Pinaki Chakraborty Ujjaini Datta

Transcription

1 REVENUE IMPLICATIONS OF INTRODUCING VALUE ADDED TAX AT STATE LEVEL Pinaki Chakrabory Ujjaini Daa Naional Insiue of Public Finance and Policy New Delhi Ocober, 2004

2 Preface The Naional Insiue of Public Finance and Policy has underaken his sudy a he insance of he Twelfh Finance Commission. The sudy eam consiss of Pinaki Chakrabory and Ujjaini Daa. Views expressed in he repor are hose of he auhors. The members of he Governing Body of he Naional Insiue of public Finance and policy are in no way responsible for hese. Ocober 2004 New Delhi M Govinda Rao Direcor ii

3 Acknowledgemens This sudy has been underaken a he insance of he Twelfh Finance Commission (TFC). The sudy examines he revenue implicaions of VAT in wo saes, viz., Andhra Pradesh and Wes Bengal. We would like o hank Dr. C. Rangarajan, Chairman and oher Members of he Commission for valuable commens on a seminar a TFC based on he iniial findings of he sudy. In ligh of he commens and discussions, his repor has been subsequenly revised The Commercial Tax Deparmens of boh he saes provided us he much needed daa required for his sudy. We are hankful o Mr. V. S. Sampah, Principal Secreary, Finance, Governmen of Andhra Pradesh, for his kind cooperaion in his regard. We are paricularly graeful o he Commissioner of Commercial Taxes of Andhra Pradesh, Mr. V. Bhaskar for giving permission o access daa from he Deparmen. We are exremely graeful o Mr. Yugandhar Reddy, and Mr. T. Vivek, boh Join Commissioners, Commercial Taxes, Andhra Pradesh, for heir kind cooperaion and help in providing us he required daa. We have been benefied a lo hrough various discussion wih boh of hem and also wih Mr. A Md. Imiaz, Assisan Commissioner, Commercial Taxes. Mr. V. Krishnamurhy and Mr. N. Krishnachary, boh senior assisans in he Deparmen, meiculously compiled and provided he daa elecronically. We hank hem for heir help. We are also hankful o Commissioner, Commercial Taxes, Governmen of Wes Bengal, Mr. C. M. Bachawa, Mr. H Duari, Addiional Commissioner, officers of he Corporae Division and officers of he Informaion Sysem Division of he Direcorae for providing us wih he useful daa, which enabled us o complee he sudy. A NIPFP, Dr. Amaresh Bagchi, Emerius Professor, ook keen ineres in he sudy and provided us consan guidance a every sage of he work. Despie his exremely busy schedule, our Direcor, Dr. M Govinda Rao spared ime o discuss criical issues relaed o VAT and suppored he work wih his ideas and guidance. We hank Dr. R. Kavia Rao and Dr. Mukesh Anand for helpful discussions. We hank our projec associaes, Darshy Sinha and Anamira Roy Choudhury for heir promp and efficien research assisance. Pinaki Chakrabory Ujjaini Daa iii

4 Inroducion Revenue Implicaions of Inroducing Value Added Tax a Sae Level The sales ax, which is he mos imporan source of revenues a he sae level in India, he idea of ransforming i o a value added ax (VAT) sysem began in early 1990s 1. Subsequenly, he commiee of sae Finance Minisers arrived a a consensus ha he exising sales ax sysem should be ransformed ino a sysem of VAT. The VAT is a mehod of axing he final consumer spending in sages. In oher words, i is a muli-sage ax levied on he value added a each sage. The ransiion processes, he mehod, he opimal design of VAT are he issues, which are sill being debaed. Though here are ambiguiies ha sill exiss on he implemenable VAT design, he broad consensus on major issues on he design of VAT seems o be emerging among he saes. The raionale behind he inroducion of VAT hough well known, sill one may briefly menion ha unlike he cascading ype of sales ax sysem, he desinaion based principle VAT can be very useful in inra-sae sales by eliminaing cascading, as well as iner-sae sales and rade wih hird counries by zero raing of expors. The aribues which impel counries o urn o VAT as he bes among he insrumens of axing consumpion and made i ino a "quinessenial" ax of his cenury primarily are: is neuraliy 2, ransparency, cerainy and self-policing mechanism (NIPFP: 1994). The VAT is he only alernaive o he curren sysem of sales axaion, which apar from cascading of ax hrough producion of inpus, creaes economic disorions hrough muliple ax raes, selecive exempions and incenives. The neuraliy characer of VAT is no only essenial for correcing for hese disorions, i also helps in developing he common marke boh inernaionally and domesically. Few saes in India have experimened wih he VAT implemenaions in a piecemeal fashion 3. A full-fledged VAT is sill o commence a he sae level. I has been agreed upon by all he saes, excep Uar Pradesh o inroduce VAT by 1 s April 1 Wih he publicaion of he repor iled "Reform of Domesic rade Taxes in India: Issues and Opion" by Naional Insiue of Public Finance and Policy in he year For a deailed discussion on neuraliy characer of VAT refer Cnossen (1992) and Tai (1988). 3 For he chronology of evens in he process of implemenaion of VAT refer (Rao: 2004)

