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Why we should not oppose the VAT
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The VAT system is non-cumulative and neutral in respect of competition; the system ensures equal distribution of tax burden between similar products; it exempts subcontracting from taxation; it is not levied on export goods; it exempts goods which have already been taxed and also purchases of capital goods among others.
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EVEN THE HINDU seems to have some reservations about the VAT as reflected in two of its editorials. As a country, we have doubts about anything new and as a result any new project takes at least a decade or two to fructify. If I am permitted to be a bit autobiographical, it was I who in this country for the first time pleaded for the introduction of VAT on the EEC pattern in a business paper on June 4, 1986, when I was commissioner of sales tax in Gujarat, essentially to avoid large scale evasion of sales tax apart from a fiscal and economic reform measure. (I studied in the University of Brussels and was the first Indian trainee with the EE Commission way back in 1970 and hence my knowledge of the subject). I gave a couple of lectures on the subject in the National Institute of Public Finance and Policy, New Delhi and my own colleagues from other States had reservations about its introduction. This was largely due to ignorance of the advantages of VAT. But Dr. Amresh Bagchi, Prof. Mahesh Purohit of the same institute and Dr. S. Gurumurthy, formerly Finance Secretary of Tamil Nadu, and much later a committee of commissioners of sales tax studied the subject in depth and a lot of thought had gone into it before its introduction. Meanwhile, the Government of India's MODVAT became a halfway house in respect of central excise. The sales tax in most States by and large resembles central excise because it is a single stage tax at the first point of manufacturer or importer (`import' here means from other States or the reseller). Gujarat and Maharashtra had a MANVAT (Manufacturers VAT) where the tax on inputs was returned or deducted by a form (of course, the form was misused on a large scale) which was exactly similar to VAT.
Rate war
Many States resorted to discriminatory taxation in their anxiety to stimulate trade or industry within the State. This had resulted in a rate war. The States also had too many structures or levels of sales tax — as many as 15 different rates in some States — distorting competition. The EEC faced a similar situation and was able to overcome it in 1967 by tax harmonisation through VAT.
Although `Customs Union' in the EEC came into effect on July 1, 1968 and trade from member countries was free from customs duties, physical controls at internal frontiers of the member countries had to be carried out because of differential indirect taxes such as turnover or sales tax and excise duties. This is a situation similar to our sales tax check-posts at the State borders. A uniform VAT could avoid this.
Incidentally, Gujarat introduced an entry tax legislation in 1987 to do away with the obnoxious `octroi.' Entry tax was patterned almost as VAT system based on documents and not on physical checks. But the trading community felt, as they feel now with VAT, that it was easier to evade `octroi' and stoutly opposed the entry tax and as a result the government was forced to withdraw the Bill from the legislature.
Cascading effect
Under the Value Added system — a non-cumulative multi-stage system where tax is levied only on the net value — tax on gross output minus tax on the cost of all materials used. Whereas in a cumulative multi-stage system, the tax liability accrues at each stage in the course of production and distribution. In this situation, it is never possible to know how much sales tax is paid on a product at each given point in the production or distribution process, for this depends entirely on how many stages the product itself, its components, and the equipment and services utilised have passed through. Even in a single industrial sector, these can vary considerably from product to product. At each taxable point, the tax paid accumulates on top of the tax levied at earlier stages resulting in cascading effect which leads to vertical-integration. Consequently, the cascade systems as in the case of sales tax are not economically neutral. They distort competition in internal as well as international trade. Of course, this necessitates maintenance of proper records which our trade and industry detest for obvious reasons.
Collection of VAT levied down to retail stage can be explained by comparison with the single-stage tax levied on retail transactions. If the rate is 10 per cent, the retailer pays a tax of Rs. 10 on a turnover of Rs. 100. With a 10 per cent tax on the value added, the retailer takes 10 per cent of his turnover and deducts from that amount the taxes his suppliers have already paid on the goods and invoiced to him. If the retailer's purchases amounted to Rs. 80 of his Rs. 100 turnover, then he would owe the tax collector Rs. 2 i.e. 10 per cent of Rs. 100 less 10 per cent of Rs. 80. This amount corresponds to 10 per cent of Rs. 20, the value added by the retailer to the product. As with the single-stage system, he will have to pass on to his customers the full 10 per cent of Rs. 100 in order to recover the amount in tax that he has paid indirectly through his suppliers, Rs. 8 and directly to the tax authorities, Rs. 2. The tax is levied in the same way at the wholesale level, and all the steps in production before the wholesaler. The system is non-cumulative and neutral in respect of competition. The only real difference consists in the methods of collection; at one point in the case of retail sales tax, and spread over all stages in the case of VAT.
Thus, (1) VAT ensures equal distribution of the tax burden between similar products, irrespective of the length of the production and marketing processes, whereas under other systems the tax burden weighs more heavily on unintegrated firms.
(2) VAT exempts subcontracting from taxation whereas in other systems tax is levied on the subcontractor every time the product liable to tax is processed.
(3) VAT is not levied on goods when they are exported, whereas under other systems exports may be partly taxed (this is the reason why we get refund of VAT at airports or by post).
(4) Under VAT, imported goods are subject to exactly the same tax as domestically-produced goods, while under other systems discrimination is often unavoidable.
(5) VAT exempts goods on which tax has already been paid from further liability to taxation. Under other systems, tax is always levied on an amount which includes the taxes paid at previous stages.
(6) VAT exempts from tax purchases of goods and certain general expenses essential for running a business.
(7) VAT is also a multi-stage tax less liable to evasion than sales tax. The buoyancy is also greater avoiding the need for tinkering in every budget.
In the EEC, VAT system per se was introduced first in the member countries barring Italy which was always a laggard and was given a year extra. At the second stage, uniform VAT rates were adopted. So, in India too, it is advisable to introduce in all States at a time. If this is not feasible, the 16 States can switch over on June 1, 2003 as programmed at present and others could fall in line next year. The Government of India has also made a good gesture of compensating the losses, if any. So there is no excuse to postpone it further to please the industry and trade lobbies.
G. SUNDARAM
(The writer is a former Secretary to the Government of India)
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