Leaky VAT

Last week, Delhi's Chief Minister Sheila Dikshit lowered VAT rates on 190 items and completely exempted some""while this will bring down prices in Delhi, as was the objective, it will also ensure that trade in these commodities in neighbouring states will get diverted in large part to Delhi as traders there try to avoid paying taxes by buying goods in Delhi.

Similarly, Punjab and Haryana's refusal to comply with the recommendations of the Empowered Committee to hike sales tax on diesel to 20 per cent (Punjab's rate is 8 per cent and Haryana's is 12) has resulted in a 40-50 per cent fall in the diesel offtake in Delhi, which has moved to Haryana.

It is a different matter that even if 40 per cent of Delhi's diesel sale has moved out, the Delhi government will continue to collect the same level of taxes since the VAT rate is now 20 per cent, compared to the earlier 12 per cent.

The bigger problem, of course, is that despite six months of hard work and 89 meetings of the Empowered Committee, the VAT system has so many loopholes.

The fact that there is a large gap between the two basic rates of 4 per cent and 12.5 per cent will undermine the self-enforcing nature of VAT, because those who have to pay the 12.5 per cent rate will lose a very small amount of input credit (all inputs are to be taxed at the 4 per cent rate) if they decide not to pay VAT; in other words, there is a serious flaw in the design.

There is then the fact that states have not implemented the VAT rates in full.

When the Empowered Committee chief Asim Dasgupta said there are very few variations in the rates between states, the Confederation of All India Traders immediately came out with a list of 12-13 broad groups of goods where there are large variations between various states""a fuller list with more goods and with details for a lot more states is being finalised.

For instance, while capital goods are to pay a VAT rate of 4 per cent in West Bengal, the rate is 12.5 per cent in states like Delhi, Punjab, Maharashtra, and Andhra Pradesh.

Tools, similarly, face a 4 per cent VAT rate in West Bengal, Maharashtra, Andhra Pradesh, and Bihar, but 12.5 per cent in Delhi, Punjab, and Jammu & Kashmir.

The fact that the committee has fixed rates on fewer than 600 items (and even these are not being fully adhered to) while the actual number of goods sold today are 10 times as many, creates its own problems because there is no clarity on how these are to be taxed, as inputs at 4 per cent, or as final consumption items at 12.5 per cent.

When the Empowered Committee meets on April 26, it will have a lot of tidying up to do.