5 2005, i.e. in he FY However, here are considerable complexiies involved regarding he reamen of inersae sales, consignmen ransfers and reamen of inpu ax credi hereon, muli-poin axaion of declared goods and exension of sae axes o exile, obacco and sugar in a full fledged VAT regime. Also, saes are worried abou how o compensae for heir revenue loss, if any, on accoun of he inroducion of VAT. Cenral governmen has agreed o compensae he saes in case hey suffer revenue loss in he process of ransiion o VAT. The objecive of his sudy is o develop a mehodology o quanify wheher here will be any loss of revenues on accoun of he inroducion of VAT and provide esimaes of compensaion if any for wo saes, viz., Andhra Pradesh and Wes Bengal. Apar from he inroducion, res of he paper has six secions. The secion I discusses he consensus on VAT design and he issue of compensaion of revenues by he cenre in case here is VAT induced revenue loss o he saes. The secion II discusses he heoreical issues wih regard o he alernaive mehods of esimaion of appropriae VAT base. The mehodology for he esimaions of compensaion and revenue neural raes is delineaed in secion III. Secion IV inerpres he daa and provides empirical esimaes of revenue gain / loss and he revenue neural raes in he conex of VAT. Secion V provides a medium erm projecion of VAT revenues and corresponding revenue loss / gain. Secion VI draws conclusions. I. Consensus on VAT Design A proper design of VAT is criical o achieve he desired oucome of value added axaion. Rao (2003, p-627) argued ha "while he desirabiliy of implemening VAT a he sae level is indispuable, i is necessary o ensure ha he ax is designed and he reform calibraed properly." The major issues in which here have been consan deliberaions in he Empowered Commiee on VAT are he rae srucure, revenue neural rae (RNR), reamen of inersae sales and reurning he righ o levy sales ax on sugar, exile and obacco o saes. The Empowered Commiee is also rying o insall a ax informaion exchange sysem for beer coordinaion and exchange of informaion in VAT regime. The objecive of VAT informaion exchange sysem is o record all inersae ransacions, primarily o check evasion. 2

6 As per he consensus achieved in he Empowered Commiee, recommended VAT raes are hree, viz., 1 per cen, 4 per cen and 12.5 per cen. While, he 1 per cen rae is applicable o jewellary, he 4 per cen rae is applicable o inpus and some iems of basic necessiies, he 12.5 per cen rae is argued o be he RNR applied o residual commodiy group. Very recenly, he saes have finalised he commodiy specific VAT raes. Saes have agreed on 4 per cen VAT rae for 250 iems including agro producs and manufacuring inpus, while 217 iems will arac 12.5 per cen ax rae. I is imporan o noe ha he esimaed revenue neural raes (RNRs) across saes vary widely. The RNR vary from 11 per cen in Haryana o 18.5 per cen in Madhya Pradesh. Among oher reasons, like he differences in ax base, he esimaed RNRs vary due o differences in mehodology of he RNR esimaion and qualiy of he daabase used for he purpose (Rao: 2003). However, he variaions in RNR are obvious given he differences in ax base across saes and he srucure of he sae economy. While a hree rae srucure, as evolved, is a vas improvemen over he mulipliciy of raes ha prevailed earlier, sill here is some confusion as o wheher he general rae is mean o be only a floor or a uniform rae o be adoped by all saes (Bagchi: 2004). As menioned, here canno be single RNR in VAT, which will collec he same amoun of revenue as under sales ax sysem for all he saes. Saespecific revenue neural raes have o differ due o he differences in ax base of individual saes. Thus, one is unclear wheher 12.5 per cen rae, which is ermed as RNR, is acually revenue neural for each sae. If no, hen his rae a he mos can be reaed as a floor rae below which individual saes should no ax a defined baske of commodiies, bu should be able o ax hese iems above he floor rae o bring in revenue neuraliy if no revenue gain. The confusion arises from he use of he erm 'uniform floor rae' in his conex and adopion of 12.5 per cen rae as he basis for compuing revenue loss in all saes (Bagchi: 2004). The saes have agreed o phases ou he cenral sales ax by bringing i down from 4 o 2 per cen in he firs year and hen o 1 per cen in he second year and complee phasing ou by he hird year. Anoher issue in VAT design needs menion here is ha here are seleced iems currenly under sales ax kep ouside he VAT. These iems are diesel, perol 3

7 and ATF, crude oil and liquor. Exclusion of services, from he VAT base is anoher major weakness of he evolved VAT design. Exclusion of services from he base, even if he saes are empowered o ax seleced services on a sandalone basis, would no eliminae he problem of cascading from he ax sysem (Rao: 2004). Exclusion of services from he base also discriminaes goods agains services and has given rise o serious problems in separaing ou he service componen in sale of goods aking place in several insances, e.g., in he case of execuion of works conracs, services of food in resaurans and so on (Bagchi: 1997). In VAT regime, full inpu ax rebae will be given o local inpus used for he purpose of local sales, axable iner-sae sales and expors. The saes have also agreed o give parial inpu ax rebae o branch ransfers/ consignmen sale. The proposed rebae would be over and above 4 per cen of he ax used for inpus. I has also been proposed ha ax on capial goods will be rebaed over hree years. In he proposed VAT regime addiional excise duy iems, viz. exile, obacco and sugar will be subjeced o sae axaion and also for oher declared goods here will be muli poin axaion. I has also been proposed ha saes would provide ransiional relief for sales ax provided o such goods held as sock on he day of implemenaion of VAT. Wihin his design, he Governmen of India has agreed o provide compensaion if here is any loss on accoun of he inroducion of VAT. In he firs year, he compensaion will be 100 per cen, he second year i will be 75 per cen and in he hird year i will be 50 per cen. A close look a he VAT design reveals ha i suffers from he similar deficiencies, which characerises he exising sales ax sysem. In a developing counry like India, if ax sysem reform were o be revenue neural, if no yielding more revenues, and a he same ime he decision of economic agens were no o be needlessly inerfered wih, here is no alernaive bu o design a sysem whereby domesic consumpion could be axed comprehensively wih a wide base covering goods and services, bu wihou giving rise o complexiies and inefficiencies ha mark he exising srucure (Bagchi: 1997). As menioned, in he presen VAT design, service ax remains ouside he VAT. Also, differenial ax raes on inpu and oupu are no jusified in a properly designed VAT. 4

