4408483

Fiscal Federalism: Towards an Appropriate VAT System for a Federal Economy
Author(s): S. Gurumurthi
Source: Economic and Political Weekly, Vol. 34, No. 40 (Oct. 2-8, 1999), pp. 2875-2888
Published by: Economic and Political Weekly
Stable URL: http://www.jstor.org/stable/4408483
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Fiscal Federalism
Towards an Appropriate VAT System for a Federal Econ
S Gurumurthi
The paper analyses the current division of responsibility between the centre and the states with reg
to commodity taxation in its historical perspective and the efforts initiated during the last 15 years to introdu
the VAT in place of union excise duties at the central and the sales taxes at the state levels. It offers a
alternative VAT model for India based on certain principles applicable also to other federal econ
planning to introduce the VAT.
where the states try to retain more discre-from the angle of incidence on the con-
The politics of the time is going towards
fragmentation, while the economics tionis over their own exemptions, rates, andsumer, it has to be recognised that the two
towards integration. revenues, the system would not work.taxes are neither identical nor interchange-
- Paul Kennedy While the system may be working satis-able and that there are some basic differ-
factorily in Germany, it should be appre-ences between the two different levies.
SEVERAL federal countries - Argentina, ciated that fiscal federalism issues still In the first place, an excise is a levy at
Austria, Brazil, Canada, Columbia, the stand in the way of a smooth switch over the production point whereas a sales tax
Federal Republic of Germany, and Mexico to a national VAT even in an industrial is levied on a commodity at one or more
- levy a VAT. The VATs of Argentina, country like Canada, not to speak of points the of sale or purchase between the
Austria, Germany and Mexico, are all problems associated with introduction of of production and final consump-
stages
centrally-controlled with revenue-sharing the VAT in developing country federation. If there is only one stage at which
arrangements between the federal and tions. any particular commodity completes its
provincial governments. It has been the This paper analyses the current division production process, the incidence of an
experience that the VAT in a federal of responsibility between the centre excise and duty should theoretically be only
economy presents several difficult issues, the states in India with regard to com- at one point. Since, however, the compo-
which have their repercussions on themodity taxation in its historical perspec- nent parts of the commodity could have
sensitive federal-state political relations. tive and the efforts initiated during the themselves
last been subject to excise duty, an
That the only three OECD countries which 15 years to introduce the VAT in the place excise duty on the final product could in
still have not switched over to the VAT of union excise duties at the central and practice involve a multiple duty on the
- Australia, Switzerland and the US - are sales taxes at the state levels and offers components unless the duty is based on
all federations is also significant. While an alterative VAT model for India based the value added components only. It was
there do not seem to be any legal proscrip- on certain principles which are applicable with a view to eliminate cascading in the
tions against the federal government adopt- to other federal economies which would incidence of excise duty that the govern-
ing a VAT despite the fact that to date like to introduce the VAT. The paper ment is of India introduced the MODVAT
general sales taxes have typically been the organised in four sections. Section I de- some time in 1985. The MODVAT has
domain of the states, there could be dif- scribes the evolution of the current systembeen dealt with in detail later in this paper.
ficulties in administering a fede al VAT of commodity taxation in India. Section In II the case of sales, the same commodity
in conjunction with the states' retail sales deals with the incidence of indirect taxes might pass through various stages of sales,
tax systems (RSTs). The simplest solu- in India. Section III covers the various making itself susceptible to sales tax at
tion, according to Tait (1988), is to entrustmeasures taken to reform the systemmore of than one point, depending upon the
the administration and collection of the commodity taxation during the lastsystem 30 of the sales tax levy. While an
VAT either with the states or with the years. Section IV presents an alternative excise duty ends at the production point
federal government and then use a formula model of VAT for India, though the prin- and does not take into account, even
to share the revenue between the central ciples on which it is formulated apply in
indirectly, elements of cost that are in-
government and the states. If this is un-equal measure to other federal economies curred after the production stage, namely,
acceptable owing to the loss of fiscal as well. freight, insurance, distribution charges and
autonomy, then a federal VAT might have the like, a sales tax is on a much more
I
a state VAT 'piggybacked' on it. Tait comprehensive concept of cost and touches
holds that as a model for other federal Commodity Taxation: Historical
not merely the cost at the production point,
countries, the German VAT illustrates the Perspective
but also subsequent elements including
need for agreed federal and state legisla-In the field of commodity taxation , the profits and the excise duty itself.
tion on base, structure, and rates and once
Constitution of India has assigned the The excise duty in India, being a union
powers of customs and excise taxation to
established, the formula for splitting the levy, does not differentiate between one
proceeds may be the most clear and least
the central government with the exception region and another and is uniform through-
contentious method of revenue distribu- of excise on alcoholic liquor, while the out the country while the sales tax struc-
tion. He, however, hastens to add that evenstates have been given the powers of sales ture and the rates of sales taxes differ from
the limited flexibility in recent years (1987- taxation. It is necessary to elaborate the state to state. Again, while most of the
88) of the federal-state split from 68/32nature and import of these two levies, excise duties are specific, sales tax are ad
to about 70/30 in Germany was notnamely, the union excise duty by the centre valorem levies with the result that during
achieved without considerable disagree-and the sales tax by the states. While there a period of high inflation, the sales tax
is no essential difference between the two
ment and concludes that in a federal system yield automatically goes up, other things
Economic and Political Weekly October 2, 1999 2875
remaining the same. In certain countries of industries, sales tax concessions either of market forces and competition, cause
where excise duties are exclusively re- as deferrals or concessional rates are quite economic distortions, and entails high cost
served for the centre, the levy of sales tax significant. Such concessional rates of sales of compliance and administration.
by states has been held to be unconstitu- tax or exemptions are available for small In this connection, the findings of a
tional on the ground that they are substan- scale and tiny industries in nine states and study of indirect taxes in India conducte
tially the same as excise duties. Similarly medium and large industries in twelve by Pawan K Aggarwal from the Nationa
the question has also been raised whether states. In addition to the general sales tax, Institute of Public Finance and Policy
the ad valorem excise duties are not really another peculiar feature of the Indian fiscal New Delhi are quite significant. The study
sales taxes. Despite all these similarities, system is that interstate sales are also liable covering the incidence of major indirect
both taxes have "distinguishing features" to be taxed by the states of origin. Despite taxes, both central and the state taxes,
and both have "a positive place in a a ceiling of 4 per cent for the rate of Central attempts to estimate effective tax rates o
comprehensive system of taxation and are Sales Tax (CST) laid down by parliament, major commodity taxes in India for th
expressly mentioned in our Constitution" tax export on account of this tax is sub- fiscal year 1989-90. The major finding
[GoI 1965]. stantial: while, on an average, nearly 18 of the study are as follows [Aggarwa
During the last 50 years, union excise per cent of the states' sales tax revenue 1998]:
duties and state sales taxes have expanded is accounted for by the CST, the shares (i) The total effective rate of taxes varied
substantially exhibiting phenomenal of certain individual states are quite high:between 3-40 per cent for most commodi-
growth and buoyancy. In 1950-51, the West Bengal (35.2 per cent), Haryanaties; (ii) For essential commodities, the
aggregate yield from the two levies was (33.9 per cent), Maharashtra (28.3 per rate varied between 3-12 per cent;(iii) The
roughly Rs 1,280 million, representing cent), Madhya Pradesh (23 per cent),effective tax rate for services like con-
1.3 per cent of the national income during Punjab (22.6 per cent), Karnataka (20 perstruction, electricity and transport was
that year. By 1963-64, this figure went up cent) and Tamil Nadu (12.8 per cent). The about 10 per cent;(iv) On an average, sales
to Rs 9,980 million, accounting for 5.8 per origin of the CST and the need to do tax accounted for the highest burden,
cent of the national income. By 1989-90, away with this tax have been dealt withexceeding 5 percentage points of the
it rose to Rs 3,74,660 million accounting in Section III. effective tax rate; union excise duty and
for 10.57 per cent of the national income. An important feature of the Indian sales customs duty accounted far less than 5
Among the tax receipts of the union tax system is that sales taxes are applied percentage points; countervailing duty
government, the excise receipts occupy extensively at the first stage of the sale generally did not account for more than
the most dominant position and account in any state - a phenomenon which has 1 percentage point, reflecting the avail-
for 43 per cent of the total tax receipts of contributed to the maximum amount of ability of tax credit against the MODVAT;
the centre as compared to 16.3 per cent cascading as the first point sales tax is (v) Effective tax rates reflected substantial
during 1950-51. Taking all the states levied ad valorem on the price of a com-input taxation, more than 30 per cent of
together, the yield from state sales taxes modity that includes the excise duty paid the total for most commodities, and even
in 1950-51 was around Rs 600 million, into the central exchequer at the last point 100 per cent for iron ore and some ser-
accounting for 27.5 per cent of the aggre- of its manufacture. Though this is some- vices; (vi) Even though services were not
gate state taxes. During 1991-92, the sales what similar to the practice in Canada, the taxed directly, the 10 per cent effective tax
tax revenue represented around 54 per element of cascading in Canada is not that rate on them mentioned above was due to
cent of the total yield from state taxes. In large as the provincial sales taxes in that input taxation; (vii) While the contribu-
the structure of the state finances, the country are on retail sales only. Another tion of sales tax in input taxation was the
position of sales taxes is broadly similar peculiar feature of the Indian sales tax highest, the contribution of union excise
to union excise duties in the case of the duty was also quite substantial, followed
system is that while the sales tax is leviable
union finances, though the relative impor- on all commodities inclusive of inputs and by the contribution of customs duty. The
tance of the sales tax differs from state to capital goods, services are excluded owing contribution of countervailing duty, how-
state. Sales tax is the single largest source to the constitutional limitations. These ever, was rather low; (viii) Tax incidence
of revenue to almost every state in India, characteristics have contributed to "com- on consumers in rural areas (11 per cent)
accounting for about 60 to 70 per cent of plexity, lack of transparency, distortionswas slightly lower than in urban areas (12
the states' own tax revenue in the case of in economic decisions and inequities inper cent);(ix) While the distribution of the
several states. That the share of sales taxes interjurisdictional division of tax bases. Itburden of indirect taxes was progressive
in the total revenue of the centre and the is increasingly felt that these problemsin both rural and urban areas, it was more
states has increased from 12 per cent in cannot be solved without harmonisation" pronounced in rural areas; the distribution
1960-61 to about 21 per cent at present [Bagchi 1997]. of the burden of individual tax compo-
bears eloquent testimony to the growing
II
nents was also progressive; and (x) The
importance of this tax. As a percentage of effective rate on food items was lower
Incidence of Indirect Taxes
the total tax revenue of the states includ- than on non-food items; that on cereals
ing their share in central taxes, the share A study carried out by the National was lower than on other food items.
