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The VAT lesson It's time to move fast on GST
November, 26th 2013

The impasse over the proposed goods and services tax, or GST, has not been broken. An empowered committee of state finance ministers met last week and delineated differences with the Centre on various issues. It is important to note, first, that the GST is the only major economic reform on the anvil that has the potential to be truly transformational. If implemented wholly and correctly, it would make India a single market for the first time; it would help keep a check on food inflation caused by delays and tax issues; it would reduce the burden of tax compliance on small businesses; and it would end the problem of cascading levies. However, for a considerable length of time, mistrust of the Centre's intentions and a desire on the part of some states to retain political control over some sectors and taxes have held this up. Nor has the Centre's inability to address the states' concerns helped matters along.

However, there are lessons to be learnt here from the experience with state-level value-added taxes (VAT) almost a decade ago. The idea of state-level VAT faced similar objections when it was first proposed, but most states found that their concerns about their fiscal health in a post-VAT India were unwarranted. On that occasion, a "coalition of the willing" pressed ahead with VAT; a similar approach needs to be tried with the GST. States' objections to the ending of octroi - entry taxes levied for goods at state or municipal borders - are more troublesome. Bringing such taxes into a revenue-neutral GST framework is essential for the creation of a single market, and it is difficult to see how a concession is possible. If necessary, the Centre must commit to an even greater transfer of funds than is strictly required to remain revenue-neutral in order to compensate the vested interests who argue in favour of state barriers to trade. It is also unfortunate that the case for a single market has not been strongly made by parties who claim a national presence - not just the ruling Congress, but also the opposition Bharatiya Janata Party.

Other problems centre around petroleum and alcohol taxation. These are sources of considerable state revenue. Altogether, sales tax revenue from petroleum was over Rs 1.1 lakh crore in 2012-13. And excise on liquor was only about Rs 30,000 crore. Even more important, however, is that these rates and controls are frequently a source of political patronage for state-level leaders. Unsurprisingly, several states want them excluded from the GST. It is argued - correctly - by most economists that large exemptions would dilute the GST framework, and render useless the efficiency gains from the seamless system of non-cascading credits and levies it promises. Thus, the states are effectively asking for a GST that is no longer a GST. However, once again, the Centre could take a leaf from the VAT book. The Constitutional Amendment Bill that the GST requires could include a provision for a later adoption of petroleum and alcohol taxes as part of the GST by objecting states. The priority should be, first, to introduce the GST and get the framework up and running so the advantages are clearly visible. The political and economic pressure on the states that are dissenting for clearly political reasons will then be immense. The Centre must promise whatever revenue transfers are required to make the GST Bill a reality in the next few months so that whichever political formation comes to power in New Delhi next year is able to implement it without much delay.

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