank cheques to them. False input credit will eat up revenue.
Other commentators have pointed that revenue neutrality (a) between labour and capital; (b) between choices for consumers; and (c) between different allocations of resources is possible only if the market is perfectly competitive and free, the VAT rate is uniform and is without exemptions. In a developing country tax policy should not be neutral but diversionary and pro-active towards development by incentives and disincentives to a desired degree. An alternative to VAT is retail sales tax (RST), which does not create any cascading effect. However this option is good only when the rate is kept low and taxpayer compliance is good. If compliance is bad, then obviously, even VAT will be no better.
Some states are reluctant to introduce VAT in a situation when many other states have not introduced it. The advantages would accrue to all only if all the states introduce VAT. If there is unevenness and if some states do not introduce VAT those which introduce will be at a disadvantage. For example, many in West Bengal have expressed their opposition to the introduction of VAT in an uneven manner. This opposition is based on sound and valid reasons.
West Bengal Finance Minister Asim Dasgupta is however in an unenviable position. As chairman of the Empowered Committee of state finance ministers he, and his party CPI(M), are bound to support implementation of VAT under all conditions come what may. At present, services are not being taxed by the states. Since the service sector accounts for more than 50% of the GDP it is a lucrative area for generation of tax revenue. But Asim Dasgupta and the CPI(M) are not vocal for a constitutional amendment to include services to be taxed by the states. Gone are the days when the CPI(M) used to chant "more powers to the states" as its main slogan. No wonder then that Asim Dasgupta was made the chairman of the Empowered Committee in the first place.
- Girish Ghildiyal