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Tied in a golden knot?
July, 06th 2007
Are the state governments facing the spectre of losing more of their resource-raising ability? Already, the power to tax manufacturing, imports and rendering of services is with the Centre which transfers a (minor) part of the resources to the states as per the formula set by finance commissions.

State value added tax (VAT) is basically a replacement of tax on sales although it is multi-point tax on value addition, structured to obliterate cascading of taxes. Even though states played a decisive role in designing and implementing state VAT through the mechanism of the empowered committee of state finance ministers, most states have (naturally) resisted what they perceived as the Centres intervention in this matter.

Some states took their own views on when to shift to the VAT regime and all had reservations about even discussing with the Centre matters touted to be their preserve such as fixation of VAT rates, identification of goods for the levy, etc. And there are dissenting voices even now Kerala finance minister was on record, dubbing VAT as a tool for the Centre to meddle with states constitutionally granted space for raising resources.

The proposed comprehensive goods and services tax (GST), set to be implemented from April 1, 2010, will, inter alia, integrate state VAT with Central VAT (Cenvat) which already assimilates excise and service tax with input tax credit. Of course, it is unclear as to how GST would be structured. The unresolved questions in this regard include: who will levy/collect/appropriate GST, whether there will be two or more rates for GST (one for states and another for the Centre) or a single rate (at the central level), etc.

Whether GST would result in further dis-empowerment of states would hinge on the structuring of GST. Another cause for the concern, according to those who see merit in the theory of dis-empowerment, is the Centres silence in the matter of reimbursement of state-level taxes for exporters. Currently, the incidence of excise, customs and service taxes in the export good are extinguished through various tax neutralisation schemes.

There is an agreement that the effect of state level taxes (VAT, octroi and entry tax) on the export goods should also be nullified. But the states are unwilling to do so, as they reckon that the more resourceful Centre should do this. The counter-view is that since states get revenue from these levies, they should be refunding the exporters. To top it all, the Centre imposed a cess on iron ore exports in the last Budget, although land sources (including minerals) are, traditionally and constitutionally, a revenue source for states. (The Centre had later agreed to share the proceeds with states).

If a single rate GST is implemented, it will tilt the balance in favour of the Centre. It is not ideal in the given circumstances, said Tapas Sen, senior fellow, National Institute of Public Finance & Policy. Services being the biggest contributor to GDP and so a major revenue target, he saw legitimacy in states demand for the power to tax highly localised services. (The Centre has already agreed to meet this demand as part of the compensation package for phasing out the central sales tax). There is also a proposal for VAT on imports (the extant countervailing duty on imports imposed by the Centre is supposedly a precursor to this). But, again, a single-rate GST could scupper all these plans, and leave states almost completely at the mercy of the Centre for its revenue.

Of course, equally robust are the Centres arguments favouring GST and the system of tax on value addition. This makes the contestation intense. The resounding success of state VAT compounded revenue growth of VAT states overshot traditional growth rate in sales tax revenue has made all states accept the system ungrudgingly, with Uttar Pradesh the latest to join the bandwagon. State finances have improved in recent years due to their own efforts and also enhanced devolution of resources by the Centre.

In fact, many states are even doing better than the Centre on the fiscal responsibility front. Tax on value addition (without tax on tax) is internationally recognised as a superior system. Its verity is incontestable. So what is wrong in it, if the Centre, which has a much stronger revenue collection machinery, takes the power for levy and collection of taxes nearly totally and devolves the resources to states? After all, even to coax states to adopt VAT, the Centre had given them a blanket guarantee of revenue support.

According to Amitendu Palit, visiting fellow at Icrier, different rates (of GST) would not beget a common market for goods and services. He, however, said there was a need to leverage the revenue mobilisation capacity of local governments (third tier) more effectively. At odds with this view, Mr Sen said that to deprive the second tier of the government (states) of the potentially biggest revenue source (services) would indeed undercut the federal structure.

Of course, GST, even if implemented with a single rate and power for levy solely with the Centre, would result in faster revenue growth. If the Centre and states institute a legally buttressed mechanism for sharing resources, then states are unlikely to be hit on the revenue front. But the question is that of independence. Considering that states have keener understanding of ground realities, their involvement in planning and designing of welfare and social sector programmes is paramount. They would, of course, like to be untied.
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