of sales tax increased from 26 per cent Institute of Public Finance and Policy,The major conclusions of the study have
in 1960-61 to around 38.5 per cent in New Delhi as late as 1994 made the been summarised below:
1989-90. Most of the states levy tax on following observation about commodity (i) Given the high incidence of input
raw materials as well as other inputs. Sequel taxation in India [see Bagchi 1997a]. taxation, there was an imperative need to
to the amendment to the Constitution in The system (of domestic trade reduce taxes) the same. It was expected that this
1982, sales tax has become leviable on that is operating at present is archaic, would be achieved as the coverage of
work contracts, hire purchases and leases. irrational and complex - according MODVATto was expanded; (ii) Given the
Among the various incentives offered by knowledgeable experts, the most complex high incidence of input taxation, the states
should
the state governments to encourage growth in the world. It interferes with the free also move to a credit mechanism
play
2876 Economic and Political Weekly October 2, 1999
in their respective sales tax structures; Even if the commission were able to then prevailing situation this question was
(iii) A VAT rate of 4 per cent on cereals also important from the point of view of
determine the proportion that the money
and pulses would be equivalent to their burden of the two taxes bore to the total promotion of exports. Most states had
current tax burden from the sales tax. For price of a commodity, it might not have assured the commission that so far this
many other products, the equivalent VAT taken them far in relation to the main task aspect was concerned, they themselves
rate would be 14 per cent. before them since the commission had to were very conscious of the need for ex-
assess the effect that money burden had ports and were devising suitable adjust-
III
on production, consumption or export ofments in sales tax levies with a view to
Reform Efforts
a commodity while the factor of taxationreducing any disincentive effect that the
The first effort toward reform of the had a bearing on the price of a commodity sales taxes might have on exports.
system of commodity taxation in India and in the commission's view, this was With these observations, the Fourth
was taken in 1965 when the Fourth Finance no more than "one out of a host of im- Finance Commission proceeded to exam-
Commission was given a term of reference portant factors". According to the com- ine the manner in which better co-ordi-
by the Government of India to measure mission, unless they were in a position tonation between union excise duties and
the combined incidence of the union excise undertake for each excisable item detailed sales taxes levied by the states could be
duties and state sales taxes and the effect cost-analysis studies of the type that were brought about. All the states had conceded
of their incidence on production, con- usually undertaken by the Tariff Commis- the point that "unrestricted and un-coor-
sumption or export of the commodities sion, they would not be able to determine dinated taxation might affect production
taxed, examine the possibility of deter- whether its production, consumption or as well as exports and there was need for
mining the proportion that the combined export was being hampered on account of coordination between the tax policies of
money burden of union excise duties and the excessive burden of either these two the union and the states". As to whether
sales taxes bore to the sale price of each taxes or some other factors. In order to this co-ordination could be achieved
commodity. The Fourth Finance Com- recommend any ceilings on sales taxes, through a system of ceilings on sales tax
mission found that even this limited study the commission had not only to determine rates on certain commodities, combined
bristled with several difficulties: while the combined incidence of the two taxes with a financial sanction in the form of
excise duties were mostly in terms ofbut also the separate incidence of each.the possibility of a cut in the state's share
The commission observed that even if
specific rates, sales taxes, being ad valo- out of union excise duties in case a state
rem levies, created the problem of con- exceeded the ceilings, was a matter on
data were available, it would be "analyti-
verting the excise rates to ad valoremcally impossible to be precise about which the the states had expressed strong
rates. "For the same commodity, excise effect of one or two variables when the views.
rates differed for different categories, number of variables was so large" with The states drew the attention of the
whereas in the case of sales tax there was the result the commission found itself Finance Commission to the fact that "sales
no such differentiation in general" [GoIunable to undertake these detailed tax was the only elastic source of revenue
1965]. Further there was so much diver- studies. left with them and any attempt to place
sity in the system of sales tax levy from Certain states had represented restrictions before on their freedom in this field
one state to another that the question of the commission that in judging the rea- would affect their capacity to
of taxation
bringing them to a uniform scale was asonableness of the restraint that a tax raise resources and thus handicap them in
job in itself. imposed on production and consumption, relation to the requirements of the Fourth
The commission noted that wherever one had to keep several factors in mind: Five-Year Plan. Sales tax was essentially
the sales tax rates were on the basis of a in the case of certain commodities it mightof regional application and was almost the
single-point levy, the problem was simple well be the objective of the government only major fiscal instrument left with them
while these rates were in terms of multi- policy to limit the growth of consumption for shaping their economic and industrial
point, double-point or a combination of and production and in the case of such policy." The commission noted that the
various systems, the conversion of thesecommodities, no corrective action was states had been using sales tax along with
levies into single-point rates created called for. If the combined incidence of power tariffs for giving incentive to in-
several problems. The commission also the two levies went to inhibit consumption dustry and trade and any dilution f their
observed that the total incidence of the of essential consumer items to the detri- power in this respect would mean a set-
excise duty and sales taxes on manufac- ment of the living standards, corrective back to their efforts for encouraging the
tured commodities might also have to action had to be taken. Similarly, if taxa-growth of industry and trade within their
include the incidence of excise duty and tion had an inhibiting effect on the pro-respective areas. It was felt that any ceiling
sales tax on their components: the deter- duction of intermediate and capital goods,on sales tax rates determined by the
mination of this multiple incidence was it was definitely a matter for concern.Finance Commission for a period of five
not always easy. The commission found Apart from the quantum of the tax thereyears would remove the element of flex-
that the states were not in a position to was also the manner of imposition andibility from the taxation system of the
furnish data regarding the total value of collection. If the taxes were levied or states and would "cut at the very root of
sales and total sales tax collections under collected in a manner which would stand the principle of states' autonomy, thereby,
each item. Had this data been made avail- weakening the federal structure". It had
in the way of the efficient organisation and
able, the problem of converting other leviesdevelopment of industry - if it would also been contended that the "mechanism
into single-point levies might have been prevent the diversification or locationof adjustments in the share out of an item
far easier, the commission felt. For theseof industry on rational lines or theof devolution, depending on the obser-
reasons, the commission found it difficultorganisation of procurement of raw ma-vance of specified conditions by the states,
to pursue even the limited study of theterials or distribution of products in the
might well be inconsistent with the con-
proportion that the money burden bore tomost economic manner--there was a case stitutional provisions regarding sharing of
the price in each excisable commodity.for overhaul of the taxation scheme. In the taxes".
While union excise duties were not co-ordinated tax policy was called for. excise duties in lieu of sales tax. Both
compulsorily divisible as per the consti- According to them, however, the proper could be evolved by mutual agreement:
tutional provisions, it was argued thatcourse once for such co-ordination was 'not the their successful functioning again de-
a tax was made divisible according mechanism to a of a financial sanction in the pended on mutual understanding. In view
certain formula, it had acquired allform theof reduction in the share out of a of what has been explained above, the
elements of a devolution item anddevolution any item but a periodic exchange commission did not recommend any
conditions imposed on the sharing scheme of views between the union and the states scheme of ceilings on the sales tax rates
might not be legally valid. It had also on problems of taxation and related sub- of any of the excisable commodities and
been
pointed out that the "linking of the shares jects with a view to evolving coordinated the question of suggesting a formula for
of excise duties with the rates of sales lines of action. adjustments in the share of the states out
taxes might run counter to the principles It had been pointed out to the commis- of union excise duties did not therefore
that a Finance Commission might decide sion that there was no need to resort to arise. While the exchange of views be-
for distributing excise duties". Certain a scheme of linking the share out of union tween the states and the Finance Commis-
states had expressed the view that between excise duties with sales tax as the then sion summarised in the above paragraphs
sales taxes and union excise duties, it was existing powers with the union govern- gives a flavour of the reaction of the states
the latter category of levies, which in ment the under Article 286 (3) of the Con- to such issues affecting centre-state finan-
case of the most of the commodities, stitution together with Section 14 of the cial relations, it is important to keep the
imposed a higher money burden. Accord- Central Sales Tax Act, 1956 were ad- above observations and recommendations
ing to them, if at all any restrictions were equate for controlling the upper limit of of the Fourth Finance Commission as a
necessary, the proper course would be to sales taxes in the case of such items as backdrop for the alternative model of VAT
place ceilings on excise duties. The might be deemed to be of special impor- proposed in Section IV of this paper.
