G Gurucharan: Fiscal myopia, coloured vision

It is an irony peculiar to our times that most reform is received in this country with circumspection and, perhaps, a touch of trepidation. Worse still, the "political-economy" of reforms often results in good economics being sacrificed for the rhetoric of politics. Sadly, so it is with the value-added tax (VAT).

The decision by the BJP-led states to withdraw from the implementation of VAT is a disturbing and retrograde step. Besides running counter to the most important tax reform at the sub-national level, it is a classic case of fiscal myopia combined with coloured vision when seen from a national perspective. With less than three days to go for day zero, this is a pity.

The case for comprehensive sales tax reform centred around the introduction of VAT is a compelling one. The sales tax regime extant in the country is archaic, complicated, non-transparent, market distorting and has large efficiency costs.

India ranks as one of the highest taxed countries. The combined burden of Central and state indirect taxes is about 30 per cent "" twice as high as in comparable countries in the region.

There exists in the states a multiplicity of taxes "" sales tax, additional sales tax, surcharges, cesses, turnover tax, octroi, entry tax, special entry tax, to name a few. Compounding the situation is the multiplicity of tax rates, anything between 15 to 20 per cent, depending on the state.

With the introduction of VAT, all these multiple levies and rates will be abolished eventually and two basic rates under VAT "" of 4 per cent and 12.5 per cent "" will cover most of the 550-odd commodities in the sales tax basket, thus making the tax regime simple to comply with and easy to administer.

Second, state sales tax results in double taxation or tax on tax, including on the price mark up at different points in the distribution chain, resulting in higher prices for the end user.

What is worse, most states continue to tax inputs and capital goods. The cost of such cascading to the consumer is about 5 per cent in the final price. By providing for input tax rebate/ credit for earlier tax paid to manufacturers and traders, VAT provides for a transparent, scientific, equity-based commodity taxation system.

The saving in the cascading cost combined with the fact that VAT rates are significantly lower than the weighted average rate of between 15 to 16 per cent prevailing in most states today, will result in lower prices for the consumer.

Third, sales tax being a single-point levy has resulted in a narrow tax base for all states. The inability of states to tax agriculture despite being empowered has meant that the bulk of the taxes are raised from industry that constitutes only 25 per cent of the economy.

Sales tax is also largely confined to wholesale trade. In contrast, VAT will allow for the value added in India's growing and organised retail sector to be taxed and will, in one stroke, broaden the tax base and improve tax revenues without burdening the consumer.

Finally, because of high state-level tax rates, the multiplicity of taxes and non-transparent processes in tax administration, we have seen the widespread growth of the "dealer-trader-tax official" nexus.

A pernicious system of clientelism resulting in corruption in tax offices and evasion by the tax payer hurts both the state as well as the consumer. By making invoicing of every transaction in the value chain mandatory and providing for self-assessment by registered dealers, VAT will help clean up the Augean stables of taxation at the sub-national level.

In sum, the VAT system will make domestic trade and industry competitive, remove market distortions, provide for ease of doing business and reduce transaction costs across the country.

Two grounds have been urged by the BJP-led states. That they will not go ahead unless VAT is implemented uniformly across the country and that adequate preparatory steps including a road map for phasing out central sales tax must be drawn up.

Neither of these hold water. The empowered committee of state finance ministers has worked in close concert with all the states for the past five years in building consensus on uniform VAT implementation in the country, and has evolved a national design for VAT common to all states.

All major states in the country barring two have either passed the VAT legislation or are ready with it. States have completed most preparations including registration of dealers, computerisation, establishing functional organisations and have carried out extensive communication exercises to educate dealers about VAT.

Work is in progress to establish an electronic information exchange system to monitor inter-state sales. A road map for phasing out CST "" with the rate being brought down from 4 percent to 2 and then to 1 per cent over the next three years beginning 2006, and finally being abolished in 2008, is in place.

The Centre has agreed to reimburse any loss of revenue on account of VAT to the states as per an agreed formula.

Sure, the national design is not perfect and considerable fine-tuning will be necessary as we go along. It is also true that a few states may not join the VAT pact.

But then not all the members of the European Union became members in the beginning. Not all the member countries of the WTO joined the organisation on the same day.

VAT is the first step in creating a unified and competitive common market in the country. It will also lay the foundation for a unified goods and services tax in the future.

Instead of taking the great leap that it is poised for, our country will take several decades to join the ranks of the global players in the world.

The author is former secretary, Budget, government of Karnataka.