Should addl excise duty make way for state VAT?

EXPERT EYE

Now that the Budget 2007-08 is approaching, one of the fiscal arrangements between the Union and the states that is under review is the arrangement by which the Union levies additional excise duty (AED) on sugar, textiles and tobacco on behalf of states.

The revenue goes to the states pursuant to a Centre-State agreement of 1957. The issue of transferring AED back to states who may then impose VAT on these three items has been the subject matter of various reports. The 12th Finance Commission recommended in December 2004 the transfer of AED to states as a part of devolution of tax.

When VAT was introduced in April 2005, the White Paper by the Empowered Committee of the state finance ministers specifically mentioned that the existing arrangement of AED would be reviewed after one year. In the last Budget, the finance minister did not make any change in the situation considering the critical questions involved. The position exists even now.

All states have not accepted VAT even now and there is hardly any unanimity among them on the issue of transfer of AED. States also realise that the position regarding tobacco is not the same as that of sugar and textiles. This distinction has been made in both Raja Chelliah Committee's report of 1993 (Final Report, Part-I, page 39, para 4.15) and Vijay Kelkar Committee's report of 2002 (Chapter 9, para 6.4, page 212).

They argued that while textiles and sugar might be transferred, cigarette should not be. Kelkar's report 2000 also observed on page 211 that "VAT on cigarette would chiefly be a tax on excise," a "tax on tax," that is precisely a cascading tax. Kelkar reiterated the position in the next report (2004) of the task force on the FRBM Act, 2003. This differentiation has not been taken into account by the 12th Finance Commission's Report, 2004 (Page 76-77, paragraph 4.57), where the only reason given is the integration into the overall VAT design of states. This is a general concept but does not take into account certain practical aspects about cigarettes, which is out and out a finished product where the value addition is about at 90 per cent at the manufacturing stage, 2% at the wholesale stage and 8% at the retail stage. The retail sale of cigarette is done by millions of roadside tiny pan shops. In the case of textiles and sugar, they are both intermediate and finished products, because of which the value addition is all along the wholesale and retail stages which can come into the VAT net, but not so for cigarette. Moreover, in the VAT arrangement, some states will lose and some will gain revenue in comparison with the share of revenue they were now getting. This unevenness happens because VAT collection depends on consumption, whereas AED disbursement depends largely on population weightage. States might impose different rates of VAT, which would create further complication.

Since cigarette is a highly taxed item, there is likely to be unethical practices if tax on cigarettes is levied on value rather than on the length as it is now. Considering all this, the transfer of sugar and textiles will be far more practicable than the transfer of cigarette. A value-based tax will be much more evasion prone for cigarette than one based on length. The memory of a famous and prolonged Supreme Court case on value of cigarettes should guide us here. Finally, the good advice of Raja Chelliah and Kelkar should not be lightly discarded.

smukher2000@yahoo.com