Finance Commission noted that out of the tance. If such action was necessary and
CENTRAL SALES TAX
68 items which were then figuring on the the states agreed, the union government
excise list, the problem of co-ordination could further enlarge the existing list, after In the foregoing paragraphs, mention
between excises and sales taxes did not providing for compensation to the states was made about the central sales tax. This
arise in 19 items, accounting for 45 for perloss of revenue rather than resort to needs some explanation. The Taxation
cent of the aggregate excise revenue. Eight a financial sanction of the type contem- Enquiry Commission (TEC) of 1953-54,
of these items, namely, cotton fabrics, silk plated in the term of reference. Certain after studying the problems of the opera-
fabrics, woollen fabrics, sugar, tobacco states had argued that a scheme of ceilings tion of the sales tax with respect to inter-
(unmanufactured), cigars and cigarettes on sales tax rates would be inequitable as state sales of goods, recommended that a
had been exempt from the levy of sales between industrially and commerciallynew law should be enacted for authorising
tax under the scheme of additional excise advanced states with a fairly large urbanthe levy of a tax on interstate sales subject
duties in lieu of sales tax. In respect ofsector and the states which were predomi- to a ceiling of 1 per cent, which the states
four other items common to excise and nantly agricultural. In the case of thewould administer and also retain the rev-
sales tax lists, namely, cotton yam, jute, former, the sales tax yield occupied a enue. In making this recommendation, the
steel ingots and pig iron, there was already much more pivotal position in their fi-commission had rejected the principle
a ceiling of 2 per cent on sales tax rates nances than in the latter: if ceilings wereunderlying the then existing constitutional
under the Central Sales Tax Act, 1956. imposed their finances would be moreprovisions relating to interstate trade taxa-
Then there were certain other items known adversely affected than the finances oftion, namely, that sale of goods should be
as 'special goods' in respect of which all agricultural states. As against this argu-taxed only by the state where the goods
the states were then uniformly levying a ment, the commercially backward states are consumed, or the state of 'destination',
sales tax at the rate of 10 per cent. In fact had argued that the sales tax revenue on and not by the exporting state or the state
the suggestion for this uniform levy had interstate sales accruing to the advancedof 'origin'. As observed by Bagchi, it is
come from the central government and the states was largely paid by consumers ina pity that the TEC, while recognising the
states had accepted it. There were in all other states and that in the distribution of role of the centre in regulating the tax on
15 items in this category out of which central sales tax - a source of revenue interstate trade, did not adhere to the logic
seven items, namely, motor vehicles, tyres which the central government should have
which it had itself expounded in the matter
and tubes, cycles and parts thereof, refrig- distributed on some equitable basis, of
the
taxation of cross-border sales to unregist-
erators and air-conditioners, wireless re- backward states had been discriminated ered dealers, namely, that the bulk of the
ceiving sets, gramophones and certain iron against under the then existing arrange- revenue from such an origin-based tax
and steel products were then in the excise ments according to which each state kept should be passed on to the importing states.
list. In the case of these items, no upward what it collected on behalf of the central Following the recommendations of the
revision had been envisaged in the near government. TEC, the Constitution was amended in
future, at any rate, since the then prevail- In view of the fact that adequate data1956 to provide for the levy of the central
ing rates had been fixed in consultation for determining the combined incidence sales tax (CST). Currently the CST stands
with the centre, in future also the revision of the two taxes and their economic effects at 4 per cent. Besides the inequity in tax
would be effected after mutual consulta- were not available, the commission could base sharing, the trading community is
tions. Thus out of 68 commodities, it wasnot proceed to the next stage, namely, that obliged to pay the CST at several stages
in the case of 49 commodities that the of fixing the ceiling and devising a for- in respect of the components of a product
question of co-ordination between excise mula for adjustment in the share out ofmanufactured in more than one state before
and sales tax arose. The states' view the excises did not arise. The procedure their assembly. In order to avoid this,
generally was that if on a proper study for framing
of a scheme of ceilings on sales several business houses resort to the prac-
the facts, it was found that in the case of and for its implementation shouldtice of setting up several branches with a
tax rates
a few selected items out of these 49, a be the same as in the case of additional view to get the parts as 'branch transfer'.
This phenomenon has prompted the states It was, however, found that this ap-quirement of inputs with outputs for cred-
and the centre to contemplate levy of a proach of selective concessions coupled
iting purposes starting from 1995-96 would
consignment tax on which no agreement with exemptions granted through more have a negative impact on the MODVAT
has been reached for the last 15 years. If than 500 notifications had only ledrevenue.
to
India were to go in for the VAT in its true several complications in tax administra- (iv) Though the number of rat
letter and spirit, there can be two opinions tion. Due to the predominance of sales brought
tax down to twelve in the
regarding dispensing with the Central Sales as the single most important sourcebudget,
of the tax structure is stil
Tax. with multiple rates and exem
revenue for most of the states, any assess-
ment of the distribution of the tax burden
making the MODVAT adminis
VAT AND MODVAT
among; different sections of society had relatively difficult, necessitating
In order to minimise the cascading become
effects extremely difficult. It was in cross-checks
this which are strenuous
of excise taxation of inputs, the govern- context that the MODVAT was formu- sue.
ment of India, in 1985, introduced a lated "as a theoretically appealing way (v) of Although credit is given for t
modified form of excise duty called the providing set-offs for taxation of inputs."paid on capital goods, the post-tax
MODVAT. Shome (1997) points out thatThe L K Jha Committee on Indirect Taxes of capital goods is used for the calcu
unlike in almost all countries which have (1978) had also recommended the levy ofof production value for tax purposes
introduced the VAT - where the conver- such a tax on manufactured goods. How- next stage. This continues the casc
sion of a turnover tax regime into a VAT element in the MODVAT.
ever, it has to be recognised that "as long
was preceded by a year or longer as
ofcredit is given only for excise duty and (vi) Interpretation of what is a creditable
administrative preparation, computer- additional duty customs paid for inputscapital good is based on a positive rather
isation and taxpayer education - in India and not for general customs duty, reliefthan a negative list, leading to represen-
the process has been one of iteration in the MODVAT would not be available tations from industry and delays in receiv-
towards a VAT, both in terms of tax to certain category of producers like ing credit.
structure and tax administration. For automobile manufacturers who depend (vii) While most countries which have
example, the credit mechanism was intro- largely on imported goods". introduced the VAT with only a few rates
duced for a few commodities at the be- Under the MODVAT scheme, union typically also have a few excise taxes
ginning, and its coverage was slowly excise duties on most manufacturing goods levied on the value of production rather
extended to other commodities. In the have been converted to incorporate a credit than on the value added such as on pe-
following two or three years, the mechanism for taxes paid on inputs. Apart troleum products, tobacco products and
MODVAT was extended to cover prac- from reduction in the number of tax rates, alcoholic drinks and sometimes even on
tically all chapters of the central excise credit is available for tax on raw materials electronic gadgets and white goods, in
tariff except petroleum products, textile as well as capital goods. Further the earlier India, the transformation process of the
products, tobacco, cinematographic films requirement of matching inputs with excise structure into the MODVAT has
and matches. This practice, according to particular outputs has been eliminated. almost eliminated the traditional excises.
Shome, is quite different from the usual Shome (1997:8-12] distinguishes the This, according to Shome, partially ex-
model of including all goods under the following features about the Indian plains why the excises suffer from mul-
VAT with a few exemptions and exclud- MODVAT system: tiple rates, since higher rates are necessary
ing small businesses under a threshold (i) It is the general experience that for otherwise traditional excises.
based on turnover. The fact, however, whenever a cascading domestic consump- (viii) Services have been neglected from
remains that MODVAT is not a value tion tax structure is converted into a VAT inclusion in the VAT base. While powers
added tax in the real sense of the term: which essentially allows input tax to be to levy tax on certain services like enter-
"The so-called Indian MODVAT is not a credited, a revenue neutral VAT rate is tainment and advertisements, other than
calculated and introduced. While this has
VAT at all, but rather a form of modified in newspapers or the electronic media, are
excise duty. The MODVAT is essentiallyhappened in most countries which haveconferred on the states, the centre has
manufacturing excise tax with creditgoneal- in for the VAT, and has necessarilystarted taxing the services sector by invok-
lowed for excise duty and customs implied
in a an increase in the tax rate on theing its residuary powers under the Con-
limited number of industries, introduced
end product since crediting of input taxstitution. Bagchi has rightly pointed out
mainly with a view to eliminate the cas-
implies a decline in revenue at least in thethat the criterion of 'neutrality' requires
short run, in the case of India, however,that services be brought under taxation
cading effect of multi-point excise levies"
[Tait 1988:30]. crediting of input taxes has been intro-through the VAT and not in the form of
It is also necessary to know the back-
duced pari passu with a scaling back ofa stand-alone tax. Since service providers
ground in which the MODVAT scheme end product tax rates over the last decade.operate mostly at the retail level, it would
was formulated. Chakraborty noted three (ii) When a production-type VAT, withneither be practical nor possible to bring
crediting only of raw material tax and notit within the ambit of a manufacturer level
measures attempted earlier for containing
the inflationary impact on account ofof capital goods tax, is converted into aVAT like the MODVAT.
the
excise taxation system: (i) In the produc-consumption-type VAT with crediting of Since the MODVAT has not been fol-
tion of an excised commodity, inputs all input tax, including on capital goods, lowed up by a similar system at the stat
belonging to Tariff Item 68 were rendered the change typically takes place over level in sales taxation, the MODVAT could
3-5 years as in the case of Columbia andat best be viewed only as a step toward
eligible for set-off. (ii) Within each tariff
item the duty paid on inputs within Turkey.
