States start dismantling VAT in different ways
While finance minister Arun Jaitley remains confident the states are on board for the GST, and that he will be able to place the GST Bill in Parliament during the current session, there is an additional problem he needs to deal with other than the high 27% revenue-neutral-rate (RNR) that the Empowered Committee of State Finance Ministers is talking of. The 27% RNR, by virtue of being very high, will probably increase the gains to be got by evading tax; it will also ensure the compliance benefit got from GST is not achieved. Even more important, as our front page story today points out, while the Centre and the states debate the scope of GST, several big states have begun dismantling the input-credit and value-added structure of the value-added tax (VAT is a substitute for sales tax) that also lies at the heart of the GST.
The first blow to VAT took place after 2009 when, instead of looking for more compliance through lower tax rates and greater computerisation of traders, states chose to raise their VAT rates by as much as a fourth—from an average of 12.5%, VAT rates went up to 14.5% and more. And over the last few years, several states are rolling back input tax credits on both sales within the states as well as across states—input tax credits are the sine qua non of any VAT or GST system. In December 2013, Punjab decided to levy VAT at only the first point of sale for finished goods like cold drinks and refrigerators, effectively denying the state the chance to tax the value addition of 30-40% at the wholesale and retail level. With no need for maintaining records on subsequent points of sale, the VAT value-chain collapsed. As a result, the state has no chance of being able to get more revenue buoyancy through increased compliance that will result from taxing the entire value chain.
Many states have also amended rules of tax credit, effectively punishing large companies that need to transfer part of their stocks across boundaries to sell to consumers. Thanks to a November 2013 change in Tamil Nadu’s VAT rules, a taxpayer in the state—say an automobile manufacturer—cannot fully utilise the tax credit on the raw materials purchased within the state if the cars are moved to, say Karnataka, for sale there. Other states, like Gujarat and Maharashtra, deny VAT credit even within their states in order to keep their revenues buoyant. Gujarat, for instance, restricts credit on input tax incurred on purchase of crude oil, natural gas and petroleum products. Maharashtra, similarly, also does not allow petroleum refiners in the state like BPCL and IOC to take credit for the input taxes paid by ONGC on its crude. While putting GST on track, the finance minister will have to ensure states don’t bring in such restrictions later in an attempt to try and protect their revenue base.