One grand bargain

Last week8217;s decision by the empowered committee of state finance ministers to start the process of phasing out the central sales tax CST 8212; this is collected when a state produces and sends goods to another state 8212; missed out on a big opportunity. Abolition of CST has been especially opposed by big producer states like Maharashtra, Gujarat and Karnataka. Since the state VAT regime came into place, there has been an increasing consensus that the CST offers perverse incentives to producers to purchase inputs from their own state, where input credits are given to producers, rather than from another state, where they will pay a CST of 4 per cent, and receive no credit. It encourages concentration of production within states regardless of where it is optimal to produce. Removing the CST also gives Indian producers a level playing field when compared with imports from other countries.

Given some states8217; opposition, the empowered committee of state finance ministers would have done better by removing the CST at one go. Since states lose revenue whenever the CST is cut, they have been resisting the change, and it is not unlikely that the rate will again get stuck at, say, 2 per cent and takes many more years to get to zero. Instead of giving states the power to tax some services which may or may not compensate for the loss of revenue and create scope for more rounds of negotiations over many years, this opportunity should be used to make a clean move towards a GST goods and services tax where states are given the power to tax all services, except those on a negative list like telecom and air travel for which no state boundaries can be drawn.

Next is the issue of tax harmonisation. Instead of giving states the power to tax 77 services in compensation for the loss of revenue from CST, a single grand bargain giving the Centre and states a common tax base of all the goods and services in the country and giving producers a single harmonious tax system would be a big step in laying the path for 10 per cent GDP growth. In the past many opportunities have been lost due to our piecemeal approach to indirect tax reform. This should not happen again.