the In India, however, it was a once-adoption of a full-fledged VAT in Indi
same item was made available as proforma for-all change in 1994-95, followed by and a not a VAT in itself, while introduction
credit. (iii) For several excised commodi-broader interpretation of the applicationof a full-fledged VAT in India would seem
ties provision was made for duty reliefof forrules in 1995-96. to present "numerous administrative and
specified inputs. (iii) The removal of the matching re- constitutional difficulties, including the
vexed question of union-state relations" with regard to the method of its implemen-study established that the centre had in-
[Tait 1988:30]. It should also be recognised tation by the centre and the scheme of
creasingly mobilised revenue from yam
that the prevailing sales tax system in redistribution recommended by the and the raw materials of yam through
India is based on the origin principle which Finance Commissions. empirical evidence for the decline in yield
allows the retention of revenue in the While the Ninth Finance Commission from the basic excise duties on fabrics and
producing state. As pointed out by Shomewas given a term of reference to examine increase in the yield from yam. The NIPFP
(1997:15), a switch-over to the destina-the possibility of merging additional excise study had strongly recommended that the
tion principle which would allow revenueduties in lieu of sales tax with basic excise divisible pool of the additional excise duties
duties, not only were the states unanimous in lieu of sales tax should take into account
to accrue to the consuming state and would
in opposing the proposal but the Finance the central tax base of raw materials, yam
approximate the central principle that the
vat should be a consumption tax, would Commission also strongly recommended and fabrics lest the centre should derive
be difficult to introduce in India since against any such move. The commission exclusive benefit from the base. Several
several industrial states might stand foundto that much of the opposition against states have also expressed their reserva-
lose revenue. the proposed merger could be traced to the tions regarding the economic criteria
In the wake of liberalisation, tax reform
manner in which the tax rental arrange- selected by the Finance Commissions for
is one of the key elements of the economicment was being implemented by the cen- the horizontal redistribution of the pro-
reform process in India. The Tax Reforms tre. For instance, it had been decided at ceeds from the additional excised duties
Committee (TRC), headed by Rajah aJmeeting of the National Development in lieu of sales tax among the states. While
Chelliah, in its Interim Report (1991), Council as early as in December 1970 that many states have favoured sales tax col-
observed that it would be ideal if one within a period of two to three years the lections in the respective states as the basis
comprehensive VAT could replace the proceeds from additional duties of excise of redistribution, the adoption of criteria
in lieu of sales tax should achieve a level
present system of central excise, states' like net state domestic product and adop-
sales taxes and other indirect taxes except
of 10.8 per cent of the value of clearances tion of the 1981 population figures by the
the state levy on alcoholic liquor and and
thethe ratio between the yields from basic Ninth Finance Commission as against the
state entertainment tax. However, it is duties
the of excise and additional excise duties 1971 population figures stipulated in the
on in
translation of this theory into practice these commodities was intended to be terms of reference have left several states
dissatisfied with the scheme of redistribu-
brought up to 2:1. The commission noted
the context of fiscal federalism as it operates
in India, makes it an extremely difficult that while the latter commitment was tion too. Going by such experience, it
and delicate task. International experience
fulfilled in recent years, the former one should not be surprising if states view any
has shown that a successful implementa- which was required to be done within move to introduce the VAT at the national
three years of the meeting of the National
tion of the VAT will require determination level not merely as an attempt to encroach
of the VAT rates by the centre and that Development Council in 1970, still re- upon their exclusive powers of sales taxa-
a centrally determined VAT should mained re- tion but could even question the alleged
to be realised. Apart from the fact
place the cascading turnover sales that tax the government of India did not fulfilsuperiority of the VAT over the sales tax
levied by states. It goes without saying system.
its promises with regard to realisation from
that introduction of the VAT in India is this levy, it had unduly expanded theEarlier in the paper, it was stated that
almost impossible as the states would notcoverage of the goods by resorting the to VAT could also be looked upon as a
be willing to give up even part of their definitional changes precluding thereby multi-stage tax which produces a burden
exclusive powers of sales taxation. Fur- more items from the levy of sales tax andequivalent to that of a single stage retail
ther it would be a Herculean task to many commodities were also subjectedsales to tax. That it is the first point turnover
convince the States about the superiority 'nil' rate of duty. These commodities, sales tax which causes the maximum
of the VAT over the first-point sales therefore,
taxes were free not merely from the amount of cascading in the absence of any
because whatever experience the states levysoof additional duties of excise but also
provision to give set-off for the tax paid
far have had in such matters cannot be escaped the liability to sales tax which at
theproduction point in the form of either
considered satisfactory to lure them intostates were prevented from imposing for excise or MODVAT both of which are
a value added tax system. For example,fear of forfeiting their share in the pro- central levies is fundamental to any at-
in pursuance of an agreement reachedceeds from additional duties of excise. tempt at a design for a national VAT for
between the centre and the states at a The Ninth Finance Commission not only India. In most of the states, sales tax is
meeting of the National Development did not recommend the merger of addi- levied mainly at the first point known as
Council in December 1956, it had been tional duties of excise with basic duties the single point sales tax. The tax is thus
decided that the centre would levy addi- of excise, but also proposed that the rev-collected from the importers, manufactur-
tional excise duties on cotton fabrics, enue loss suffered by the states on accounters or the wholesalers. The only states still
woollen fabrics, rayon or artificial silk of the exemptions of additional duties inhaving multi-point tax on a few commodi-
fabrics, sugar and tobacco in lieu of sales lieu of sales tax allowed by the centralties are Karnataka and Kerala.
tax on the commodities earlier levied by government should be estimated. The The TRC, in its final report, recom-
the states with the states agreeing to abolish National Institute of Public Finance and mended an admixture of the VAT, namely,
sales tax on these commodities. Under this Policy (NIPFP) which was entrusted with MODVAT at the centre extending to most
tax-rental arrangement, the entire net this responsibility found that states werecommodities and rationalising sales tax
proceeds from the additional excise duties losing revenue on account of exemptions system at the state level. It recommended
in lieu of sales tax are to be distributed in the case of khandasari sugar, certainthat a value added tax, namely, the re-
to the states on the basis of recommen- items of textiles like rubberised textiles,formed central excise system, should be
dations of the Finance Commission every knitted or crocheted fabrics and fabrics of extended to the wholesale stage, whole-
five years. States have expressed theirman-made materials coated or filamented sale stage being defined as traders who
unhappiness with this arrangement both with preparation of LDPE. The NIPFP buy from manufacturers and sell to other
manufacturers or traders. The TRC ob- of the central government. Maharashtra perience with the VATs in federations
served that they should be subject to state was the first one in India to take a
the reveals widespread usage of central VATs,
VAT in addition to excises payable by bold initiative to introduce a VAT in its
the with collection by states under the super-
manufacturer and that only the value addedtrue spirit covering the entire spectrumvision
of of the centre and revenue-sharing,
manufacturing and trading in the state.
at their hands should be subject to tax and feel that it is difficult to avoid the con-
the manufacturers who buy from these Besides extending relief for manufactur- clusion that, from the point of view of
wholesalers should also be able to obtain federal politics, this option is a non-starter
ing inputs, the intermediate dealers, namely
credit for the tax paid earlier. According those selling goods purchased from regist- for India. According to them, the alterna-
to the committee, this would provide ered dealers, called 're-sellers', who weretive would be to have the centre reducing
adequate safeguard against the attempts atnot liable to pay sales tax have also been rather than expanding its role in indirect
undervaluation by the manufacturer to brought within the purview of the VAT taxation. Under this option, the centre
reduce excise liability which is the causein Maharashtra. Bagchi, who recently would retain only a small number of high
of many disputes in excise besides cap- undertook a study of the operation of the revenue-yielding excises and the states
turing the value added at the hands of the VAT in Maharashtra, is highly apprecia- would then administer their own VATs to
wholesalers. The TRC recommended that tive of the bold steps taken by the state replace the current system of sales taxes
the VAT at the wholesale stage could be in pushing through the VAT despite the and to replace union excises on many
collected by the states' sales tax depart- risks involved for revenue growth [Bagchi goods. According to these authors, the
ment concerned in close co-operation with 1997]. Preparations for the possible intro-option of a system of state VATs is likely
the officers of the central excise depart- duction of the VAT on a wider scale are to be politically attractive to the states
ment and the amount of the VAT collected going on in Delhi, Karnataka, Madhya since most of the states could be expected
could be allowed to be retained by the state Pradesh and Tamil Nadu in the form of to prefer to collect the tax revenue them-
where it is collected: "This central VAT training officials and feasibility studies.selves rather than be dependent on the
can be levied with the co-operation of the Nevertheless, the VAT, in its true spirit, centre. Pointing out that the proposal to
states who can be persuaded to accept this make the VAT a state tax would be at odds
cannot be realised in India unless a lasting
levy, because their own right to levy the solution is found for removing the cascad- with the prescriptions that the central
sales tax on goods will no way be circum- MODVAT should be further developed
ing element in the first-point sale taxation.
scribed, and at the same time, they willAnother fundamental issue to be ad- and that the centre should assist the states
get the entire revenue from the VAT dressed at is the question of commodity with the transition from sales tax to the
the wholesale stage" [GoI 1992]. taxation at two levels, the central/federal
VAT, the authors clarify that in their view,
The above recommendation of the TRC the state-run system of VATs could only
and the provincial, in large countries. While
should be appreciated in the context thata VAT is levied best at the national level,be considered a long-term option and that
"in the short run, a dual VAT is almost
the first-point sales tax is of a cascadingafter a study of the experience of Canada,
type and no credit is available to the Bagchi has concluded that the above option certainly the only way forward in the
wholesaler for the excise or MODVATis not open to a federation where the
development of value added taxation in
already paid since the states cannot be
subnational governments derive a major
India" [Burgess, Howes and Stern 19931.
expected to give credit for a tax paid into of their tax revenue from the sales
portion The above recommendations suffer from
the central exchequer. In this connection, tax. Bagchi goes on to make the followingcertain shortcomings apart from practical
it needs to be mentioned that the moment sweeping observation, of course on difficulties
jus- in their being implemented. In
a product leaves the manufacturing point tifiable grounds: "What comes out loud the first place, the authors have proposed
after completion of the production process and clear from the Canadian experience this model drawing parallel to a similar
in all respects, the central excise duty is that domestic taxation of commodities proposal under consideration in Brazil at
regime ends and all subsequent transac- at two levels cannot be carried on entirely that time. Brazil, however, as observed by
tions should only be deemed to be sales independently" [NIPFP 1994]. This is theNorregaard (1997), besides offering an
and they can be subject only to sales taxes same view expressed by other experts likeexample of a VAT assignment system that
Bird who have held that no country hasis generally believed to have had detri-
and not to any form of central excise duty
yet been able to work out a satisfactorymental effects on economic performance,
like a central VAT although this might be
way of operating sales taxes independentlyalso provides empirical evidence of the
collected and retained by the states as per
the recommendation of the TRC. This at two levels of government [Bird 1994].difficulties of co-ordinating and adminis-
particular recommendation of the TRCBagchi suggests a concurrent VAT at twotering a VAT levied at the subnational
therefore is not sustainable as per levels
the of government, namely, both thelevel, with the state level VAT on inter-
existing constitutional provisions. Further,
centre and the states, but integrated in thestate transactions being levied on an origin
sense that the base will be laid down at
it should also be recognised that nearly basis at a lower rate than on transactions
80 per cent of the sales tax revenuesthe
ofnational level while allowing the states
within the state, giving rise to significant
the states come from excisable commodi- to fix the rates. The states could have distortions and administrative difficulties.
