VAT will widen States' tax base

THE SYSTEM of State-level value-added tax (VAT) finalised by the Committee of State Finance Ministers (CSFM) will be less than the ``ideal'' VAT but would still represent a substantial progress over the current complicated system which results in evasion, corruption and a narrow tax base.

If VAT is introduced, as intended, in April 2002, all over the country, it will be another step towards strengthening the ``common market'' character of the Indian economy and also helping Indian manufacturers face both international and domestic competition.

A first step in this direction, already implemented, was the agreement reached by States on enforcing a floor rate (not uniform rate) of tax on identified commodities and the agreement to abolish, with prospective effect, tax exemption/deferral for attracting investment.

Going by a presentation made by Dr. Pawan Kumar Aggarwal, Professor, National Institute of Public Finance and Policy (New Delhi), in Chennai recently under the auspices of the Madras Chamber of Commerce and Industry (MCCI), the proposed VAT design (see Table) will retain some weaknesses of the present system.

These negatives include continuation, for a few years, of the Central sales tax (CST), which is both levied and collected by States on inter-State transactions and is ``Central'' only in terms of its enabling legislation) and turnover tax or additional sales tax (AST), which is in the nature of a tax on income since, at least in concept, it is not allowed to be recovered from the consumer.

Also, there will be more than one rate, namely, exemptions which break the VAT chain and two other (floor) rates. (Regarding octroi, entry tax, entertainment tax and similar levies, the Finance Ministers have not so far discussed their integration into VAT, according to Dr. Aggarwal).

Nevertheless, introduction of a State-level VAT should be welcome for its many advantages, despite the resistance of trade, attributable partly to traders' failure to understand the concept and partly from their reluctance to go back into the ST net for fear of harassment by tax officials and hassles of record- keeping. (At present, there is single-point, that too mostly first-point, taxation, on most commodities in most States and hence traders in subsequent stages of the transaction chain are out of the ST system).

Tamil Nadu, which passed a legal amendment as far back as 1996 for introducing VAT at the second seller's point (and not till the last retail point) suspended its operation right from the beginning because of inadequate preparation and failure to enlighten traders on the system. Not much headway has been made in several States even now in creating awareness about the beneficial effects that VAT would have for manufacturers, traders, consumers and the tax administrators, namely, for the economy as a whole.

The first need is to make the potential assessees understand that in the multi-point VAT, tax at every stage will be levied only on the value added by the manufacturer or trader at his point, by giving the manufacturer/trader credit for taxes on his inputs/purchases against the tax payable on his sale. Also, the operation of the system would not involve disclosure of the traders' margin.

By refunding tax on inputs/purchases, the net benefit to the consumer is that at every stage the tax element added to the cost of the commodity is restricted to the value added at this stage. Thus the price escalation caused by taxing the tax element included in the cost of a commodity at every stage of sale till its last point of consumption is avoided.

What is more, under the present system, traders tend to consider the tax element in their purchases as part of their investment and include it in calculating their mark-up or profit margin while pricing. This ``pyramiding'' effect of tax on prices will also go once VAT is introduced.

The two aspects, together with the fact that VAT makes the choice of raw materials and processes independent of the distortion in their relative costs caused by differential taxes on them, will strengthen the competitiveness of Indian products in both domestic and foreign markets.

The States' exchequer should also benefit because the tax base will be widened and the entire value addition occurring after the first point of sale will be captured under VAT. According to Dr. Aggarwal, it was found in a study of the electronics sector that the value addition after the first point of sale was 400 per cent.

This reflected partly genuine value addition at subsequent stages by way of transportation, packing and repacking, selling costs and the like, and partly the undervaluation indulged in by dealers at the first (and only) point of tax.

The VAT system has an in-built disincentive against evasion because at every stage of sale, the buyer will insist on a proper invoice/bill so that he could claim credit for the tax paid by him on his purchases.

The revenue-neutral VAT rate would tend to be higher than present rates initially to compensate for loss of revenue from phasing out of CST, input tax credit and zero rating of exports and inter-State transactions. However, once VAT leads to the expected buoyancy, the rate can be lowered progressively.

Of course, there are many issues that need to be attended to before VAT is enforced. These include computerisation at the official level, education of the staff and inculcating an assessee-friendly culture among them and preparation to deal with transitional problems while operating the VAT system.

R. GOPALAKRISHNAN

in Chennai

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