8 As is well known, he basic objecive of he ax sysem is o make i neural o rade and business decision, exernally and inernally. This canno be done even wihin he exising VAT design unless seps are aken o eliminae CST. Wih CST, ax exporing and non-neuraliy wih all heir ill effecs on economic efficiency and iner-jurisdicional equiy will persiss (Bagchi: 1997). The proposal of he Empowered Commiee is o give credi o ax paid only on inra-sae sales and purchases and his will only resul in some sor of 'inra-sae VAT' wih provision for inpu ax credi only on inra-sae rade which will only cause rade diversion-no creaion, and herefor is welfare reducing (Rao: 2003). Revenue loss apprehension appears o be he main reason for he roadblock o he removal of CST and he consequen provision of inpu ax credi. Hopefully, he CST will be eliminaed as envisaged in he VAT design from he hird year from he inroducion of VAT. A heoreical jusificaion of he raionale for cenral governmen compensaing VAT induced revenue loss could be wo: (i) he posiive exernaliy argumen and (ii) he balancing of unequal loss across saes due o differences in heir ax srucure. The posiive exernaliy argumen emanaes from he fac ha inroducion of VAT will eliminae he inequaliy which, curren inernal rade axaion gives rise o and also would help reducing economic disorions and inefficiency in economic decision making and resource allocaion 4. As, he posiive exernaliy of inroducion of VAT would benefi he economy as a whole, cenre wih beer command over resources should compensae he resulan revenue loss. However, he desired oucome of VAT will be manifesed in is appropriae form when CST will be eliminaed. The second argumen for compensaion arises from he fac ha ax srucure of saes is differen due o he differences in he manufacuring base across sae and correspondingly he resulan revenue loss will be differen which needs o be compensaed by he cenre so ha horizonal inequaliy does no accenuae furher. A sudy of VAT in Chinese provinces by Ahmad E., Raju Singh and Benjamin Lockwood (2004) also observed ha VAT reform did no affec all he provinces uniformly. The sudy furher noed ha move o a VAT paricularly affeced provinces where indusry represens a large share of heir economic aciviy. 5

9 Poor provinces where agriculure is sill pre-dominan and richer provinces where services have aken a growing role would be less affeced. As menioned earlier, wheher here will be any revenue loss on accoun of he inroducion of VAT, one needs o poin ou wha are he possible sources of revenue loss. The possible sources of revenue loss and gains are many and hus he issue of deermining he compensaion is a complex one. The primary apprehension abou revenue loss arises on he full and comprehensive inpu ax rebae ha has o be provided o local inpu purchase, loss on accoun of inersae sales or CST loss due o rae reducion and he full inpu ax rebae hereon, parial inpu ax credi on branch ransfers and consignmen sales and expors and ransiional loss. A he same ime here will be revenue gains arising ou of axing value addiion a every sage of producion. Secondly, as per he naional consensus on VAT design, he saes would be beneficiary of he axing of AED iems, namely, exiles, obacco and sugar which will provide hem revenues o offse a subsanial porion of he loss ha may arise due o CST loss and on accoun of inpu ax credi. Also, here will be revenue gains due o he muli-poin axaion of declared goods. Ulimaely, he esimaion of revenue loss needs o be adjused agains he revenue gains VAT would possible generae. II. Esimaion of Base: Theoreical Issues An exercise of his naure, requires an esimaion of correc base for VAT, which in any form of axaion is he key for he measuremen of ax poenial. Theoreically, he applicable base of a value added ax depends on a number of facors relaed o is design, e.g., wheher i is origin or desinaion based, of he income or consumpion ype, implemened wih a credi invoice or subracion mehod and conains many or few exempions. The mos widely acceped form of he VAT is a desinaion based, consumpion ype sysem implemened wih a credi invoice mehod. As menioned, he saes in India also agreed o implemen he similar sysem of VAT in heir respecive saes. 4 The economic impac of commodiy axaion, hough no fully quanified, an analysis of is impac on economic decision making is analysed by (Bagchi: 1997), (Rao:1993), (Rao and Vaillancour:1994, 6

10 The saring poin for he esimaion of VAT base is he gross domesic produc of an economy, in he case of saes he gross sae domesic produc, since i represens he sum oal of he value added in he producion of goods and services wihin a sae economy. However, for a desinaion based consumpion ype VAT, he legiimae quesion ha arises is wheher final consumpion expendiure, which represens he sum oal of value added of domesic consumpion is no a more direc saring poin in esimaing he VAT base. I depends o a large exen on he scope and he naure of exempions of he VAT under consideraion. For a desinaion based consumpion ype of VAT levied comprehensively wih no exempions, he base is simply he final consumpion on goods and services. Generally, here are hree alernaive mehods of esimaing base of VAT, viz., GDP adjused for expors and impors, he consumpion expendiure and he axable urnover of sales ax. GDP adjused for exernal secor ransacions would represen he oal expendiure on privae consumpion, governmen consumpion, fixed capial formaion and changes in business invenories. The esimaed GDP adjused for he value of services of exemped secor, governmen wages, fixed capial formaion and ne consumpion abroad would precisely define he VAT base. Alhough GDP daa is available from he naional accoun saisics, i is very difficul o ge disaggregaed daa on exemped secors and on value of goods and services o be excluded from VAT base. Use of GDP, hus as VAT base becomes problemaic even a he naional level VAT calculaion. I becomes even more difficul in he case of saes as here is no reliable daa available on expors and impors from he saes apar from he iems o be excluded from he esimaion of VAT base wihin he exemped secor from he sae GSDP. Anoher alernaive, which can be used as he base of he VAT, is he consumpion expendiure. The consumpion expendiure daa is available a he sae level as well as a all India level. The sae specific consumpion expendiure daa can be used as a proxy for he base of VAT. The aggregae privae consumpion expendiure daa for he counry as a whole is provided by he Naional Accouns Saisics (NAS). Sae wise consumpion expendiure daa also on 5 yearly basis is NIPFP: 1994). 7