ties. This will give an idea of not only theflexibility in determining their base All
too three levels of government are as-
dimensions of the cascading involved inbut departures from the national base signed taxing powers on consumption, but
the first-point sales taxation and the prob-should be kept to the very minimum with and different tax systems, and with the
lem of introducing a true value added taxdecided in consultation with the centre. A tax covering the widest base, the VAT-
devoid of any cascading element. It is true study by the NIPFP (1994) recommended type ICMS assigned to state governments
that several states like Andhra. Pradesh, a manufacturer's VAT and the centre and and not to the federal government. Fur-
Kerala, and West Bengal have introduced state sales taxes converted into a destina- ther, a large fraction of the federal govern-
the credit principle on a diverse set oftion-based VAT as an interim solution. ment consumption tax (the IPI) is trans-
commodities, particularly inputs for manu- Burgess, Howes and Stern (1993), while ferred to lower levels of government under
facture, following the MODVAT schemeconceding the fact that international aex- tax-sharing arrangement. This particular
design is believed to encourage tax com- central excises, state VATs and an end to
trade, through such major contributions as
petition between entities of government vertical revenue sharing would only be
Cnossen and Shoup (1987) to the recent
and to foster tax evasion, which is further long-term option, a dual VAT in the shortproposals of the European Commission
exacerbated by a large number of tax rates run is inevitable [Burgess, Howes and(1996), tax experts have put forth a variety
and exemptions. Some of the shortcom- Stem 1993]. of solutions to the perceived problems.
ings of the ICMS were eliminated in 1996 Nevertheless, one has either resolved the
IV
through a major tax reform. Following the
Alternative Model
issue or achieved full acceptance. Despite
1996 reform, which zero-rated all exports the arguments advanced in favour of the
and introduce\ a credit for capital goods, There is a broad consensus in the origin principle of applying a VAT within
the federal government has proposed a literature on fiscal federalism that the VATs
a country or the European Union, the
more comprehensive reform, which would are appropriately assigned to the authors
centralfeel that 'the case for the desti-
replace the present ICMS and IPI with level of government. This dictum, nation
accord-
principle clearly wins the day. The
both a federal and a state level VAT, ing to Norregaard, rests on theconditions
fairly of wage and exchange rate
levied on the same tax base and at homo- extensive administrative capabilities re- needed to avoid substantial dis-
flexibility
geneous rates for interstate as well as intra-quired to operate the tax, a requirement
tortions in production efficiency if differ-
state transactions. It has also been pro-that is generally best met by central ent jurisdictions levy different rates under
govern-
posed that this tax should be levied on aments in combination with the need to the origin principle seem unlikely to be
destination basis. Although the proposed make the VAT neutral with respect to thesatisfied in most federal states, let alone
mechanism, as pointed out by Ter- spatial allocation of production and con- the EU. According to Keen and Smith
(1996), the destination method is both
Minassian, is in principle compatible withsumption, implying that - generally - the
different arrangements for the sharing ofVAT should conform to the destination more compatible with independent taxa-
revenues among the states, any move fromprinciple [Norregaard 1997:65-66]. Fur- tion of consumption and, in practice, less
the current origin principle is bound tother, a subnational VAT system would likely to result in important economic
have a significant impact on the distribu-pose problems with regard to which provin- distortions.
tion across the states of their major rev-ces or states should receive the revenues At present, the EU applies the destina-
enue source, entailing losses for states thatfrom the VAT on imports, and which tion principle using 'the deferred pay-
are net exporters to the rest of the country should bear the burden of the VAT refunds ment' method (Cnossen and Shoup, 1987).
and gains for those that are net importers.on exports. Following this kind of reason- Exports by firms in one member country
Expressing serious doubts on musteringing, Norregaard concludes that compre- A to registered traders in other member
the political consensus required for hensive VATs should be left solely with countries are zero-rated in A without border
the constitutional amendment needed the national governments. Further expe- clearance being required. Such sales are
to achieve this objective, Ter-Minassian
rience with federations, particularly large therefore treated in the same way are all
federations at that, has shown that any
(1997) recommends that a more practical sales outside the EU. In contrast to imports
system which involves commodity taxa-
solution would be to replace the existing from non-EU countries, however, imports
system of sales and excise taxes with tionaat two levels, namely, federal and by registered traders in A from firms in
more standard VAT with a single rate or
provincial, cannot ensure implementation other EU member countries are not taxed
two rates, levied at the federal levelof on a VAT in its true spirit. In this con- at the border. Instead, importers in A in
the
broad base including services, with nection it is necessary to study the recent effect pay the VAT on imports at country
the proceeds shared with the statesdevelopmentsand in the European Union and A's rates on their own sales since they
municipalities on a derivation basis,Canada, and which represent a major depar- have no input tax credits to offset against
complimented by a narrow range offrom the traditional approach to the the tax due. The system works on a self-
ture
excises. federal VAT. assessment basis: importers are supposed
Secondly, the model of Burgess and to declare their imports compute the VAT
CROSS-BORDER TRADE: EU EXPERIENCE
others envisages that in return for that would be due, and claim credit for that
decentralising the system of VATs to states, The main reason why the VAT was VAT, all in the same return. The effect
the centre might also be able to negotiate originally adopted as the required form is that the VAT is collected on imports
for
a number of binding agreements with the general sales taxation in the European only when they are resold or incorporated
states in relation to the harmonisation of Union was its advantage in implementing in goods sold by the importing firm, since
bases and the simplification of rate struc- the destination principle with respectimported to inputs, unlike domestic inputs,
tures. Further they have proposed that cross-border trade. As observed by Bird will not generate offsetting input tax
agreement of the states to submit to a and Gendron (1998), only with the value credits at that time.
central, though possibly state-controlled, added form of sales tax could member The authors observe that the system
regulatory tax agency would also be countries be sure that imports were fairly may be contrasted with the 'clearing-
desirable. house' method under which the VAT
treated in comparison to domestic prod-
In the light of the history of fiscal re- ucts, and that exports were not subsidisedwould be charged on exports by the
lations between the centre and the states by over-generous rebates at the border: "It
exporting state, with a credit allowed for
elaborated in the foregoing pages, it isis thus somewhat ironic that the best waythis VAT by the importing state as for any
highly doubtful whether these recommen-to apply VAT to cross-border trade within other input VAT, but at the tax rate imposed
dations would be acceptable to the states the EU has been a matter of considerable by the exporting state. Revenue accounts
and even if there is broad agreement amongdebate since the beginning. This issue has would then be balanced between states
major states, harmonisation of the rates not yet been resolved." either on a transaction basis or more likely,
and uniformity in application may remain From the Neumark Report (1963), with as in the recent European Commission
a distant dream. Further, even the authorsits recommendation for the eventual adop- proposal discussed below, in accordance
conclude that while the combination of tion of the origin principle for intra-EU with consumption statistics. The authors
note that the deferred payment system, according to Bird and Gendron, this pro- country in the world for sales tax aficio-
which in effect puts reliance on private posal may perhaps be viewed as a sort of nados. The country has ten provinces,
sector accounting subject to VAT audits, uniform 'Euro VAT' imposed at the pre- with five distinct sales tax systems. There
appears to work as well as or better than retail stage, in the-sense that it is Europe- is a federal VAT, the Goods and Services
explicit public offsetting of accounts. This wide and uniform and not in the sense that Tax (GST), that applies throughout the
is particularly so because, since 1993, all or any of the revenues accrue to the country. In one province (Alberta), the
exporters who zero-rate sales to other EU as such or that it is administered by GST is the only sales tax. In four prov-
member countries have been required to the EU. Bird and Gendron (1998) observe inces, namely, British Columbia,
quote the VAT registration number of the that from another perspective, however, Saskatchewan, Manitoba, and Ontario, in
buyer. Keen and Smith see at least three the Keen and Smith (1996) scheme in addition to the GST there is a separate
problems with the deferred payment sys- effect rectifies one asymmetry, between retail sales tax (RST) applied to the GST-
tem as it now operates in the EU: (1) the trade within a member state, and trade exclusive tax base. In one province, Prince
sustainability of revenues in the face of between member states, by creating a new Edward Island, the provincial RST is
cross-border shopping, (2) the asymmetri- one, between sales to registered taxpayers applied to the GST-inclusive tax base. In
cal treatment of trade within and between and sales to final consumers. According three provinces, namely, Newfoundland,
member states, and (3) problems in cross- to the authors, this scheme opens the door Nova Scotia, and New Brunswick, there
border audits, which must rely on the to a new form of fraud, since sales to is a joint federal-provincial VAT, called
inevitably weak reed of interjurisdictional registered tax payers are taxed at a lower the harmonised sales tax (HST) and ad-
information exchange. rate. Under the system now operating in ministered by the federal government at
The authors hold that although there Quebec, Canada appears both to avoid this a uniform rate of 15 per cent. Finally, in
seems to be little evidence of significant problem and to provide a good basis for one province, Quebec, there is a provin-
revenue loss from cross-border shopping cross-border audits, while retaining most cial VAT, the Quebec sales tax (QST),
in Europe, problems may arise with re- of the advantages of the Keen-Smith applied to the GST-inclusive tax base. The
spect to such high-taxed excise products proposal. QST is administered by the provincial
as motor vehicles. Further, there has been The most recent proposal from the government, which also administers the
greater concern on the growing phe- European Commission (1996) takes a very GST in the province on behalf of the
nomenon of 'distance sales' through mail- different tack. Emphasising the complex- federal government.
