Extension of VAT up to retail stage possible

EXPERT EYE

One of the issues on which there is debate among economists is whether VAT should be implemented all the way to the retail stage.

Economic superiority of VAT, if it extends to the retail stage, is well-established in literature and fiscal experience. Though all countries have opted for retail VAT, it is necessary to weigh all the viewpoints for the sake of clear thinking.

VAT which covers manufacturing but not retail is called manufacturing VAT (Manvat). An example of this is Cenvat. In India, however, Cenvat has not been extended up to the retail stage, not on economic grounds but on the grounds of a restriction imposed by the Constitution.

The Constitution allows only the central government to tax manufacturing, which is under Entry 84 of List 1 of the 7th Schedule, that is, the Union List. The Central VAT has to stop before the retail stage since the list entrusts tax on manufacturing only to the Centre. Retail-stage sales can be taxed only by the states.

Such a Manvat has many defects. If it stops at the pre-retail stage, it covers only manufacturers, that is, VAT is charged on the wholesale value at the first sale. This means that value-addition at the stage of the dealers remains uncovered.

This also leads to passing on of the value of goods to the stage of the next dealer, who might pay for advertisements. Producers are induced to push as many trading functions forward as possible so as to keep their cost outside the tax base.

Secondly, if it covers functions only up to the manufacturing stage, the issue that will often crop up will be the definition of manufacturing, which is a highly litigated subject.

In Canada, when the tax was on manufacturers' sales tax, there were many litigations on the scope of manufacturing. This has also happened with the central excise duty and Cenvat in India.

Thirdly, exempting the retail level will mean a distortion of neutrality since retailing margins differ across products as well as companies.

Lastly, if retailers are excluded, higher tax rates will be necessary to guarantee the same yield as when retailers are included.

On the other side, the usual argument against VAT at the retail stage is that it will involve numerous small firms whose records are so inadequate that taxing them will be a waste of administrative resources.

This is, however, an administrative argument and not a conceptual one. Once a suitable threshold is selected, the problem can be taken care of. Therefore, there are strong arguments for extending VAT to the retail stage.

Considering the above arguments, it is quite clear that unless there is a Constitutional limitation, VAT should not only cover manufacturers but also retailers. It should not be a pre-retail VAT but a comprehensive VAT that includes the retail stage.

There is, however, another alternative worth considering. Extension of VAT to wholesalers as well, that is, to the first, second and third dealer etc, but not to the last retail stage.

This has the advantage of combining the best of both the systems. The wholesale dealers, who add maximum value to goods, will be covered and the revenue collected will be the highest. At the same time, it will not have the defect of having too many dealers to cope with.

This combination of pre-retail VAT and retail VAT may be worth trying in our country.