FROM BUSINESS WORLD OF 7 FEBRUARY 2006
Scrap this pointless VAT
The
budget is not far, so lobbyists are active. Amongst them is the cigarette
industry. That is not surprising, since it bears the highest taxes, next only
to the drinks industry. The tax is not even a tax on tobacco; the biri industry
does not have to pay tax. The anti-tobacco lobby, led by Dr Ramadoss, is only a
biri lobby in disguise. Since four-fifths of tobacco is smoked in biris,
restrictions on cigarettes make no difference to cancer. They only reduce
revenue and expand the market for biris.
But the tobacco
industry is not lobbying for a reduction in excise. It is lobbying against the
conversion of the excise into value added tax (VAT). But surely VAT was
introduced last year? It was, but three commodities were kept out of it:
textiles, tobacco and sugar. Fifty years ago, the central and state governments
agreed that since these commodities could be easily transported across state
borders, if states levied different rates of tax on them, there would be rampant
smuggling across state borders. It would be best if cigarettes were taxed by
the center and it passed on the revenue to the states.
This
argument applied even after VAT was introduced. But the whole point of
introducing VAT was to give the center and the states overlapping powers of
taxing commodities., and the three commodities could not be exempted from it.
The argument could not be settled in time, and introduction of VAT on the three
commodities was postponed by a year. That year ends on 1 April; after that,
states can tax them.
If
the industry is to be believed, the VAT India has introduced is peculiar. The
point of VAT is that only value added is taxed. So if VAT has been paid on
inputs, a manufacturer can deduct it when he pays tax on his product. But in
India, he will not get rebate on central VAT when he pays state VAT on
cigarettes, and vice versa. This means that states would levy tax, not on the
manufacturer’s price, but on it plus the central excise, which comes to 130 per
cent of that price.
The distributor’s margin – the
difference between what the manufacturer gets and what the consumer pays for
cigarettes – is no more than 10 per cent. But because of the high excise, the
margin comes to 23 per cent of the manufacturer’s price. And if a state levied
a 12.5 per cent tax on the margin, that would come to 29 per cent of the
manufacturer’s price. That, according to the industry, is unfair; when other
FMCG goods are taxed at 12-16 per cent, cigarettes should not be taxed at 29
per cent.
The
cigarette industry says such a state VAT would imply tax on tax, which VAT was
introduced to avoid – it would be a tax on the excise paid by the manufacturer.
It would raise cigarette prices further, induce more smokers to shift to biris
and pan masala, and reduce total tax revenue. State governments would get
little return on the administrative machinery they build up to tax cigarettes;
they may even lose money.
Further,
most cigarette sellers are small and not subject to VAT, so state governments
will get little revenue. If some distributors are subjected to tax while others
are exempt, the former will evade tax. If different states levy different rates
of tax, cigarettes will be smuggled from low-tax to high-tax states.
Finally,
the value of a product can be disputed, and if the tax rate is high, it is
worthwhile for both tax authorities and taxpayers to dispute it. Cigarettes
generated endless litigation when they were taxed on the basis of value; the
litigation will return if states levy VAT.
Some
of these arguments are good, some are bad. But together, they constitute a
damning case against the Indian variety of value added tax. The two taxing
authorities – central and state – multiple rates of tax and an exemption limit
that leaves most businesses out of the tax net – these features together ensure
endless complexity and leave scope for evasion, oppression and corruption. And
to what end? The tax will not mean the end of tax-on-tax; it will not entail a
single tax authority, and it will not reduce evasion. As Ashok Mitra has shown,
VAT has not even increased revenue. If so, why not go back to the old system of
taxing a commodity at a stage where there are fewest players and the tax is
most difficult to evade? The governments of this country have been entranced by
economists into thinking that VAT is a great tax. They have made so many
political compromises while introducing the tax that they have got a caricature
that is worse than the taxes they replaced.
