It will help them tap full potential
The finance ministrys move to allow states to tax services is a move in the right direction and it will give state revenues more buoyancy. The measure seeks to compensate for the loss of revenue from the phasing out of the central sales tax on interstate transactions from the second half of the fiscal year. It is a major giveaway for the Centre, which is allowed to levy taxes upto the retail stage, while its power to levy taxes on goods ends at the manufacturing stage. With a pick of one-third of the 99 services currently in the central services tax netmainly on services of a local or intra-state naturethe states can expect to mop at least a fifth of the Rs 35,000 crore raised as service tax by the Centre. The potential is much larger if the Centre allows the states an additional 44 new services as indicated, including more lucrative segments like legal, educational and medical services. Particularly because services tax collection has grown by more than 50% in recent years. It would also help expand the tax base as the states, with a richer local information base, are better placed to tap the full potential of the services sector, more than half the economy.
A selective transfer of service taxes to the states has pitfalls. It can create distortions, as the states cant provide input credit on taxes paid on those services outside their purview. And there are dangers if each state decides to levy rates on different services without any rationale, as had happened with sales tax. In fact, fears of a surge in service tax rates in the states has led some expert groups to recommend the Centre and states jointly arrive at a list on which the former would levy the tax and leave collection to the states. So, the Centre should lay down broad guidelines like the number of rates and bands to bring more uniformity across the states. And ensure states have uniform definitions of various services; problems here have been a major bugbear even for the central services tax, leading to a large number of court cases. In fact, the central government even had to appoint a committee to look at the various circulars, instructions and clarification on service taxes to clear up issues. The moves to expand the states tax powers also gives the Centre another opportunity to motivate the states to integrate other taxes on entertainment, electricity, goods, passengers and luxury taxes on goods and hotels with state Vat. In fact, it should even be a precondition for such a bonanza to the states.