order and electronic commerce. Still Keen ity and defects of the way in which the Canada thus presents a variety of inter-
and Smith (1996) conclude that the special present VAT system attempts to deal with esting situations: separate federal and
schemes now in place in EU countries cross-border problems with respect to firms provincial VATs administered provin-
probably deal with these problems about operating in more than one member coun- cially, joint federal and provincial VATs
as well as can be done. There are three try, the commission proposes a 'common' administered federally, and a federal VAT
such schemes: (1) distance-selling (for
VAT system which would look very dif- and provincial RSTs administered sepa-
ferent from either the present system or
example, mail-order), under which firms rately. Our discussion here, however, is
the Keen and Smith proposal. As Smith
engaged in such business must charge confined to the salient features of the QST
VAT on the destination basis once their notes, the commission's proposed system and HST, which are relevant to the main
turnover exceeds a specified threshold;has
(2)five interlocking elements: a uniform focus in this chapter.
base and virtually uniform rates; exten-
vehicles are subject to tax in the country
sive administrative co-operation; a single
of registration; (3) firms otherwise exempt QUEBEC SALES TAX
from the VAT are subject to VAT on the place of taxation for every business within
destination basis once their imports theex- EU; the extension of the 'chain' of Though the Quebec sales tax (QST),
VAT credits to include cross-border trans-
ceed a specified threshold. Similar provi- which is the VAT imposed by the province
sions apply with respect to subnational actions; and, finally, the allocation of VAT of Quebec and Canada' federal GST are
VATs in Canada and have been recom- revenues among member states on theboth broad-based taxes on consumption,
mended to deal with problems of interstate basis of aggregate consumption statistics.there are certain differences between them,
trade under the state retail sales taxes in Bird and Gendron (1998) note that in though they have become much less at
the US. Although there is no simplemany respects, this proposal is essentiallypresent compared to the time of their initial
uniform way to deal with all cross-borderequivalent to the VAT now operating in imposition in 1991. While the GST is
shopping problems under any destination-several small Canadian provinces under levied at a single rate of 7 per cent which
based sales tax, in practice this defect hasthe system of the "harmonised sales taxapplies to most taxable goods and services
not yet given rise to serious problems in(HST)". As the authors feel that this degree consumed in Canada, the QST now also
terms of either revenue or complianceof 'commonality' is neither necessary nor has one general tax rate of 7.5 per cent
costs, as discussed below. desirable in Canada, it seems even less which is applied to the price of the good
In order to deal with the second problem likely to be a viable basis for the separate or including the GST, so that the com-
they see with the present EU system, countries that make up the EU. Like Smith, bined rate is 15.025 per cent. Though the
namely, the asymmetrical treatment of the authors think that a more satisfactory QST initially imposed had two different
trade within and between member states, approach to the problems with the current rates for goods and services and a number
Keen and Smith (1996) propose the intro- regime may be found in less sweeping of differences in base from the GST, most
duction of a special 'harmonised' (uni- changes that would leave member states significant differences between the GST
form) rate of VAT (VIVAT, in their ter- with considerably more fiscal autonomy. and the QST have disappeared. For ex-
minology) to be applied to transactions ample, although there is still no QST on
CANADIAN EXPERIENCE
between registered traders, while leaving books, the tax is now eliminated by giving
member states free to impose different At the present time, as Bird and Gendron an instant rebate following payment of the
rates on final sales. From one perspective, note, Canada may be the most interestingtax. While the administration of this rebate
has led to complicating the system, this audit priorities. Once the final audit plan
anyone in the HST provinces must charge
approach, according to Bird and Gendron is agreed upon by the Ministere du RevenuHST on such sales. HST registrants making
(1998), permits the preservation of a du Quebec (MRQ), MRQ then carries out such purchases may then claim credit for
uniform VAT base for both federal and the audits, reporting back to Revenue this tax, but final consumers or exempt
provincial taxes while allowing differen- Canada with respect to additional assess-
purchasers will have to bear the full tax
tial treatment at the final consumer level.ments, appeals, and so on. Since the QST whether they buy from in-province or out-
The major difference between the two is applied to a GST-inclusive base, theof-province sellers. Purchases across in-
Quebec government obviously has some
tax bases relates to input tax credits. Certain ternational borders are subject to HST on
input tax credits for large firms that incentive
are to monitor the GST as well as import. Like the GST, complex rules
allowable for GST are not allowable for the QST. Although Quebec cannot di-determining the 'place of supply' are
QST. The government of Quebec was
rectly monitor, say, a zero-rated export
intended to bring to tax many cross-border
supposed to eliminate all such restrictions sale to an Ontario firm to ensure that such service supplies and to remove any tax
initially by November 1996 and then bya firm actually exists, the normal process inducement to cross-border shopping.
March 1997. In fact, however, the govern-of federal GST audit to some extent serves According to Bird and Gendron, the
ment announced in its March 1997 budget as a cross-check to ensure that QST has federal government's apparent objective
that it intended to maintain those restric- not been evaded. The existence of a fed- in persuading the small provinces to adopt
tions for an indeterminate period, presum- eral sales tax in a sense thus monitors a common HST system was to have both
ably forrevenue reasons. Despite this minor interjurisdictional sales within the coun- a common base and minimum variation
hitch, it could be claimed that the QST try for purposes of provincial as well in as
rates, preferring them to lie in the 14-15
and GST constitute an operational 'dual federal taxes. On the whole, according pertocent range. In practice, all the three
VAT' system. The rates of the two taxes the authors, the system appears to be
provinces have imposed a 15 per cent rate.
are set quite independently by the two functioning well, with each agencyThe
ap-authors note that in terms rather like
levels of government. Though essentially pearing to place reliance upon the com- those used in the recent EU proposal of
the same, the tax bases are also determined petence and integrity of the other. 1996, the federal government's justifica-
independently. Further from the begin- tion for this approach was that a common
HARMONISED SALES TAX
ning, the GST in Quebec has been admin- sales tax base and rate would yield sig-
istered along with the QST by the pro- In April 1997, the federal government
nificant savings in compliance costs for
business and administrative costs for
vince: that is, the province collects both of Canada and the governments of its three
taxes at the same time and then turns over small and fiscally dependent eastern
governments. According to them, the
the federal share to the federal govern- provinces, Newfoundland, Nova Scotia economic rationale for requiring uniform
ment. Such arrangements have long been and New Brunswick, harmonised the rates across provinces is weak since, as
common in Canada in the income tax federal GST and the sales taxes of those demonstrated with the QST, there are no
field, although the agreed single admin- provinces in what is called the harmonised significant costs in imposing differential
istrative agency has always been the fed- sales tax (HST). The basic elements of theprovincial rates on final sales in a desti-
eral government, and they have applied HST include the replacement of the pre- nation-principle sales tax. Further, there
in Quebec. According to Bird and Gendron, vious separate federal and provincial sales are good economic and political reasons
no problem has been reported with such tax systems with one harmonised VAT;for permitting rate differentiation to meet
collection arrangements, regardless of athe combined federal-provincial rate of 15 specific revenue needs, preferences, and
direction of the revenue flow. per cent in the three participating prov-the like. The HST thus unnecessarily
Taxes on interprovincial sales from oneinces; and a single administration of bothhinders provincial autonomy in the sales
business to another are basically handledfederal and provincial sales taxes by thetax field. At the same time, the authors
by a deferred payment system very muchfederal government. The new combinedpoint out, it has tied the federal
like that now applied in the EU as 'tran-rate consists of the 7 per cent GST andgovernment's hands since it cannotchange
sitional' regime. Exports from Quebec,an 8 per cent provincial tax (applicable toeither the base or the rate of the tax without
whether to another province or anothera base excluding the GST), for a total HSTthe unanimous agreement of the affected
country, are zero-rated. Imports into therate of 15 per cent. This new combinedprovinces [Bird and Gendron 1998].
province from another province, or abroad,rate is significantly lower than the previ- According to Bird and Gendron (1998),
are taxable, but the tax is only assessedous combined rates of 19.84 per cent inthe HST, in some ways, is clearly superior
on interprovincial imports when there isNewfoundland and 18.77 per cent in theto the initial 1991 agreement between the
a sale by a registered importer to consum-other two provinces. The federal govern-federal government and the government
ers. This system is essentially the same asment and the participating provinces shareof Quebec and the important policy dif-
that now applied in the EU, with, however,total tax revenues on the basis of province- ferences which initially plagued the
the critical addition of the overridingspecific consumption patterns, in accor- Quebec deal are not present. Nonetheless,
federal GST as an enforcement mecha- dance with allocation formulae to be it is far from clear that the HST is superior
nism. Interprovincial sales to final con-developed jointly by the federal govern-
to the QST-GST system as it has evolved
sumers, as the EU, give rise to problems.ment and the provinces.. overthe years and currently operates. Given
in principle, non-registered persons are Revenue Canada administers the the presence of the GST at the federal
harmonised tax under a comprehensive
required to self-assess the QST on imports level, some harmonisation in federal-pro-
for private consumption or for use in tax co-ordination agreement for the ad-sales tax systems appears to be
vincial
exempt activities. As in the EU, someministration of sales taxes in each necessary. The authors suggest three prin-
special regimes apply for certain high- province. As with the QST, exports toto achieve sound harmonisation: (1)
ciples
value items and in other cases. other provinces are zero-rated. At theharmonisation
same should lead to simplifica-
With respect to audits, Revenue Canada,time, however, unlike the QST, GST tion of the sales tax system, so that com-
the federal tax agency, establishes certain
registrants in other provinces selling to and administration costs and the
pliance
related efficiency losses are minimised; true of shopping and trade between bor- only the EU problems discussed below but
(2) harmonisation should respect provin- dering provinces with different sales tax also problems with subnational VATs in
cial autonomy by allowing provinces to regimes like either Quebec and New several large developing federations dis-
choose a sales tax rate that may differ from Brunswick or Quebec and Ontario. These cussed earlier.
