The Hindu : Can VAT deliver proclaimed benefits?

Online edition of India's National Newspaper
Monday, Mar 24, 2003

Business

Business

Can VAT deliver proclaimed benefits?

With VAT introduction in the States imminent, the studied reluctance on the part of the powers-that-be to take the common man into confidence as to what VAT has in store for him is intriguing, says R. Sashidharan

THE INTRODUCTION of Value Added Tax (VAT) has serious implications for the States' finances, especially for those with a concentration of manufacturing industry. First, as under VAT there will in effect be no tax on raw materials (as a result of the input tax credit), it is feared that there will be a steep fall in revenue from the present levels. Second, if VAT is to achieve its avowed purpose of avoiding the cascading effect of taxes, other levies such as entry tax, luxury tax, octroi and mandi cess will have to be rolled into VAT. For the same reason the Central Sales Tax has also to be abolished and revenue from that foregone.

Third, as VAT is a multipoint levy it will cast its net over millions of new dealers, entailing complexities and high cost of administration. Fourth, if services were also to be taxed it would exacerbate the administrative challenges. And last, the States cannot ignore the political fallout of VAT's potential to cause prices to soar.

Sensing that the States were cool to the VAT proposal, the Centre encouraged them to tailor a VAT that would address their fears. Conjuring visions of a unified indirect tax system as in other countries, industry lent its support too. Following this, more than three years ago, a Standing Committee of State Finance Ministers, which had just then concluded a consensus on uniform minimum rates (floor rates) for sales tax, was re-christened `Empowered Committee' for exploring the possibility, and the ways and means, of introducing a VAT regime. One representative of the Central Government is also on the committee, but as an observer and not a full-fledged participant.

The committee never sought the views of industry, trade or the consuming public. At the conclusion of its deliberations, it made known to the Centre that VAT would entail losses to the States, and unless the Centre promised to compensate them adequately they would not move over to VAT. The Centre agreed to this and the States reached a consensus on VAT to be introduced from April 2003. There is no indication as to the likely size of the compensation to the States, the basis of its determination or how the Centre will be funding it.

Focus on revenue

Breaking down internal tariff barriers to enhance Indian industry's competitiveness was not on the committee's agenda, as otherwise it would have resolved to immediately do away with CST and other local taxes. It is clear that the committee's focus has merely been on protecting the States' revenue interests and not so much on establishing a seamless Indian market. More disturbingly, there is silence as to the legal sanctity of the States' commitment to the proclaimed consensus. They are not interested in any agreement that would fetter their sovereign taxing powers.

In a little noticed section on VAT, the Kelkar committee's consultation paper on indirect taxes argued that a binding agreement among the Centre and the States would provide a constitutional guarantee for proper implementation of VAT. The wisdom of this recommendation is self-evident. Two years after the uniform floor rate consensus on sales tax, several States now observe it only in the breach.

It is obvious that the States will brook no encumbrance on their taxing powers. But, in the absence of unification of these taxes, and uniform rates and practice in all the States, VAT cannot deliver any of its proclaimed benefits. And to achieve such unification and uniformity, there has to be in place an effective Constitutional provision or an equivalent legal agreement among the States — not merely a loose and non-binding consensus.

Implementation of VAT in countries with a federal structure and in the EU that consists of different sovereign nations has been achieved through either legislation or agreement that binds all the constituent states/nations.

Is VAT consumer friendly?

The recent flurry of reports and articles on VAT are uniformly silent about its impact on the single most important player in any scheme of taxation: the consumer. Throughout the deliberations of the Empowered Committee and even now, the consumers have been kept completely in the dark about the policies and issues discussed, whether VAT would lead to a price-rise as experienced in other countries, and how, if at all, it would benefit them.

Maharashtra which had, in fact, introduced a VAT in 1995 and hurriedly withdrew it after a rise in consumer prices, has not clarified whether the now proposed VAT will be consumer-friendly. Likewise, Tamil Nadu and Kerala, after experiments in the past with their own versions of VAT, have not explained how they hope to overcome the problems posed by its previous avatars.

When VAT is introduced, it will replace sales tax; but other levies such as entry tax, octroi, luxury tax and mandi cess will continue. Unlike sales tax, VAT will be a multi-point levy; and while the sales tax rates are mostly around 7 to 8 per cent, the VAT rate for most goods will be 12.5 per cent. This means a 50 per cent hike for most goods. And as the new tax will now be levied up to the last point of sale, it will be calculated on a higher value and at a higher rate than the current sales tax, leading to increased pries for the consumer.

The States' fear over a fall in revenue seems unwarranted as VAT is known to increase tax revenues. The revenue neutral rate (RNR) of 12.5 per cent has been worked out keeping this condition in mind. Given the fact that the total tax collection is not going to fall, consumers cannot expect the prices to fall either.

Supporters of VAT claim that since it provides for set-off of taxes paid on inputs, the wholesale price will fall to that extent and hence will not lead to rise in prices. This argument is misleading for several reasons. First, the States have already pegged a high RNR, thus compensating themselves for any loss on account of set off of input taxes.

This means that the set-off sop will not reduce the tax burden. Second, in the case of branded items like soaps and detergents, the raw material cost is not a significant component of the consumer price, and the current levels of input taxes are also very low. Therefore, the input tax set-off will not translate into any significant gain.

Once the higher rate VAT is implemented, it will far outweigh the input taxes set off, and push prices up.

The complexities of the scheme appear to have prevented the numerous consumer welfare bodies, which are otherwise vigilant, from demystifying the VAT. With its introduction in the States imminent, the studied reluctance on the part of the powers-that-be to take the common man into confidence as to what VAT has in store for him is intriguing.

(The author is a Chennai-based lawyer)

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