11 available from naional sample survey. This mehod of esimaing VAT is called consumpion expendiure approach. However, he consumpion expendiure mehod is no free from limiaions, primarily due o he non-availabiliy of daa on exemped commodiy consumpion and exempion of dealers wih urnover below he axable limi. Given hese informaion, one can esimae he VAT revenues of individual saes hrough consumpion expendiure approach. I is possible o esimae VAT revenues hrough "ax urnover" mehod. Advanage of ax urnover mehod is ha i is based on he daa of axable urnover of goods available wih he respecive sales ax deparmen of saes. However, axable urnover daa, includes he inermediae inpus as well. As under VAT, ax paid on inpu by a VAT regisered dealer would have o be rebaed, one has o esimae he inpus eligible for inpu ax rebae from he ax urnover daa. I is also o be noed ha inpus eligible for credi will be he axable inpus alone. Thus, one has o deermine no only he inpu componen from he axable urnover, bu also he srucure of inpu used, viz., axable inpu and non-axable/ exemped inpus. Anoher issue ha requires aenion is he quanificaion of locally produced inpus and he use of impored inpus wihin he axable inpus. As per he conemplaed VAT regime, locally produced inpus will be eligible for inpu ax credi. Of course wihin a full fledged VAT regime, full inpu ax credi will be given irrespecive of he origin of inpu. A mechanism of such a sysem of ransfer of inpu ax credi is ye o evolve in he implemenable VAT design in India 5. As i is well known, axable goods produced wihin a sae is sold via (i) local sales, (ii) axable iner-sae sales, (iii) consignmen / branch ransfers and (iv) inernaional expors. In he presen sysem, daa available wih he sales ax deparmen of saes, hough provide commodiy wise / dealer wise daa on general sales ax and cenral sales ax, i is difficul o obain disaggregaed daa on expors and consignmen / branch ransfers from he sae. 5 The sandard reamen of iner-sae rade or expor under desinaion based VAT is zero raing. Anoher alernaive, which he European Commission firs proposed in he early 1990s is o replace zero raing by full ax a he same rae as domesic sales, wih a credi hen available agains he oupu ax in he imporing counry hrough a 'clearing house' mechanism. Through his mechanism revenue would effecively be reallocaed across provinces so as o preserve he same allocaion of revenues under zero raing. 8

12 Apar from his, axable urnover daa suffers from several oher deficiencies. As he axable urnover daa perains o firs poin sales in mos of he saes, i excludes he rade margin added in he subsequen sales by wholesalers and reailers. In oher words, when one is conemplaing a VAT regime, which by naure is a sysem of muli-poin axaion, one has o make suiable assumpions wih regard o he rade margin in he subsequen sages of value addiion for which no hard daa is available. Also, he rade margin / value addiion differs across commodiies. Thus, in he absence of deailed informaion, i is difficul o esimae he precise revenue gain from axing of value addiion in he subsequen sages of ransacions. I is also o be noed ha i is difficul o obain sae specific consumpion daa on addiional excise duy iems, viz., exile, obacco and sugar-as hese iems are subjec o sales ax under he ax renal arrangemen wih he cenre. Thus, one needs o esimae he sae specific base of hese axes and hen arrive a he revenues from hese goods for a paricular sae wih he applicable VAT raes. I also may be noed ha axable urnover excludes all exemped urnovers and also he urnover of dealers below he hreshold limis under he curren sales ax sysem in he saes. However, in he calculaion of VAT base, furher deducion needs o be made in he urnover daa in which dealers who will remain below he hreshold limis under he new VAT regime. In he presen sudy, among he hree mehods discussed above, we have used he las mehod, viz., ax urnover mehod for he esimaion of VAT revenues and he inpu ax credi based on he daa obained from he respecive commercial ax deparmens of Andhra Pradesh and Wes Bengal. III. Mehodology of Esimaion of VAT Revenue and Inpu ax credi The mehodology for he esimaion of VAT revenues and he quanum of inpu ax credi is delineaed below. G Ls Cs X B (1) Where G GrossTurnover L s Local Sales Turnover 9

13 C s Cenral X Expors Sales Turnover from he Sae B BranchTransfers L O s s G O (2) C s s X B O s Sales Ousidehe Sae The inpu componen in he local sales urnover is I (3) cc L s I Where, I Inpu, O Oupu, O In case of a group of commodiies, is he inpu coefficien vecor. I is o be noed ha oal inpu can be decomposed beween axable and non-axable inpu. The inpu ax will be applicable in he case of axable inpu. In oher words I I x I T (4) Where I Exemped Inpu, I Taxable Inpu X T The inpu ax in urn would be I i IT (5) where, i is he rae of ax on inpu Subracing equaion (5) from equaion (2) we ge he axable local urnover as he VAT base free of any inpu ax. V L I (6) s The VAT revenues would be V R V v (7) r where V VAT Base, V VAT Revenues, v R r VAT Rae Esimaion of Inpu Tax Credi Before we proceed furher, i is o be menioned ha under he curren VAT design, hough revenues would be colleced from he local sales and also CST a 2 per cen, ax rebae would have o be given o local purchase of axable inpus used for he 10

14 producion of axable commodiies irrespecive of wheher hey are sold locally or ouside he sae. In oher words, local inpus eligible for inpu ax credi has o be esimaed no only on he local sales bu also on iner-sae sales, consignmen/branch ransfers and expors. Thus, i has o be on he gross urnover defined in equaion (1). Following he mehodology adoped in he calculaion of inpu ax componen for N, we esimae he inpu ax componen for C s, X and B. I I x cs X I i (8) s XT cst C I i (9) Ib B IbT i (10) Where, I XT Share of Taxable inpu for exp or urnover I cst Share of Taxable inpu for cenral sales urnover I b Share of Taxable inpu for branch ransfers Deducing equaion (8), (9) and (10) from X, C s and B respecively, we obain heir urnovers ne of inpu ax. Toal gross urnover wihou inpu ax is G ' V C X B (11) ' s ' ' In esimaing he value of inpus qualifying for VAT rebae, i should be remember ha no inpu ax rebae is given o inpus relaing o urnover of imporers, inpus procured from ouside he sae and exemped inpus. Thus, rebae would be available for he inpus produced locally in manufacuring axable goods for he purpose of local sales as well as sales ouside he sae including expors. Given his condiion, we assume ha he share of imporer's urnover is. Conversely, he urnover excluding ha of imporer is he following: G '' (12) ' ( 1 ) G Again for he esimaion of local inpu purchase, we apply he inpucoefficien vecor o obain he oal inpu componen in he urnover excluding imporer's urnover and furher adjus he local inpus by subracing he exemped inpus. The remaining axable inpu is again adjused for he inpu purchase from ouside he sae. The remaining amoun obained is eligible for inpu ax credi, which 11