the federal sales tax; and (3) there should problems will continue to create some Bird and Gendron have shown that in
only be one agency to administer and pressure to harmonise on provinces which the light of the Canadian experience,
collect the sales tax. have not done so yet. If, for example, the independent subnational (dual) VATs are
The authors point out that the authors note, Manitoba chooses to enter feasible in the absence of border controls,
harmonisation agreement with Quebec the harmonisation agreement, Ontario may and second, that in some ways it is easier
respects provincial autonomy but initiallyface increased competitive pressure to to resolve some problems of cross-border
failed to achieve the other two principles.harmonise since it will then be between trade when there is a dual VAT system,
For example, auditing rules in Quebec two provinces with harmonised sales taxesthat is, when subnational VATs are
used to depend upon whether the business and lower taxes on business inputs. Suchmatched by a national VAT which pro-
was headquartered in that province or not. considerations may speed up the vides a substantial degree of control over
At present, however, Quebec's sales taxharmonisation process in Canada. interjurisdictional trade. The GST-QST
is more or less fully harmonised with the The Canadian experience, according tosystem, according to the authors, has
GST, and all three of the principles statedthe authors, suggests that a VAT can beproved to be administratively feasible and
above are more or less satisfied. In con- imposed at the provincial level in a rela-capable of dealing satisfactorily with cross-
trast, the HST agreement satisfies the first
tively efficient manner as long as businessborder trade between registered firms wile
and third of those principles but clearlyinputs are not taxed. Under their retailstill providing all jurisdictions with con-
restricts provincial tax autonomy. Fromsales taxes, the provinces have tradition-siderable fiscal autonomy and avoiding
ally taxed many business inputs, largely arguments about who gets how much
the prospective of those provinces signing
the agreement, presumably the financial for revenue reasons: "Taxes hidden from revenue. In the case of the EU, similar
benefits received were worth the loss of the public are easier to get away with in
results might be achieved simply by re-
a democracy, if inherently less desirable.
tax freedom, but it is hard to see why any taining the present 'transitional' system,
of the larger provinces would buy into this combined with more attention to
Jurisdictions with net exports may tend to
deal. overtax in these circumstances (as often intermember coordination of VAT app
Holding out that a centralised VAT cation and administration, with no n
seems to be assumed in critiques of origin-
seems neither a realistic political possibil- based subnational VATs). Alternatively,
for imposed rate uniformity and m
ity nor a desirable outcome given the they may tend to undertax, as assumed in freedom for local variations, especially
current assignment of taxing powers in the tax competition discussion, if they fear the consumer level, if desired. Accord
Canada, the authors feel that the federal- a loss of tax base." According to the to the authors, the basic condition requ
Quebec harmonisation agreement, as ini- authors, even with a VAT, business inputsis that all parties concerned trust the qual
tially implemented, was not a good model may still be taxed to some extent (indeed,of the administration in the other jurisd
because of the many differences in the owing to the treatment of the financialtions. If more weight is placed on reduc
sector, they almost invariably are), butadministrative and compliance costs
base; but neither is the recent agreement
between the federal government and the such taxes are likely to be much lessfunds are available to offset revenue los
three Atlantic provinces, which comes at important than before the introduction of something more along the lines of the H
the cost of a significant decrease in pro- a VAT. In fact, as the authors note, the system may be preferred. The authors
vincial tax autonomy. The revised QST reduction of distorting input taxes is onethat both approaches may perhaps
arrangement, the authors note, seems much of the main reasons favouring the VATpursued simultaneously, with the stron
closer to a good solution: there is a single as a form of sales taxation. and richer units following the QST p
(provincial) administration; there is basic The phenomenon of cross-border shop-and the smallerand poorer ones the
conformity on all important aspects of the ping, the authors note, makes it difficultpath. Though problems with respect
dual VATs that significantly affect com- for provincial governments to tax mobilecross-border shopping and distance s
pliance costs; and there is complete au- populations. Whilecross-border shopping through mail-orderor electronic comme
tonomy in rate setting (and, to a limitedhas hardly been a serious factor in geo-will persist under any possible approa
extent, even in granting exemptions to graphically large countries like Canadathe authors point out that 80 to 90 per c
final consumers, if desired). Further, the
with dispersed populations, this phenom-of taxable trade takes place between r
authors add, as the recent Quebec budget enon could limit the scope for independentistered firms, and Canadian experien
demonstrated by maintaining restrictions sales tax policy at the subnational leveldemonstrates both that it is not that di
on input credits for large businesses, there in smaller countries. While problems withficult to handle this trade in an econom
may even be room for bad but politically 'distance shopping' on account of mail-cally and administratively acceptable fas
popular tax policy without damaging the order and internet remain even in largeion and that under the right conditions
general system. While this may not be countries, the authors point out that ap-existence of a central VAT (or its fu
good news for tax experts but it will, no plying what is in effect more or less thetional equivalent in terms of informat
doubt, be welcomed by governments. present EU system for treating cross-border exchange) may make it simpler to r
According to the authors, Canada's trade works better within Canada than it subnational VATs.
present system, with some provinces seems to do in Europe, partly because the The authors recommend the following
harmonised and others not, of course existence of the overriding federal VATtwo minor administrative changes in order
provides some opportunities for tax provides a verification mechanism that to facilitate the implementation of a two-
arbitrage. There are also administration does not exist in the EU. "Indeed, both tier VAT system: (1) To include an ap-
and compliance costs when businesses Canadian systems - the HST and the QST propriate location code in VAT registra-
engage in cross-border trade. The same is - may prove helpful in thinking about not tion numbers. (2) To include the VAT
number of both buyer and seller on the agency responsible for the levy and ad-
proposed surrender of sales taxes to the
invoice. For such a system to work satis- ministration of the VAT. In fact this is onecentral goverment for being merged with
factorily, the authors feel that there must the union excise duties for transforming
of the principles stated by Bird and Gendron
be adequate exchange of information as we noted earlier. Secondly, the HST
both the taxes into a full-fledged value
between both levels of tax administration, agreement, clearly restricts provincial taxadded tax could be appreciated from these
a process that can be greatly facilitated if autonomy. It may be seen that only three figures.
both have VATs and hence a direct finan- smaller provinces have agreed for this Among the central taxes, while the union
cial interest in its success. From this arrangement and not any of the larger excise duty, after its proposed merger with
perspective, the authors note, it is imma- states' sales tax, will be transformed into
provinces. It is doubtful if the states would
terial whether there are actually two sepa- agree to such restrictions placed on their a value added tax, the other major tax,
rate administrations or one; or, if there is
powers by the centre. I am of the firm viewnamely, customs duty or import and export
one, which level operates it. According tothere is no need to have two types of
that taxes, should always be imposed by the
the authors, a single central administration VAT, one at the federal and another at the national government only, "to reduce the
and a common base as in Canada's subnational
per- possibility of introducing major distor-
level. In the light of the ex-
perience gained so far, it is desirable tions
sonal income tax system or the HST would to within the country through differen-
vest commodity taxation only in one level
probably be most efficient, but this degree tial foreign trade taxes imposed by differ-
of convergence is not essential: "What is
of government ent jurisdictions" [Norregaard 1997:69].
and that has to be the central
critical is either a unified audit or a or highfederal government only. This would The only two other major central taxes are
level of information exchange between mean that the provinces or states will have the personal income tax and the corporate
the provincial and federal administrations, to necessarily give up their powers of salesincome tax. Let us examine the possibility
as generally prevails in Canada undertaxation.the of assigning any of these taxes to the
Apart from the political sensitivity
QST." In the absence of a central VAT, of the issue, it should also be appreciated states.
the authors feel that it would be difficult that the states or provinces would not be Most of the countries in the world assign
to set up adequately functioning merely satisfied if the loss of revenue on the personal income taxes in their entirety
subnational VATs in the absence of a account of surrendering their powers of or a large proportion of them only to the
border control system. sales taxation is adequately compensated central government since it is used for
According to the authors, Canadian stabilisation as well as redistribution. There
by a generous revenue-sharing mecha-
experience suggests not only that there
nism is are, however, exceptions to this practice,
by the central or federal government.
