UP goes the VAT way

Chief minister Mayawati has removed a significant hurdle in the country’s transition to a goods and services tax (GST) regime by April 2010. Uttar Pradesh, the lone state holding out on the landmark tax reform, implemented the value-added tax (VAT) system on Tuesday, almost three years after most other states made the move.

Although there was never any doubt that UP would fall in line, the delay had the potential to threaten an early transition to the GST system. Adoption of VAT by all the states is central to the implementation of GST, as it is a more comprehensive form of VAT that combines central excise, service tax, state VAT and other indirect levies under one tax code.

Further, implementation of GST is essential to create a common market for goods and services and to remove the influence of tax arbitrage opportunities on business decisions. Mayawati’s argument that the failure of the Mulayam Singh regime to adopt VAT had cost the state is valid. Delays in implementation may have cost the state a few industrial projects.

VAT, as a destination-based consumption tax, is more industry-friendly than the origin-based local sales tax because it allows input credit for taxes paid earlier in a production chain. However, Mayawati’s decision to drop prosecution provisions from the VAT statute, a political decision to blunt traders’ resistance to the taxation system, is undesirable. Prosecution provisions are necessary to curb tax evasion and must be built into the state VAT law.

The fear that adopting VAT would result in lower revenues have proved to be misplaced. Overall, the revenue growth in states which implemented VAT with effect from April 2005 has been robust, although a few states, which moved from a higher tax rate regime (about 15%) to a lower VAT rate (12.5%), did experience below-target revenue collections in the first year.

Maharashtra was one of the exceptions where revenue growth in the second year was negative. But that was a consequence of flood-related damage. The central government must now build a political consensus among the states to adhere to its plans to migrate to GST by April 2010.

Source : Economic Times - Gurgaon, Haryana, India, dated 05/01/2008