15 by muliplying he corresponding ax raes for inpus we have obained he inpu ax credi o be given under a VAT regime for local inpu purchase. IV. Inerpreing Daa and Esimaion of VAT Revenues Given he ime consrains and he daa inensive work involved in his kind of exercise he sudy concenraed on wo saes, viz., Andhra Pradesh and Wes Bengal. The daa obained from he Commercial Tax Deparmen of Andhra Pradesh consiss of commodiy wise daa on sales ax collecion under APGST for wo hundred and weny commodiies. We also have colleced deailed daa of urnover and ax paid by 1488 dealers. Deailed informaion of hese dealers are used o obain various parameers used for his sudy. However, in case of Wes Bengal, such disaggregaed level of daa on urnover was no available. We have obained he daa on commodiy wise ax collecion under general sales ax of Wes Bengal. The urnover is obained by muliplying he corresponding effecive ax raes wih he ax collecion. In boh he saes, he general sales ax (GST) ac and cenral sales ax (CST) ac govern operaion of sales ax. The former deals wih he axaion of inrasae sales and he laer deals wih he axaion of inersae sales. In boh he saes ax is charged a he firs poin of sale. However, in Andhra Pradesh, already here are 23 commodiies under VAT and in Wes Bengal also, roughly same number of commodiies are subjec o double poin axaion. In Andhra Pradesh, he amoun of revenues colleced under VAT in he year was Rs core which as a percenage of oal sales ax revenue was 0.57 per cen. Anoher characerisic of he sales ax sysem in Andhra Pradesh is he applicaion of urnover ax a he rae of 1 per cen. Before we go ino he deails of he esimaion of compensaion, an idea of he srucure of sales ax and he rae srucure is given in Table 1 and Table 2. I can be seen from he Table 1 ha he ax colleced under he cenral sales ax is seadily declining in boh he saes. In Andhra Pradesh, he share of ax colleced under CST declined from per cen in o 7.89 per cen in However, in case of Wes Bengal, he share of CST declined from per cen o per cen during he same period. I is o be noed ha beween he wo saes, he conribuion 12

16 hrough CST in oal sales ax is relaively higher in case of Wes Bengal compared o Andhra Pradesh. Table 1: Srucure of Sales Tax in Andhra Pradesh & Wes Bengal (Per cen) Andhra Pradesh Wes Bengal GST CST GST CST Noe: GST = General Sales Tax, CST = Cenral Sales Tax Source (Basic Daa): Commercial Tax Deparmen, Governmen of Andhra Pradesh And Wes Bengal The rae srucure of he sales ax shown in Table 2 reveals ha he number of raes in Andhra Pradesh, under he exising sales ax rae srucure are much less compared o Wes Bengal. Rae specific composiion of urnover and corresponding conribuion o oal revenues reveals ha in Andhra Pradesh, corresponding o 4 per cen rae of ax, per cen of he urnover is concenraed and heir conribuion o oal revenues is per cen. In Wes Bengal also he highes concenraion of urnover is a 4 per cen rae and heir conribuion o oal revenues is per cen. In Andhra Pradesh, he second highes revenue conribuion comes under 8 per cen rae, followed by 16 and 12 per cen. In Wes Bengal, however, he highes conribuion of revenues comes under 10 per cen rae, followed by 4, 12 15, 8, 8.5 and 17 per cen. The conribuion o oal axes under oher raes is minimal in boh he saes. I is o be noed ha his rae srucure excludes he raes applied o diesel, perol, ATF and liquor and oher raes having insignifican conribuions o revenues. The raes under diesel, perol, ATF and liquor are specifically kep ouside he analysis because hey are no going o come under VAT under he presen VAT dispensaion. 13

17 Table 2: Sales ax Raes, Corresponding Turnover and Conribuion in Tax Revenues Tax Raes (in per cen) Rae specific axable urnover (in per cen) Conribuions o oal revenues (in per cen) Andhra Pradesh Wes Bengal Source (Basic Daa): Commercial Tax Deparmen, Governmen of Andhra Pradesh & Wes Bengal As hese commodiies (diesel, perol, ATF and liquor) will remain ouside he VAT, heir conribuion o oal revenues of he sae will remain unchanged even when he VAT is inroduced. In oher words, if he weighage of hese axes are higher in he oal ax, revenue conribuion o be affeced by inroducion of VAT will be lower. If he average rae in hese few commodiies are very high in a paricular sae vis-a-vis, average rae of sales ax, he average rae of sales ax excluding hese iems will be much lower. Accordingly, oher hings remaining consan, he possibiliy of revenue gain / loss will be higher in a VAT regime depending on differenials beween he average raes of sales ax excluding he raes applied o non-vaable iems and he weighed average raes of vaable commodiies. 14

18 Table 3: Rae Srucure of Seleced Non-Vaable Commodiies and heir Conribuion o oal Revenues: (Per cen) Andhra Pradesh Wes Bengal Tax Rae % Conribuion in revenue Tax Rae % Conribuion in revenue Perol Diesel ATF Liquor Toal Source (Basic Daa): Commercial Tax Deparmen, Governmen of Andhra Pradesh & Wes Bengal A comparaive picure of rae srucure and conribuion of hese non-vaable iems, viz., perol, diesel, ATF and liquor in oal sales ax revenues of boh he saes are given in Table 3. I is eviden from he Table ha all hese iems are axed a a much higher rae in Andhra Pradesh compared o Wes Bengal and heir conribuions in revenues is much higher in Andhra Pradesh vis-à-vis Wes Bengal. The average rae of ax in hese iems is as high as more han 28 per cen in Andhra Pradesh and he same is per cen in Wes Bengal. Thus, when one is alking abou VAT revenues and he aendan issue of compensaion, i is applicable only o 55 per cen of he sales ax revenues of Andhra Pradesh and around 70 per cen of he sales ax revenues of Wes Bengal. The esimaed average rae of ax being 8.5 per cen in boh he saes, he average of raes of sales ax in vaable iems is much lower in Andhra Pradesh compared o Wes Bengal. In oher words, oher hings remaining consan, rae adjusmen under VAT should ideally provide higher revenue gains in Andhra Pradesh compared o Wes Bengal and correspondingly he proporional loss should be much lower in Andhra Pradesh compared o ha in Wes Bengal. However, he quanum of loss would also depend on he inpu componen eligible for inpu ax credi in he oal inpu in individual saes. If he local inpu componen used for local manufacuring is higher, he inpus qualifying for inpu ax credi will be higher and correspondingly revenue gains will be lower. As menioned, one of he key componens in he esimaion of compensaion is he esimaion of inpu ax credi. In order o arrive a he inpu componen in he axable urnover we have used he all India inpu coefficien marix obained from he inpu-oupu able published by CSO. Use of inpu-oupu able in he absence of updaed one may no ruly reflec he acual inpu inensiy of a 15

