The Telegraph
Since 1st March, 1999
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- The crossover from sales tax to centralized VAT must not be rushed

Even morons are supposed to be aware where their self-interest lies. Not so, apparently, the state governments in this country. Come April 1, 2003, they will march to their beheading; they are going to abolish sales taxation and embrace the Centre-administered value added tax.

It is a long, complicated story. Much ballyhoo has been raised in recent weeks over the precarious state of state governments’ finances; the states are unable to make ends meet, their development expenditure is fast plummeting down to zero, they are unable to meet even their monthly commitments of salary and retirement benefits; they propose to keep dearness allowances on hold.

The facts, let it be admitted, are more or less as stated. What is, however, mostly left unsaid is the spate of developments that has led to this kind of a situation. The states depend for a substantial part of their fiscal resources on devolutions from the proceeds of income tax and Union excises. These taxes are levied by the Centre but, the country’s Constitution says, have to be shared with the states according to formulae laid down from time to time by successive finance commissions. The states also receive some further amounts from the national exchequer, according to recommendations of the finance commissions, to cover chronic deficits, as assessed by the latter, in their revenue account.

But the Union government has been playing devious games with receipts which legitimately belong to the domain of the states. Sales taxes have been by far the most lucrative source of income for the state governments, contributing to as much as 80 per cent of their total tax receipts. Way back in 1956, when the Congress was ruling supreme at the Centre as well as in all the states, a constitutional amendment was rammed through forfeiting the prerogative of the states to levy sales tax on three all-important commodities: textiles, sugar, and tobacco and tobacco products, which were the lushest source of sales tax revenue.

The amendment abolished the taxation of sales of the three commodities, and substituted in their case an additional duty of excise to be levied and collected by the Centre and distributed in full amongst the states. The states were grossly short-changed in the process. The Centre gets a large proportion of the yield from excise duties while it gets nothing out of the proceeds of additional excise duties. It has been therefore always in the Centre’s interest to go easy on additional excise duties on tobacco and tobacco products, textile and sugar and at the same time, stiffen the rates of basic excise duties, thereby robbing the states of thousands of crores of rupees.

This was more or less the story till the early Nineties. Then came the formidable economic reforms and, pari passu with it, the increasing dominance of the Washington twins, the World Bank and the International Monetary Fund, over India’s public finance administration. Thanks to the reforms, the rate of growth in the economy has shrunk significantly in the course of the past decade. The consequence is a sluggish rate of increase in receipts from income tax and excise duties.

Since, apart from sales taxation, the receipts of the state governments depend to a major extent on their share of collections from these two Central levies, the financial crisis has inevitably deepened for the states. In any event, they had been already under great strain to balance their budgets, because of constraints under the existing constitutional dispensation and forced to borrow heavily from the Centre, the Reserve Bank of India and the market. The repayment burden of such borrowings has mounted at a furious pace in recent times, further intensifying the financial difficulties of the states.

Enter at this juncture, the IMF and the World Bank are dinning advice to the ministry of finance in New Delhi. It is a hackneyed, tiresome sort of advice whose tune has not changed over the years. The primary task of fiscal administration, according to the Washington twins, is to balance the budget; it is only when the government is able to cut down its expenditure so as to match it with its receipts that price stability will reign in the system, which in turn will encourage private initiative, so essential for efficient and speedy economic growth.

There are many ways of lowering expenditure and adding to income. The government in New Delhi should raise extra revenue by selling off public undertakings, including the profit-making ones, as it has been doing of late. It must also cut down on its hand-outs to the state governments, never mind even if such hand-outs are strictly according to stipulations set by the Constitution. And the Centre should practice absent-mindedness with respect to the states.

Why should, for instance, the Centre bother whether the states have enough resources at their disposal to cover their expenditure' If they do not have the resources, and neither the Central government nor the RBI is willing to offer them additional accommodation, the states will perforce have to curtail their expenditure. It is a matter of indifference to the Washington twins the turmoil such reduction in outlay could trigger off in the states.

The slackening pace of economic growth adversely affecting revenue receipts has provided the occasion to the Centre to follow the World Bank-IMF prescriptions to the hilt. Releases from the pool of earnings from income tax and excise duties have been reduced severely. The states are naturally at the end of their tether. Leave aside the issue of developmental outlay, every month their major worry is how to meet the contractual obligation of payment of salaries and allowances. With little or no economic growth, unemployment too is getting aggravated every day. The shrinkage in state government expenditure, were it to persist, is bound to give rise to increasing social tension.

The Washington twins could not care less. They have urged the Centre to put a further squeeze on the states. The modality they have chosen is the proposed abolition of the right of the states to levy sales tax — their most important source of receipts — and substitute it by a Centrally-administered VAT, scheduled to be introduced from next April. The replacement of sales taxation by VAT, the states are being told, will lead to an explosion in overall tax revenue from which the states too will benefit. Striking increases in revenue receipts in the wake of the introduction of VAT are claimed to have taken place in several countries.

This is pure hokum. The United States of America, the most industrially advanced and the richest country in the world, has not introduced VAT because politicians in the federating states have done their basic arithmetic and have refused to go along with the optimistic projections made by so-called fiscal experts. Canada, almost an equally rich country, has introduced only a fractured form of VAT; the province of Quebec, French-speaking and highly autonomy-conscious, has kept itself out of it.

For a country of India’s continental size, with thirty-odd states having their special problems and oddities, any hasty move to impose a country-wide VAT, after abolishing sales tax, may actually be an invitation to chaos. New Delhi has itself admitted that, contrary to earlier assertions, in the initial years, aggregate receipts from VAT are likely to be considerably less than the total receipts the states are now realizing from sales taxes. It has promised to compensate the states for their loss for the first three years. The suggested compensation for the first year is 100 per cent of the loss, for the second year, 75 per cent, and for the third year, 50 per cent. Beyond the third year, the states will have to grin and bear the loss; the Centre will not come to their rescue any more. Besides, it is not even clear in what manner the loss to the individual states is to be calculated.

There is a sentence in a Thomas Hardy novel, perhaps in Far From the Madding Crowd: “there is a time for embrace, that is also a time for parting”, or something to that effect. One must strain to be fair. The proposal to substitute sales taxation by a Centralized VAT conceivably has points in its favour as much as points against it. But these points need to be deliberated over before a constitutional amendment effecting the cross-over is rushed through. The current year, when the finances of state governments are in a horrifying mess, is hardly the most appropriate time for such a revolutionary change.

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