Value Added Tax and tariff system: Indian perspective

Arvind Virmani (2002), working on attaining a uniform national VAT rate for India, noted that an ideal indirect structure for the country would consist of two sets of indirect taxes (a constitutional amendment would be needed for this purpose): A single uniform rate national VAT on all goods and services (except for a limited number of pre-specified exemptions) and State sales taxes on a dozen specified goods with a pre-specified upper limit on the sales tax rate for each of these goods.
The Central government would have the responsibility of setting the national VAT rate in consultation with the States and for administering it with the help of the States as needed. Preliminary calculations suggest that a VAT of 15 per cent may be sufficient to ensure revenue neutrality with respect to existing central and state indirect taxes. The proceeds from this tax would be shared between the central government and the states in the proportion necessary to ensure that there is no diminution of the states' indirect tax revenues. To ensure that the indirect system is equitable, and to support positive externalities, the following goods and services would be exempt from the VAT: Foods, including processed (cereals, pulses, vegetables, fruits, milk & products and possibly sugar), Drugs, Medical Equipment & medical services (Diagnostic; Disability compensating or Disease preventing/curing), Environment friendly fuels (Cooking gas, kerosene), Educational services and Knowledge services (Educational material, R&D, Testing, Consultancy). There would also be a sales volume exemption of say Rs. 100 thousand or 200 thousand based solely on the need for minimising compliance and administrative costs. All other exemptions should be abolished. Administration of the system for transactions up to some limit (Rs. 1.0/2.0 million) could perhaps be decentralised to the states. In addition, the State government would have the right to levy sales taxes on a limited set of final, finished consumer goods (to ensure that there is no cascading and no taxation of intermediate goods). The maximum total tax on any good or service should not exceed 50 per cent. This means that with a VAT rate of 15 per cent, the sales tax must not exceed 35 per cent (upper limit/maximum). Such a high rate could, however, be applied only to de-merit goods such as tobacco products (cigarettes, cigars, chewing tobacco) and hard liquor. Fuels with negative environmental externality, such as petrol & diesel, could be subject to a maximum sales tax of 25 per cent. The same maximum rate could also apply to cars and low (< 5 per cent) alcohol beverages like beer & wine.  A few other items such as air travel, air conditioners, motor cycles/scooters and home entertainment products (excluding radio and TV), Entertainment services like cinema, hotels and restaurants service could be subject to a maximum sales tax of 15 per cent (i.e. 0 to 15 per cent). Across the world, sales taxes are normally levied at the point of sale to the consumer. Because of evasion and related problems, India follows the practice of "first point sales tax," where the tax is collected at the point of sale by the producer. Strictly speaking, this is better termed as an excise tax. However, as long as cascading and multiple taxations are avoided and all states follow the same method, either method can be adopted.
Khan and Nagma (2013) in their study on the "Impact of Value-Added Tax (VAT) Revenue in Major States of India" stated that introduction of State level VAT is the most significant tax reform measure at the state level. The state-level VAT being implemented presently has replaced the erstwhile sales tax system of the states. Under Entry 54 of list II (State List) in the seventh Schedule to the Constitution of India, "tax on sale or purchase of goods within a State" is a state subject. VAT has been introduced by all states/union territories (UTs) by now.
The initial experience of implementation of VAT has been received well by all the stakeholders. The transition to the new system has been quite smooth. The revenue performance of VAT implementing States/UTs has been encouraging so far. During 2005-06, the tax revenue of the 25 VAT implementing states/UTs registered an increase of around 13.8 per cent over the tax revenue of 2004-05, which is higher than the Compound Annual Growth Rate (CAGR) of sales tax revenues of these states for the last five years up to 2004-05. During 2006-07, the tax revenue of the 31 VAT state/UTs had collectively registered a growth rate of about 21 per cent over the tax revenue of 2005-06. This indicates that the VAT system is gradually stabilising and has started yielding the desired result (Economic Survey, 2007-08, p.35).