19 paricular commodiy. However, i is also o be noed ha if here is srucural change in he commodiy composiion of oupu arising due o efficiency gain because of higher compeiion in he new economic environmen, he inpu coefficien will be lower if recen inpu coefficien were available, which means higher value addiion. Thus, he use of inpu-oupu able does no under esimae he inpu componen and correspondingly he inpu ax credi. In fac, he use of inpu oupu able ends o over esimaes he inpu componen and hereby he inpu ax credi. One of he limiaions of his exercise is ha in he absence of an updaed inpu oupu able, he esimaion of inpu ax credi suffers from an upward bias. In pracice, he acual inpu ax credi may be lower han esimaed in his exercise. I is also o be noed ha he inpu coefficiens could be eiher a global raio, secor specific one or commodiy specific. Earlier sudies on he esimaion of inpu componen used a global raio insead of secor specific or commodiy specific coefficiens (Aggarwal and Narayana: 1995, Aggarwal: 2002, Aggarwal: 2003). The applicaion of global raio o arrive a he inpu componen would provide spurious esimaes of inpu componen. A closer look a he inpu coefficien marix revealed ha inpu coefficiens differ across commodiies widely. If we classify he inpu coefficien marix ino hree broad caegories, viz. primary, secondary and eriary secors, he corresponding inpu coefficiens works ou o be 0.25, 0.68 and 0.33 respecively. Also, here are large inra-group variaions wihin hese hree sub secors. Given hese large variaions in inpu-coefficiens across commodiies, his sudy deviaed from he earlier sudies by no adoping a global raio for he calculaion of inpu componens from he commodiy wise axable urnover daa. Insead, commodiy specific inpu coefficien vecor is applied o esimae he inpu componen hrough a sysemaic commodiy mapping from he inpu coefficien marix of 115 commodiies available in inpu-oupu able agains axable urnover of 220 and 163 commodiies for Andhra Pradesh and Wes Bengal respecively. Through his mehod, inpu componen in oal axable urnover works ou o be and per cen for Andhra Pradesh and Wes Bengal respecively. As hese wo raios are much higher han he aggregae inpu-oupu raio of 48 per cen repored in inpu-oupu able, inpus ha will be eligible for inpu ax credi will be much higher in his mehod. 16

20 Having obained he inpu componen, we have esimaed he share of exemped inpu in he oal inpu. Again his raio obained from he inpu-oupu able works ou o be 9.81 per cen. In oher words, he share of axable inpu in oal inpu is more han 91 per cen. As per he presen VAT dispensaion, only he local inpus will be eligible for he inpu ax credi. Thus, a precise esimae of local inpu purchase is essenial for he deerminaion of inpu ax credi. As menioned earlier, for he sae of Andhra Pradesh, we have obained deailed informaion wih regard o he urnover of 1488 dealers for he year Among ohers, he daa obained comprises of oal inpu purchase from and ouside Andhra Pradesh, purchase in he course of inersae agains C-Form and also agains F-Form. The daa on oal sales boh inside and ouside Andhra Pradesh is also obained from hese deails. Based on hese informaion, local inpu purchase works ou o be per cen in case of Andhra Pradesh. Local inpu purchase works ou o be 35 per cen in case of Wes Bengal. In case of Wes Bengal, alhough we did no have dealer wise informaion, he commodiy wise daa on impor was obained from which he non-vaable iems of impor were deduced. This inpu componen is again adjused for exemped inpus. Having obained he axable inpu we have arrived a he quanum of inpu ax credi o be given in he VAT regime for he general sales ax. Similar exercise was repeaed for he esimaion of inpu ax credi for CST, consignmen ransfers and expors. We have been able o obain informaion on expors from he commercial ax deparmen of Andhra Pradesh for he year , which amouned o Rs. 11,358 crore. Based on he discussion wih he CTD officials, we have applied a growh rae of 18 per cen per annum o obain he expor volume for he year Though he esimaion of inpu ax credi for CST and expors were sraighforward, he esimaion of he same for consignmen ransfers required furher adjusmen. As per he VAT design, in case of consignmen ransfers, a regisered dealer shall no be eligible for inpu ax credi unless he amoun of ax on such urnover of purchases exceeds he amoun calculaed a he rae of four percen or applicable rae of ax, which ever is lower, and he amoun of inpu ax credi shall be calculaed a such rae which exceeds four percen or applicable rae of ax, as he case may be. Based on his principle, inpu ax credi is esimaed accordingly for he consignmen / branch ransfers. 17

