Debating India

A notable step forward on VAT

Monday 2 May 2005

The agreement reached by 21 States, which have adopted the value added tax (VAT) regime in place of State sales tax, to converge their rates on some essential items marks a notable step forward in implementing the much-delayed reform. The expansion of the exemption list to include bread, salt, khadi and items supplied under the public distribution system will make the State-level VAT more acceptable to both the consumer and the trader. Also, the Empowered Committee of State Finance Ministers has been wise to resist the temptation of exempting only unbranded salt and unbranded bread and discriminating against branded products out of a misconceived prejudice against branding. While it is true that unbranded products represent the less organised and weaker sections of the production and distribution chain which need support, it should be remembered that encouragement of branding implies encouragement of quality upgradation and efforts to match consumer demands. Also, since branded products tend to carry a premium in their price, consumers with a lower purchasing power would have the option to go in for unbranded products and there is no need for a discriminatory tax on branded products within the group of essential commodities. The shifting of medical devices from the 12.5 per cent to the four per cent category shows a welcome capacity for considered response to suggestions from trade, industry and consumers.

The Empowered Committee is also reported to have agreed on the lower of the two rates or four per cent, as against 12.5 per cent, in the case of capital goods but for a negative list. Despite the latest agreement, problems are bound to arise while implementing the VAT system, such as the identification of life saving drugs as distinct from other drugs, or drugs as distinct from cosmetics, or inputs as distinct from final products, and capital goods vis-?-vis accessories. But what needs to be realised is that one major merit of the VAT system, not emphasised in debates in the past in India, is its "neutrality." This signifies that by installing a single tax rate on inputs and refunding taxes paid on inputs, VAT will encourage manufacturers to choose products and processes on the basis solely of techno-economic considerations, while in contrast, under a regime of differential rates and without setoff of taxes paid on inputs, such decisions would be influenced extraneously by the difference in the tax rates on the inputs. This aspect, apart from prevention of the cascading effect (of tax on tax) and the in-built safeguards against corruption and evasion, should vindicate the decision of these 21 frontline States, setting them apart from those that remain doubting Thomases. The States adopting VAT should stick to the decision not to change rates at least for a year and not to grant price-based or end use-based exemptions, which would only invite litigation and corruption.

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