As is usual now, the Union budget for fiscal 2006-07 contains policy statements that go beyond the mere arithmetic of receipts and expenditures of the government. Of these, the one that stands out in terms of its likely impact on the economy and the governmental system of the country is the announcement of the intent to usher in a 'national VAT' in the form of an integrated goods and services tax from 2010.
The idea of a single tax on goods as well as services levied nationally at a uniform rate throughout the country in place of the system of domestic trade taxes that remains troublesome despite all reform is hugely attractive. Curently, taxes on goods are levied by the Centre at the manufacturing level through Union excises now christened CENVAT while states levy tax on the sale of goods independently, each under its own laws and procedures. Some uniformity has since been brought about in the sales taxes by moving over to a system of VAT in most states. But the differences among the states in the tax structure are still considerable.
Then there are sundry taxes like entry tax that impede trade. Services, on the other hand, are taxed only by the Centre separately from goods. Cascading from Central taxes ' that is, the additional burden caused by cumulation of tax on inputs ' is alleviated to a large extent by permitting credit for tax paid on the purchase of services against CENVAT payable on goods and vice versa. Life would obviously be much simpler, particularly for businesses operating in more than one state if goods and services were taxed at a single rate applicable throughout the country and all taxes on purchases were made creditable against the tax payable on sales, no matter where within the country the purchases or sales take place. This is what the GST seems to promise and, understandably, the announcement of a target date for its introduction has been widely hailed.
But what will be the design of the 'unified national tax' on goods and services that is under contemplation' Will it be a single levy to be imposed and administered Centrally, replacing not only CENVAT and the tax on services but also the VATs now being levied in the states' If so, what will happen to the tax power of the states that fetches two thirds of their 'own revenue', namely, sales tax of which VAT is a variant' The finance minister did not specify beyond saying, 'There is a large consensus that the county should move towards a national level Goods and Services Tax that should be shared between the Centre and the States.' How the sharing will be done was not indicated by the finance minister nor did he spell out any roadmap for getting the national GST in place, except for the observation that, following the practice the world over, goods and services should be taxed at the same rate. As a step towards the convergence of service tax and CENVAT he has raised the service tax rate from 10 to 12 per cent.
In a post-budget interview, the adviser to the finance minister, Parthasarathi Shome, has given an inkling of the shape of the GST to come. From the interview, it would appear that what the finance ministry has in mind for a final GST is an 'enmeshed system of Centre and States combining both goods and services'. For that, first the states will be allowed to tax some services and the tax powers of the Union will be enlarged to enable the Central government to tax goods at all stages of sale and not merely manufacturing. Finally, the rates will be the same at both levels so that crediting can be allowed 'between Centre and States and vice versa' (Businessworld, March 13). This does not throw any light on the critical question, 'What will happen to the States' powers to tax sales under the promised GST regime' The outcome aimed at is, however, clear: there will be only one rate of GST both for the Centre and the states.
The Kelkar task force of 2004, which mooted the idea of the GST while proposing 'a commonality' in the base of the GST for both the Centre and the states, did not go so far as to suggest the same rate for the tax at both levels. Nevertheless, the KTF wanted a standard rate to be laid down for the Centre (12 per cent) and another (8 per cent) for the states to be applied across all states. Apparently, the task force did not envisage a situation whereby the Centre alone would levy the tax and the revenue would be shared, nor did they want the same rate of tax to apply at both levels.
In the KTF scheme, the states would continue to administer the GST but with little room for autonomy in that not only the base but also the rate would be set for them. Given that the essence of a tax power lies in the power to fix the rate, such a regime would mean the end of states' autonomy in sales taxation. Thus the GST of even the KTF model will severely limit the scope of the states to raise revenue on their own, even if they are allowed to tax some services. The proportion of taxes raised by themselves in the combined tax revenue of the Centre and the states will dwindle from one-third at present to about one-sixth, making them even more dependent on Central transfers than they are now. That will undermine not only fiscal autonomy but also accountability in governance at the state level, as it will lead to a further separation of taxing and spending decisions. With a single national VAT, the vertical fiscal imbalance will accentuate further. Only one tax levied at only one level is what the corporate world is dreaming of, encouraged by what the finance minister has said in his budget speech.
The demand from trade and industry for centralizing sales tax is not new. It was put forward before the taxation inquiry commission of 1953-54, but was rejected by the commission on the consideration that it would dislocate the financial structure of the states and there would be many practical difficulties in centralizing a tax with such 'local moorings' as sales tax. The last fifty years have changed the world. Globalization has imposed the imperative of harmonization of taxes across countries and regions. Computers have revolutionized tax administration. Even so, if federalism is to survive, subnational units must have the requisite fiscal autonomy.
Unfortunately, the autonomy envisioned for the states in the Constitution has suffered onslaughts from many directions, the encroachment on their tax powers being particularly damaging for the federal system. While some restraint on their tax powers was called for to prevent tax exporting and harmful tax competition ' and so the move towards a harmonized GST at both Central and state level is to be welcomed ' absolute uniformity is neither desirable nor necessary. Several models are now available for operating a VAT at two levels in a federal country without crippling the states in the matter of taxation.
If, however, the states' autonomy in fiscal affairs is to survive in the face of growing demand for their abrogation to facilitate business, the states have to be vigilant. The way things have been going of late is not very reassuring. The power to tax services has been brought under the Union list by a constitutional amendment without demur from any state except Tamil Nadu. Again, instead of removing the cap on the sales tax that can be levied by the states on some commodities imposed by a parliamentary law ' the 'declared goods' ' one more item (liquid petroleum gas) has been added to the list apparently unilaterally. What is more, the standard rate of state VAT has been brought under a 'uniform floor', taking away the discretion of the states to go beyond it. The last one has been the outcome of a consensus among the states. So the states seem to be losing their tax autonomy by default or even by consent. None of these augurs too well for India's federalism.