21 Anoher aspec of VAT revenue esimaion is he esimaion of revenue gain due o mulisage axaion. Thus, o obain addiional revenue gain we have esimaed he subsequen sages of value addiion by adding rade margin. As per he noificaion issued under Cenral Excise Ac 6 for assessmen of goods on he basis of reail sale price (MRP), commodiy wise abaemen as a percenage of reail sales price ranges beween 35 o 50 per cen. Reail sale price as per he noificaion implies he maximum price a which he excisable goods in packaged form may be sold o he final consumer and includes all axes, freigh, ranspor charges, commission payable o dealers and also charges owards adverisemen, delivery, packing and forwarding as he case may be. Given his abaemen rae based on he definiion of reail sale price, a rade margin of 10 per cen a he second poin and furher 10 per cen in he las sage is applied o esimae he addiional revenue gain from value added which, as eviden from he abaemen rae, is a highly conservaive esimae of value addiion. The esimaes of value added is no ha of all he commodiies in all sages of ransacion, bu paricularly o hose iems in which under he VAT regime applicable rae will be 12.5 per cen. This is paricularly done o avoid value addiion on hose iems, which are used for inermediae consumpion. However, in he case of inermediae goods, i is assumed ha here will be value addiion a leas a one sage and in ha he margin of value addiion is assumed even lower a 5 per cen. Cerain oher componens requiring quanificaion for he esimaion of revenue loss / gain are he following: (a) he quanum of AED revenues (adjused for cenral ransfers) if he sae levy axes on exile, obacco and sugar, (b) loss due o he aboliion of urnover ax, (c) loss on accoun of he increase in urnover hreshold o above Rs. 3 lakhs in Andhra Pradesh and Rs. 5 lakhs in Wes Bengal and (d) he quanum of ransiional relief o be given o he manufacurer / dealer for sales ax provided o such goods held as socks on he day of implemenaion of VAT. 6 Noificaion number 13/2002-C.E. (N.T.) daed and heir subsequen amendmens (cenral Excise Manual wih Service Tax , 37 h Ediion). 18

22 Like any oher revenues, esimaion of sae specific ax base for exile, obacco and sugar is a mus for he esimaion of revenues ha he sae can generae by levying axes on hese commodiies. However, in he absence of published daa, i is no possible o obain he sae specific ax base of hese commodiies. However, he daa on final consumpion of hese commodiies a naional level is available from he naional accoun saisics excep for sugar. The consumpion daa repored in naional accouns saisics includes he consumpion of boh sugar and gur. Thus, assuming he oal consumpion of sugar and gur a a raio of 65: 35 we have arrived a he oal consumpion of sugar (Aggarwal and Narayana:1995). Having obained he naional level per capia consumpion, we have muliplied per capia consumpion of sugar and exile wih he respecive sae populaion o obain he oal consumpion in he sae. Bu in he case of obacco consumpion, such an exercise was no possible as obacco is consumed by a subse of he oal populaion wihin a sae. Thus, o arrive a an appropriae base of obacco consumpion, we have esimaed he oal obacco consuming populaion in he sae of Andhra Pradesh and Wes Bengal based on a sudy conduced by World Bank (1999). This sudy provides he esimae of obacco consuming populaion above he 0-15 age groups in differen regions across he World. According o hese esimaes, in Eas Asia and Pacific region 59 per cen of he male and 4 per cen of he female in he residual age group consumes obacco. However, as we do no have a daa on he age group below 0-15 from he census, we have deduced he 0-14 age group of populaion from he oal populaion of respecive saes of Andhra Pradesh and Wes Bengal and applied he corresponding raios for obacco consuming male and female in he Eas Asia and Pacific region o arrive a he esimaes of obacco consuming populaions in he respecive saes. Having arrived a he esimaes of obacco consuming populaion in hese wo saes, we obained he consumpion of obacco in he respecive saes. On he basis of he above esimaes we have obained he oal revenues hese wo saes can possibly collec if sugar and exiles are axed a 4 per cen and obacco is axed a 12.5 per cen. This revenue is adjused for he possible revenue loss on accoun of he reducion in AED ransfers from he cenre in lieu of sales ax. We have obained informaion on he amoun of loss due o he aboliion of urnover ax and esimaed he loss on accoun of he increase in he hreshold limi of 19

23 VAT above Rs. 3 and 5 lakhs in boh he saes by deducing he oal ax colleced currenly from he dealers having urnover upo Rs. 3 lakhs and 5 lakhs. This works ou o be Rs. 56 crore in he case Andhra Pradesh and Rs crores in he case of Wes Bengal for he year Having obained separae esimaes of all hese componens, we have arrived a he esimaes of revenues ha he sae will mobilise, if he proposed VAT design is implemened. I can be seen from he Table 4 ha he hird poin VAT revenue will be Rs crore in case of Andhra Pradesh and Rs crore in Wes Bengal. By subracing he componens of revenues ha will be given as se off and various oher losses saes will incur, viz., ransiional loss, loss on accoun of aboliion of urnover ax, increase in he urnover hreshold we obain he ne VAT revenues. Adding he CST revenues a he rae of 2 percen esimaed on he base free of inpu ax and he addiional excise duy gain (adjused for cenral ransfers) wih he ne VAT revenues, we obain he aggregae revenues in he proposed VAT regime. The esimaed VAT revenue when deduced from he revenues obained under GST and CST we ge he ne revenue gain / loss for individual saes. In case of Andhra Pradesh, oal loss works ou o be Rs crore and Rs crore for Wes Bengal. 20

24 Table 4: Esimaes of Compensaions: (Per cen) Andhra Wes Bengal Pradesh Sales Tax Revenues (a+b) a. GST b. CST Revenues ouside VAT Vaable GST Revenues VAT revenue a he firs poin VAT revenue a he second poin VAT revenue a he hird poin Deducible iems from he VAT revenues Inpu ax credi on inra-sae sales Inpu ax credi on iner-sae sales Inpu ax credi on expors Inpu ax credi on consignmen sale Transiional relief Loss of urnover Tax VAT Rev. Loss Loss due o increased urnover hreshold Ne VAT Revenues CST Revenues a he rae of 2 per cen AED Revenues adjused for Transfers Toal Revenues (VAT+CST+ AED) Revenue Gain (+) / Loss (-) Source (Basic Daa): Commercial Tax Deparmen, Governmen of Andhra Pradesh & Wes Bengal As boh he saes are having a revenue loss, i is imperaive o esimae sae specific revenue neural raes. The esimaed revenue neural raes can be obained by dividing revenue yield under VAT adjused for revenue loss / gain wih he hird poin / final VAT base. RNRs under various alernaive scenarios are given in Table 5. The revenue yield and base considered for he RNR calculaion differs across scenarios. In he firs case, revenue comprises of revenues under GST and CST (a he rae of 2 per cen), he base being he esimaed hird poin VAT base. In an alernaive scenario, when CST will be eliminaed, he ax base remaining consan, here will be a higher demand of revenues from he same base, which will in urn increase he RNR. In he second case, if he AED revenues and AED base are added wih he exising revenue yield and base in he scenario I, we ge anoher se of RNRs, which is lower han ha of scenario-i. In oher words, if he AED iems are also axed a he revenue neural raes, he RNR will be lower. 21