From the above analysis of five years of pre- and post-VAT period, we can see that average CAGR of post-VAT period of all six majors states of India is greater than pre-VAT period. The average CAGR in post-VAT period is 16.35 per cent as compared to 10.52 per cent in pre-VAT period of six major states. This indicates 5.83 per cent increase in CAGR in the post-VAT period as compared to pre-VAT period. Therefore VAT is revenue raiser in the selected states. The maximum gain of post-VAT CAGR is in Bihar. The main reasons for this were better tax compliances, strong enforcement measures and steps taken by the state government to identify and plug the gaps leading to revenue loss. The middle performing states in terms of CAGR are Andra Pradesh (AP), Orissa and Kerala. In case of AP, the good performance is on account of revision of rate of tax on the residuary entries under Schedule V of APVAT Act 2005 from 12.5 to 14.5 per cent and on aviation turbine fuel from 14 to 16 per cent and the cost of collection of Sales Tax/VAT is below in Indian average (Audit Report, Andhra Pradesh, 2010, p 9). Orissa performed well due to revenue efforts through higher effective rates. Orissa has raised the lower rate from 4.0 to 5.0 per cent without the fear of trade diversion. The cost of collection of sales Tax/VAT in Orissa is less than Indian average due to the voluntary tax compliances mechanism of the OVAT Act and the efficient tax administration (Audit Report, Orissa, 2010, p.9). In case of Kerala, VAT revenue rose due to better tax compliance as compared to sales tax (Audit Report, Kerala, 2010, p.9). The least performing States in terms of CAGR are Karnataka and Maharashtra.
However, the main reasons for less gain in terms of average CAGR in post-VAT period is the sharp decline in revenue for the year 2008-09 due to economic slow-down (Audit Report, Karnataka, p12to13 and Maharashtra, p.10, 2010 ). In case of broadening the base of tax revenue, VAT has resulted in some amount of success. Only Bihar, Maharashtra and Orissa improved their tax buoyancy in post-VAT period. In the period 2005-10, the buoyancy of state's own tax revenue with respect to GSDP increased 3.53 per cent. Sales Tax/VAT is the main contributor of state own revenue tax. Therefore, buoyancy of Sales Tax/VAT with respect to GSDP increased in these periods significantly (Audit Report, Bihar, 2010, p.8). In case of Maharashtra, MVAT reduces the compliance burden on the tax payers and increases the efficiency in tax collection system. The cost of collection of revenue in the Maharashtra is less than the all India average.
Therefore the buoyancy of Sales Tax/VAT with respect to GSDP increased in post-VAT period (Audit Report, Maharashtra, 2010, p.10). In case of Orissa, VAT improves the tax compliances mechanism and efficient tax administration. Therefore buoyancy of Sales Tax/VAT with respect to GSDP increases in post-VAT period significantly (Audit Report, Orissa, 2010, p.9). In other states such as AP and Karnataka the reasons for no improvement in the buoyancy of Sales Tax/VAT in post-VAT period is because of many weaknesses in VAT system. Audit reports pointed out non/short levy of output tax, incorrect allowance of input tax credit, incorrect/excess allowance of input tax credit, incorrect allowance of tax deducted at source, non/short payment of tax deducted at source, non/short payment of tax, incorrect /excess carry forward of refund, non/short levy of interest, non/Short levy of penalty, non forfeiture of tax collected in excess and other irregularities involved (Audit Report, Andhra Pradesh, p.16, Karnataka, p.16, 2010). Kerala sales Tax/VAT buoyancy with respect to GSDP slightly increases which is less than satisfactory. VAT failed to have stabilisation effect on the above six states. The main reasons for this are the annual growth rate over the previous period is not consistent in these states in post-VAT period. Initially the growth rate increases generally in all states in 2006-07 but declined in 2008-09 due to the economic slow-down and this decline increases further in 2009-10. Therefore, the increasing -decreasing trend of growth make VAT unstable in these states. From the above we see that VAT improves tax compliances and improves tax administration efficiency of the above states. However, some weakness exists in these states due to which VAT failed to perform up to the mark.
Although the VAT system of the Indian states is not fully comparable to that of the most developed countries, it is remarkable that a country as vast and diverse as India has successfully introduced state VAT nationwide. The country is now in the process of changing over to GST, which offers an opportunity for the states to address the inadequacies of the present VAT system. Considering the issues involved in incorporating services in the GST net, it is desirable that the states adopt entirely new legislation, rather than make cosmetic changes to the existing VAT legislation for the purposes of adapting it to GST. The challenge for the states is to put in place a GST system which is friendly both to revenue production and tax-payer (Sebastian, 2012, p.33).
[This is a part of the Conference Paper titled "From Differential to Uniform Rate System: The Political Economy of Reforming Value Added Tax System in Bangladesh" presented at the Members Conference of the Institute of Chartered Accountants of Bangladesh. Mr Nojibur Rahman, Secretary, Internal Resources Division and Chairman of NBR, was the chief guest while Barrister Jahangir Hossain, member, VAT Policy, was the special guest. Jamaluddin Ahmed, PhD, FCA, is Chairman, Emerging Credit Rating Ltd.
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