VAT’s the good word for Budget 2005

The countrywide tax on goods and services would set the stage for major growth


When Budget 2004 was presented in July, the finance minister had had very little time to prepare. The public has been promised, by both the FM and the PM, that Budget 2005 will present major tax reforms.

The Kelkar Task Force report was released after the Budget was presented in July. The most important proposal was a countrywide tax on goods and services (GST), based on the principle of a value added tax (VAT). This tax addresses the series of mistakes in the tax structure today, which are holding India back from becoming a single national market, holding back exports of manufacturing and agro-based industries, and from cutting customs duties.

The finance minister and the Prime Minister have spoken about moving towards GST. If Chidambaram can achieve this, he would not only be able to raise revenue, but would set the stage for a big leap in India’s growth.

The first step is widely seen as the state VAT, to be operational from April. The work of implementation is being done by an empowered group of state ministers. However, the existing plans are riddled with mistakes in ideas and administration. If you have any illusions that this is going to lead to the GST as described in the Kelkar report, you are mistaken. The word ‘VAT’ draws instant sympathy from a lot of quarters, but the state VAT (as presently conceived) delivers on very little of the promise of a proper VAT.

The biggest problem is that the empowered group and the states involved in the implementation of VAT see it as a paper-based system. But a VAT which is not run through an IT system will be suffused with corruption and will increase paperwork for both taxpayers and collectors.

If VAT is not run with the IT system, it will be suffused with corruption
A clean GST should replace the malfunctioning central excise and service tax
The time to start building infrastructure for a full-fledged GST is now
Border checkposts will be required, which will cause delays that more than undo the progress made by the construction of highways. The goal of India as a single national market will not be achieved, as VAT credits will not flow across states. Each state will be like a little country. VAT integration across countries in the EU works better than state VAT would across the states of India.

What is needed is an IT system like the Tax Information Network (TIN), where TDS or VAT credit is recorded in a central database. Through this, paper and fraud are largely eliminated.

Such an effort is not forthcoming from the committee working on state VAT, given the lack of sustained organisational capacity required for thinking, planning and implementation.

The state VAT effort talks about an IT system, but this is an addition for reporting and cross-checking purposes. Given the management difficulties of state VAT, there is a major role for the Centre to provide leadership in showing how a modern GST would work.

This is good tax policy for the Centre, which will benefit by having a clean central GST replacing the malfunctioning central excise and central service taxes. And it will help kick off new thinking among those involved in the state VAT project.

Hence, in Budget 2005, the Centre must set up an IT-intensive central GST, merging all goods and all services, where all transactions will be recorded in one central database. This IT system should be the centrepiece of how VAT credits and refunds take place, and the treatment of VAT on imports and exports should be completely linked to the system.

While this sounds like a tall order, such a system is a small step away from the existing TIN system and can be implemented in 2005-06 itself. The number of establishments involved is smaller than the number of establishments that have already been plugged into TIN.

If India is to have a full- fledged GST within two years, the time to start building infrastructure for it is now. But equally, a properly implemented central GST would reverse the long decline in the excise tax/GDP ratio. By better integration of Cenvat and service tax, and providing credits, this step would help in improving exports and growth.


Ila Patnaik

Ila Patnaik