25 Table 5: Esimaed Revenue Neural Raes (per cen) Andhra Pradesh Wes Bengal RNR Excluding AED Revenue and Turnover General RNR RNR (Vaable GST + CST) RNR if CST is eliminaed Specific RNR RNR (Vaable GST + CST) RNR if CST is eliminaed RNR Including AED Revenue and Turnover General RNR RNR (Vaable GST + CST) RNR if CST is eliminaed Specific RNR RNR (Vaable GST + CST) RNR if CST is eliminaed Source: Commercial Tax Deparmen, Governmen of Andhra Pradesh & Wes Bengal The single RNR across hree defined ses of commodiies axed a 1 per cen, 4 per cen and 12.5 per cen works ou o be 8.1 per cen in Andhra Pradesh and 10.6 per cen in Wes Bengal, in scenario-i, when CST is levied a 2 per cen. When CST is eliminaed, he single RNR on hese hree defined se of commodiies works ou o be 8.6 and 11.4 per cen in Andhra Pradesh and Wes Bengal respecively. However, as he iems axed a he rae of 4 per cen are mainly inermediae goods and some iems of basic necessiies, which under he presen VAT dispensaion canno be axed a a higher han he prescribed rae of 4 per cen, he RNR needs o be esimaed on he aggregae axable base of commodiies o be axed a he rae of 12.5 per cen. The RNR works ou o be 13.0 per cen and 14.0 per cen for Andhra Pradesh boh wih CST and wihou CST respecively. In case of Wes Bengal, he same works ou o be 13.6 and 14.8 per cen respecively. As eviden form he Table 5, RNR will be marginally lower when AED revenues and base comes under ax and ax base. V. Projecion of Revenues On he basis of he esimaed VAT revenues and he revenue loss for he year , we require esimaing he loss or gain of revenue in he medium erm, i.e, for he period beween and As we have made our esimaes wih 22

26 respec o he year , he same year is considered as he base year of projecion for boh he saes under alernaive projecion scenarios. Observed GST Buoyancy Based The firs sep in he esimaion of projecion of gain or loss is he esimaion of medium erm profile of sales ax revenues ha saes could possibly mobilise, if he exising sales ax regime coninues. The second sep is o esimae he profile of VAT revenues, he revenues under CST and AED and also he profile of deducible iems from he VAT revenues. The projeced profile of GST for boh he saes are obained by esimaing he observed buoyancy of vaable GST iems for he period beween o The esimaed buoyancy works ou o be 1.10 for Andhra Pradesh and 0.90 for Wes Bengal. For CST, we have esimaed he buoyancy for a longer ime series daa from o in a double log specificaion. These buoyancies work ou o be for Andhra Pradesh and for Wes Bengal. Based on he observed buoyancy of GST and CST, we have esimaed he buoyancy based growh raes of hese wo componens of axes. For he period beween and , he rend raes of growh of GSDP were and per cen for Andhra Pradesh and Wes Bengal respecively. Applying he same growh rae, we have obained he profile of GSDP of boh he saes for he period beween and Applying he buoyancy based growh raes of GST and CST on he base year , we have esimaed he profile of sales ax revenues from o The profile of hird poin / final VAT revenues is arrived a by applying he same buoyancy as ha of applied in he case of Vaable GST. For he esimaion of CST revenues under VAT, we have firs esimaed he urnover of CST from he projeced CST profile. Then esimaed he inpu ax componen in he projeced urnover based on he mehodology discussed in secion III. Deducing he inpu ax componen from he urnover we obained he ne urnover of CST wihou inpu ax for he projeced period and corresponding CST revenues a he rae of 2 per cen. AED revenues are assumed o remain consan as a percenage of GSDP of respecive saes during he period of projecion. 23

27 Finally, in order o arrive a he ne VAT revenues we need o adjus he revenues downward for he inpu ax credi and oher deducible iems. The oal deducible iems in he base year consiued around 22 per cen of he hird poin VAT revenues in Andhra Pradesh and 16 per cen in case of Wes Bengal. We assume ha his raio will remain consan hroughou he projecion period. If we deduc hese iems from he projeced hird poin / final VAT revenues, we obain he ne available VAT revenues o he saes. The differences beween he projeced ne VAT revenues and he vaable sales ax revenues including CST provides he profile of gain/ loss in he medium erm, i.e., for he period beween and Table 6: Projecion of Revenues (Scenario I) : o (In Rs. Crore) Andhra Pradesh Sales Tax Excluding Non-Vaable Iems General Sales Tax Cenral Sales Tax Ne VAT Revenues Third Poin VAT Revenues CST Revenues AED Revenues Deducable Iems from VAT Revenues Loss/ Gain Wes Bengal Sales Tax Excluding Non-Vaable Iems General Sales Tax Cenral Sales Tax Ne VAT Revenues Third Poin VAT Revenues CST Revenues AED Revenues Deducable Iems from VAT Revenues Loss/ Gain I can be seen from he Table 6 ha beween and , he profile of sales ax revenue (excluding non-vaable iems) increases much higher han he ne VAT revenue in he corresponding period resuling in revenue loss o he sae of Andhra Pradesh and Wes Bengal One of he major reasons for he sharp increase in he revenue loss from onwards is he complee aboliion of CST revenues. 24