VAT’s the big deal?

Traders in the Capital want to strike against the introduction of value-added taxation (VAT) on the grounds that it will hit their incomes. Nonsense. What they are really worried about is that they may have to reveal their real income! The system of VAT requires the maintenance of documentation pertaining to income at each stage of the production and distribution chain. This makes hiding income much more difficult and the worst affected will be the biggest tax evaders: the trading community. Nowhere is tax evasion more rampant than in and around Delhi, as a study conducted by the National Institute of Public Finance and Policy once showed. So in the name of not wanting to hurt consumers, of not wanting to be harassed and not wanting to suffer a loss in income due to the alleged increase in the tax burden, the trading community is up in arms against VAT. Delhi will be among the handful of states not to have a legislation in place by April 1, the deadline set by the Union finance ministry for the introduction of VAT.

Fears that VAT will necessarily result in increased retail prices have been shown to be exaggerated. A study put out by the Karnataka government, for example, has shown that with some odd exceptions like pulses, VAT is not going to push up commodity prices. Rather, for commodities like edible oil, toilet soaps, bread, biscuits and readymade garments, post-VAT retail prices should be below pre-VAT rates. The tax neutrality, the study says, will be largely because of the removal of cascading on account of input tax rebating. The fear expressed in a study undertaken by UTI Securities that distribution costs may go up for many companies and that they may then pass this on to consumers can also turn out to be exaggerated if firms come under competitive pressure and are forced to absorb the VAT effect rather than pass it on to consumers.

Part of this problem can be addressed by adjusting some of the tax rates downwards. The key to the success of VAT lies in low rates of taxation. The problem with sales tax is that many states have tried to milch this revenue cow through usurious rates of taxation. Hence, adjusting rates downwards, rather than funking on VAT, is the answer to the problem. Finally, one lesson of all tax reform undertaken in the past decade is that no change should be made in policy merely because it makes theoretical sense. It is not economists but tax administrators that must ultimately decide the timing and sequence of tax reform, because there has to be an increase in the tax to national income ratio rather than a decline — that is the bottomline. The government cannot afford to lose revenue through tax reform.