Centre should compensate Revenue loss to States

VAT is implemented by most of the States only on the insistence of the Centre. Therefore, the Central Government should compensate possible loss. States should desist from attempting to recoup revenue loss by fixing higher rate of RNR or by levying additional entry tax or luxury tax, which will be inflationary. Allowing states to collect service tax to compensate loss due to vat, a retrograde move. Centre should tax more services to raise funds for compensation.

S. Sridharan, VAT Consultant, Madurai

State Governments have developed labour pains on transition to VAT. The possible revenue loss in States with a large spread in the rate of Tax and more goods in higher tax slabs may be substantial. The States now look towards the Centre, for maintenance of the VAT baby after it is born, for after all the Centre is the father of VAT. The father is undecided and is alternatively suggesting the Mother (State Governments) to look after the baby by itself and at times reluctantly agreeing to share the maintenance cost. Is the Centre reacting like a responsible father?

The loss to the States with a smaller spread of rates and maximum rate of tax less than 20% is not likely to be substantial as the existing rates of tax may require only little adjustment to fit into the proposed VAT rates.

The slab rates1 in different States various from a low of six rates to a high of 15 rates and the maximum rate of tax (excluding on liquor) is between 15% to 33%

Source: Paper on Road Map for National and Sub-National VATs in India by Dr. Mahesh C Purohit

1. The rate structure in different States are before hormonisation with the uniform sales tax floor rates

2. The maximum rates are exclusive of rate of tax of liquor.

3. The number or rates now is 14 with the merging of 11% goods in the 12% slab w.e.f 1-12-2001.

The major source of revenue for the States comes from Petroleum Products and Liquor. The rates of tax of liquor are not likely to be lowered under VAT and these goods may not be covered under VAT.

Most of the States have a surcharge on sales tax and Additional Sales Tax of 1% to 3%. Under VAT there will be no place for surcharge and Additional Sales Tax and the States will have to contend with revenue loss on scrapping of these levies.

Further raw materials and capital goods, in most of the States, are subject to tax at concessional rate of tax of 3% to 4%. Under VAT, the concessional rate of tax will not apply. The raw materials and capital goods will be subject to tax at the rates applicable. The loss to the Government is that input tax rebate will apply to raw materials and on capital goods also (though on capital goods input tax rebate may be deferred) and the Government may not realise the 3% to 4% taxes that was hitherto collected.

The loss of revenue in a State with predominantly revenue from manufacturing sector is therefore likely to be higher than a State, which imports from other States and where most of the revenue is realised from trading activity. If the revenue neutral rate is not fixed at a higher level, loss on transition to VAT, particularly in highly industrialised States, is unavoidable.

The State Governments, to protect revenue loss, is likely to fix a higher RNR which will result in price hike across the board and the poor consumer will have to bear the brunt as ultimately is the consumer, you and me, who pay the tax.

The impact on prices on introduction of VAT in several countries was as follows:

Source: IMF Data and various Country reports reported in seminar papers of CII

It may be seen from the above table that price change in developed countries are lower than in developing economies.

Fixing a higher RNR to completely offset the possible revenue loss is not desirable, as it would be politically inadvisable besides being inflationary. Should the Governments try to make the transition to VAT a zero sum game by fixing a higher RNR?

It took the Centre 4 years to align and rationalise the Central Excise Rates. Should the States be expected to align the existing large rate structure in one budget? The States should be allowed 2-3 years time frame to align the rates of tax into a three rate structure.

States like Tamilnadu and Kerala have resorted to levy of Entry tax to shore up revenue. One may see a mini budget, as in Tamilnadu, prior to introduction of VAT.

The Centre must dissuade the States from fixing a higher RNR or from levying additional taxes in the form of entry tax or luxury tax to compensate the loss due to transition to VAT. In fact, the Centre should give fiscal incentives to States implementing VAT. After all it is only on the insistence of the Centre that most of the Governments are switching over to VAT.

Though the possible revenue loss on switch over to VAT is difficulty to quantify, Tamil Nadu have estimated the possible revenue loss at Rs.600 crores. The estimated revenue loss to Andhra Pradesh is Rs.300 crores, according to Mr. Ramakrishnulu, Minister of Finance, Andhra Pradesh.

One of the avenues contemplated to recoup the revenue loss is to allow States to levy service tax. Constitutional amendment will be required to allow independent levy of service tax by the States. Therefore it has been reported that the Centre is contemplating retaining the power to levy service tax and to fix the rate of tax, and to allow the States to collect and retain service tax on 25 services.

If this happens imagine a situation where different States have different services liable to tax and don't you foresee a situation similar situation in sales tax on the cross border differences in the levy of tax.

Further the state governments are already over burdened with the task of grappling with the transition to VAT. Requiring them to handle service tax as well will be a tall order.

The proposal to allow the State Governments to collect and retain service tax on 25 services to offset the possible revenue loss in the course of switching over to VAT appears to be a short sighted move, particularly when the long term focus is to bring all taxes in the VAT structure. Dual levy of service tax by the Centre as well as by the States will lead to more centers of powers and consequent harassment of taxpayers. Service tax needs to be integrated in the VAT structure. If there is a State service tax and Central service tax, will service tax paid to the Centre be given a setoff by the States?

The present levy of service tax by the Centre itself needs to be reformed. There is a need to codify the present levy of service tax in a self-contained comprehensive legislation. The Centre has already initiated steps to reform the levy of service tax and efforts should therefore be to codify the levy of service tax properly under the existing Central levy.

The scope of levy of service tax must be enlarged to cover more services, if not all the services excluding basic services predominately used by the middle and lower income group of the society. In an economy, basically the users of manufactured products are the middle and lower income group and the users of service belong to the higher income group.

For instance, levying a service tax on the services of a specialty hospital will only tax the rich who are the users of the service. A rich person may find it is relatively easier to evade income tax but evasion in service tax may be difficult has the service industry is better organised.

There is a debate on the taxing of agricultural income. There are very many big landlords who are in the high-income bracket but are not taxed. These rich landlords definitely use a number of services and by taxing services, they are also made to contribute to the national exchequer.

The Government should therefore levy tax on all the services excluding of course the basic services that are mostly used by the common man.

Service tax should be integrated into the VAT structure. The Centre should retain the administration of service tax and the services that are taxed should be uniform throughout India. Service tax relating to manufacturing or professional activity should be given set off against either Cenvat, State VAT or the service tax liability, at the option of the service tax payer. The Centre should reimburse the input tax credit given by the States. The additional revenue generated by taxing new services may be used by the centre to compensate States the revenue loss on transition to VAT.

The States may be given powers to levy services tax only on composite contracts which involved the supply of labour as well as materials to avoid the present difficulties faced by the States to levy tax on composite works contract.