no need to be excessively pessimistic In order to assert their independence and
about which include the Scandinavian countries,
supremacy, the states or provinces would
the possibility of decent subnational VATs Switzerland, the Baltic countries, Russia
but also that one helpful solution tolike
someto enjoy certain powers of taxation,and the other countries of the former Soviet
problems of cross-border trade maywhich Union. In the US, the income tax is levied
lie in they would like to put to the best
the creation of a parallel tax structure
use, of
without merely depending on a share both by the federal and the state govern-
the country or union as a whole. They in revenue from the central or federal ments and in some cases even by the city
draw three conclusions from Canada: government,
first, as the case may be. The governments,
al- while, in Canada, the cen-
with good tax administration, indepen-ternative model suggested in this paper tral and provincial governments levy
dent subnational VATs on the destination
rests on this principle. income tax. Incidentally, the US, Switzer-
basis are feasible; second, such VATs land and to some extent, Canada follow
If the states have to be persuaded to give
probably work best when there is anup their powers of sales taxation in favour the principle of 'concurrency' with regard
of the centre to enable the latter to intro-
overriding central VAT on approximately to the levy of personal income tax. It is
the same base - and either (and preferably)
duce and implement the VAT by replacing
true that the more developed is a country,
both taxes are operated by the same ad- the current system of commodity taxation the higher is the likelihood that individu-
ministration or else there is very close co-at two levels, it could not be achieved by
als receive income from different sources,
a mere, however generous or liberaland
operation, particularly in audit; third, since it these income may be derived from
neither of the preceding conclusions de- different jurisdictions. This may move
could be, revenue-sharing formula but only
pends upon which level runs both taxes giving to the states some other powers countries
of to prefer a global income tax
(if there is to be one administration) nor system in which the different income
taxation in exchange, adopting a 'give and
upon the adoption of uniform subnational take policy', reflecting the true spirit sources
of are added together for each indi-
tax rates, a dual VAT structure may be true federalism. This is the basic principle
vidual, which requires collection of infor-
made consistent with a wide range of on, which the alternative system recom- mation on personal income from other
administrative and policy sovereignty mended in this chapter is founded. jurisdictions, with possibilities of tax
[Bird and Gendron 1998]. In the case of India, 65 per cent of the
evasion being large. In these circumstances,
While the authors concede that two combined tax revenue of the centre and as observed by Norregaard, it is preferable
VATS may not be cheaper than one, they to keep the global income tax base with
the states is raised by the centre, the balance
may, in their view, work better than seems 35 per cent being raised by the states. This the central government which is better
generally to be thought, in part because 65 percentage share of the centre is made equipped to acquire the necessary infor-
each to some extent acts a check on the up of union excise duties (26 per cent), mation. Since, however, the mobility of
customs or taxes on international trade (21
other, not least with respect to cross-border individuals and households tends to be
trade. The system of QST as well as HST per cent), corporate income tax (8 per less than that of business, the personal
cent) and personal income tax (7.2 per
suffers from two drawbacks apart from the income tax, as pointed by Ter-Minassian
problem of cross-border shopping. In the (1997:9), is more suitable for partial as-
cent). The 35 percentage share of the states
is composed of sales taxes (20 per cent),
first place, there is really no need to have signment - through tax overlapping - to
VATs two different levels and the system state excise (5.25 per cent) and vehiclesthe sub-national, particularly, the provin-
should work better if there is only one
taxes (3 per cent). The magnitude of the
cial level. However, it is necessary that
the definition of the tax base should be However, some states apportion all sources mum rates. The Swiss cantons may use
homogeneous throughout the country and of business and non-business income. The their own factor formula and there is no
the rate differentials among sub-national factors generally include sales, property,consolidation of returns in Switzerland
jurisdictions be kept relatively small. Inand payroll factors but they vary from[Mintz 1998]. In Brazil, the states can levy
fact the system followed in the Nordic state to state. Many states use an equally a 5 per cent surcharge on the corporate
countries and Canada, where the provin- weighted average of payroll, sales, and income tax. The argument put forward by
cial income tax is levied as a percentage property (the Massachusetts formula) butsome of these countries is that the economy
of the federal income tax is definitely almost half of the states use some other could benefit from state and local govern-
variant, most often by putting twice the
superior to a normal flat rate system, since ments competing for industrial develop-
weight on the sales factor. Corporatement, that local governments are entitled
the former increases the revenue elasticity
of the subnational tax as the subnational income is measured by adjusting the fed- to recoup the cost of public services used
eral definition for specific state provi-by business, and that, in any case, many
governments will stand to gain in the event
of increases in the income tax by thesions. Maximum rates of corporate in-companies do most of their production
central government. Since international come tax at the state level vary from 3.4
and sales within a single jurisdiction [Bahl
experience is in favour of allowing bothper cent in Indiana to 12.25 per cent in 1994:133-35].
the federal and the provincial governmentsPennsylvania, the average being about 7 If one is serious about introducing and
per cent. State taxes are deductible from
to exploit the personal income tax, this is implementing a value added tax in its true
best achieved by permitting the states tothe federal corporate income tax. Though letter and spirit in India, the system of
'piggyback' its income tax on the federal46 states in the US impose corporate commodity taxation in vogue at present
or central tax base. income taxes, the share of corporate in-has to undergo a sea change into 'some-
In the case of India, the Constitution come tax in total revenues of the states thing rich and strange': the union excise
provides for levy of a surcharge on incomehas declined in the recent years. In duties
fact of the centre and the sales taxes of
tax, which is, however, not sharable with Michigan has replaced its corporate the in-states have to be merged, the central
the states. It is suggested that the powercome tax with a value added tax, which sales tax abolished and the powers of
to levy surcharge on personal income tax differs from the value added tax elsewhere
commodity taxation fully vested in the
in the sense that it is based on the additive
should be delegated to the states for their central government to facilitate the trans-
exploitation. Any move in this directionmethod. Under this method, the tax base formation of the existing cascading taxes,
should be invariably accompanied by isa determined by adding wages and profits namely the union excise duties and sales
corresponding reduction in the marginal before taxes and debt service with certain taxes into a full-fledged value added tax.
adjustments.
rates of income tax. As a consequence, the This has to be invariably accompanied by
share of central tax revenues to be de- In contrast, the Canadian system is based giving the powers to the states to exploit
volved to the states might have to be
on a more harmonised approach for de- personal income tax by 'piggy-backing'
reduced. While giving the power to the
termining the amount of corporate income the central income tax base on the one
states to levy the surcharge on income tax
allocated to provinces. Partly this is driven hand and allowing the states to levy
by the tax collection agreements which the
would specifically favour the industrialised corporate income tax on the lines of the
states, the states as a whole would havefederal agreement has with seven provin- system prevailing in Canada and the US.
more flexibility. Here is a classic case of
ces whereby the federal government col- Since the sales tax revenue accounts for
autonomy versus equity. lects provincial corporate income taxes at as high 20 per cent of the combined tax
It should, however, be appreciated thatno charge and the provinces agree to use revenue of the centre and the states, even
giving the power to the states to levy the
the federal corporate base for determining the above dispensations alone may not be
surcharge on income tax alone would not income. The provinces are free to set their adequate to compensate the states for the
be enough to compensate the states for own rates of tax and the federal govern- loss of revenue which the stands are likely
ment will administer on their behalf tax
agreeing to surrender their powers of sales to suffer. Therefore the shortfall has to be
taxation. This takes us to have a look at credits, namely, investment tax credits forcomplimented by the traditional revenue
the possibility of allowing the states to manufacturing equipment or research andsharing mechanism of the revenue from
exploit the corporate income tax base on development, which reduce the amount ofthe new VAT. In order to ensure a fair
the lines of the system prevailing in coun- provincial tax owing to the province. Threeshare to the states, it would also be nec-
tries like Canada and the US. According provinces, Ontario, Quebec, and Alberta, essary to assign a suitable weight, say, 10
to Norregaard (1997:66), there is almost collect their own corporate income tax. Into 15 per cent, to the 'collection' or 'con-
universal agreement that the taxation of fact these three provinces account fornearly tribution' factor in the scheme of horizon-
larger business, and in particular corpo- 75 per cent of the provincial corporatetal redistribution of the revenue from the
rate profit taxes, should be left to the income tax base in Canada. All provinces,new VAT among the states. In other words,
national government and to provinces or including those that collect their ownpart of the divisible pool of the new VAT
states only where these are very large corporate
as income tax, use a common factorrevenue will have to be made available to
in Canada. formula where equal wights on sales andthe states on a derivation basis. This would
The current experience with allocationpayroll to determine the shares. Even thosebe necessary since the loss of revenue of
is found in the US, Canada, and Switzer-provinces which collect their own tax, usethe states on surrendering the powers of
land. In the US, the 46 states that levya base similar to federal base except forsales tax to the centre will be directly
corporate income taxes use a factor for- a few adjustments. The federal govern-proportional to the quantum of the revenue
mula to apportion income to its jurisdic-ment provides a 10 per cent tax credit tofrom the first-point sales tax bulk of which
tion. Non-business income such as capitalmake room for the provincial corporatecomes from the excisable commodities.
gains, royalties, dividends, interest, and income tax. In Switzerland, the cantons Fine-tuning of the vertical as well as
rents may be taxed separately by the statelevy corporate income taxes on a progres-horizontal sharing of the new VAT
if the income is earned in the jurisdiction.sive basis subject to minimum and maxi-revenue will have to be done carefully in
consultation with the states and the mecha- federal regulation, has been a source of Fiscal Federalism, World Bank, Washington,
nism of the Finance Commission will beintergovernmental conflicts in Canada DC, pp 133-35.
[Clark
best suited for this purpose. While the 1996]. The Canadian authorities Bird, Richard M (1994): 'Cost and Complexity
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system of dual level of commodity taxa- gained in several federal economies, ir- Tax and Public Finance, 5, Kluwer Academic
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For instance, we could apply the above developed or developing, has established Burgess, Robin, Stephen Howes and Nicholas
principles to another federal economy, fairly beyond doubt the undesirability of Ster (1993): The Reform of Indirect Taxes
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Alan A Tait on an earlier draft of the paper]. Perspective: An Overview', Fiscal Federa
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economic rents. Such revenues are rather ism in Theory and Practice, op cit, p 9.
Aggarwal, Pawan K (1998): Who Pays the Tax?
unevenly distributed, going largely to the A Study of Incidence of Indirect Taxes il
three western provinces. Eighty five per India, Gayatri Publications, Delhi. Economic and Political
cent of all oil and gas is produced in one Bagchi, Amaresh (1997a): 'A State Level VAT?
western province, Alberta and the natural Harmonising Sales Taxes: A Comparison of Weekly
India and Canada' in Parthasarathi Shome
resources are largely responsible for the available from:
differences in the fiscal capacity of provin- (ed),Value Added Tax in India: A Progress
Report, National Institute of Public Finance
ces. At the same time, under the Canadian Churchgate Bbok Stall
and Policy, New Delhi, p 90.
constitution, the federal government also Churchgate Station
- (1997b): VAT in Maharashtra: A Report,
has the authority to tax natural resources (unpublished). Opp Indian Merchant Chambers
and the federal government's main source Bahl, Roy (1994): 'Revenues and Revenue
of revenue from oil and gas has been the Churchgate
Assignment: Intergovernmental Fiscal
corporate income tax. This division of Relations in the Russian Federation' Christine
Mumbai - 400 020
powers, namely provincial ownership and Wallich (ed), Russia and the Challenge of

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Fiscal Federalism: Towards an Appropriate VAT System for a Federal Economy

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