THE messy implementation of state VAT raises questions about the autonomy of states in matters of taxation. While it makes enormous sense that decisions about expenditure and allocation of resources must be made at the local level, can taxes truly be local? Well, VAT is essentially a national tax, but we are trying to implement it as a sub-national (state-level) tax. Given that the country is unconditionally integrated in terms of the movement of people or goods, can a state have true autonomy in determining what to tax and at what rate? India is trying to implement a sub-national VAT because of notions of fiscal federalism prescribed by the constitution. Our constitution correctly understood that income tax is a national tax—that it is silly to have each state taxing the income in its own boundary. But our constitution was unfortunately written a long time ago, before the idea of VAT existed, and it gives states powers to impose sales tax on goods sold in the state. A nascent form of VAT originated only in France in 1955. In a globalising economy, countries are effectively losing autonomy in determining national tax rates. For example, firms flee from countries with high corporate tax rates. When production is organised across countries, tax rules have a significant role in determining where firms place their production. The situation of states within a country is similar. If one state were to raise tax rates on items on which other states have lower rates, it will lose business. If one state were to tax an item that others exempt, then it will lose business. The state VAT is an attempt to create a harmonised system so that industry and trade have no incentive to move across states because of differences in tax rates. However, if states must have the same tax rates owing to the national character of production in the country, why not give up the illusion that they have any autonomy in determining these rates? After all, with commitments to WTO, countries are giving up their autonomy to tax exports and imports. The loss of autonomous taxing power in the hands of states is inevitable. India will get to that destination in one of two ways. There is a hard way—and an easy way. One could continue on the present path, where states try to implement different tax rates and obstruct the movement towards a single national VAT. This will hurt revenues and growth in states that indulge in such activism, and generate dislocations in their neighbours. Over a period of perhaps five years to a decade, the message will sink in, states will learn their lesson and then create a completely harmonised system with a single rate for all states and all goods. But in this hard way, they would each still have a large state tax administration machinery. Keeping this machinery alive involves costs and harassment to firms. This sounds painful. There is an easy way: Look beyond the present fracas, and move for a constitutional amendment which hands over the power to tax all value added in goods and services to the Centre, exactly as has been done with income tax. In this world, the Centre would collect a central GST and the finance commission would then fix formulae for its distribution to states. This way faces political obstacles, from state politicians and bureaucrats who fancy themselves as running little countries. Consumers, traders and industrialists should exert strong political pressure to ensure that these illusions of autonomy are not allowed to hold back India.
