April 1, 2003 will truly be All Fools' Day for Finance Minister Jaswant Singh. And for no fault of his. More than once in the past 12 months, chief ministers and finance ministers of states had committed to replace sales tax with value-added tax (VAT) by then. But four days before the deadline, no more than five of the 30 states seemed likely to adopt VAT (see box). Even these six states may take several weeks before they can fully implement VAT. And even when they do that, the VAT system will only be partially effective until all states implement it.

Ironically, April 1, 2003 is a twice-postponed deadline. VAT was initially supposed to be implemented nationwide from April 1, 2001. That was deferred to 2002 and later to 2003. An added irony is that none of the states is opposed to the system of VAT-in fact all state governments cutting across political lines have been singing praises of it.

So why are they having second thoughts now?

Blame it primarily on electoral politics. The states suddenly developing cold feet on VAT are the ones that are scheduled to have assembly elections this year. Delhi leads them all. An enthusiastic supporter of VAT till a year ago, the Delhi Government was all prepared to adopt the new tax from April 1, 2002. But that was when elections weren't as close as they are now. Sure, on many products Delhi has lower rates of sales tax than the rates it will adopt under VAT which could cause a minor hike in prices. But concern for prices is not behind Delhi's reluctance to adopt VAT-it is the swelling protests from traders against the new tax system. Traders are an important vote bank and source of funds for almost all political parties.

Delhi's buckling under traders' pressure has set off an expected chain of competitive populism. Rajasthan, set to introduce VAT till a week ago, decided to put its implementation on hold till Delhi adopted the new tax. The reason: a tax system and tax rates different than neighbouring Delhi's could hurt Rajasthan's economy and trade. Madhya Pradesh, another state where elections are due in October, is likely to postpone the introduction of VAT despite being the first state to be ready with the necessary legislation. If that reads like a list of Congress-ruled states, the traders' lobby has been equally effective with the BJP.

Delhi BJP President Madan Lal Khurana is dead opposed to VAT, notwithstanding Jaswant's strong support and blessings to the tax. In fact, some of Jaswant's budgetary calculations could go awry if VAT isn't implemented soon. The blame game apart, the real cause of the delay is traders' protests and inadequate preparation by state governments.

Why are traders-and not manufacturers or consumers-up in arms against the introduction of VAT?

For many traders, the biggest fear is the fear of exposure. Exposure of fudged accounts and evaded taxes. In the existing system, sales tax on most products is paid by the manufacturer-not by the retailer and on very few products by the wholesaler (see graphic). Which means most traders don't have to keep detailed books of accounts. Worse, most do not declare their sales and income correctly. The result: massive theft of tax. A few years ago a large chain of sweet shops in Delhi had declared daily sale of Rs 8,000 at one of its outlets in the city. A raid by the Sales Tax Department found daily sales to be Rs 92,000-more than 10 times the reported figure. Underreporting of sales means evasion of income tax as well. Says Ramesh Chandra, member secretary of the Empowered Committee on VAT (a committee comprising finance ministers of all states): "Traders have got used to evasion-multi-point evasion."

CHAOS OVER VAT
N. Chandrababu	Digvijay Singh	Sheila Dikshit
COMING CLEAN: Overcame tax sops to meet deadline States likely to adopt VAT on Apr 1 Maharashtra, Andhra Pradesh, Karnataka, Tamil Nadu and Uttar Pradesh.	COLD FEET: A believer in VAT, was forced to rethink States likely to do so in a few months West Bengal, Madhya Pradesh, Haryana, Bihar, Goa, Gujarat, Orissa and Jharkhand.	WITHDRAWAL SYMPTOMS: Polls led to change of mind STATES unsure of when to adopt VAT Delhi, Punjab, Kerala, Rajasthan, Chhattisgarh and Himachal Pradesh.

Under VAT not only will wholesalers and retailers have to pay taxes, they will also have to ensure that traders they deal with pay tax. This is how it works: a trader (say, retailer) is allowed to deduct from his tax liability the tax already paid by the person (wholesaler) who sold the product to him. But to be eligible for that deduction, the retailer must have proof of tax paid by the wholesaler. Or else the retailer will have to foot the entire tax (his and the wholesaler's). This system of self-policing not only ensures that a trader pays taxes, he also keeps records of the tax paid by the traders he is dealing with.

It is this feature of VAT exposing evasion that has made it so irresistible to governments and so intolerable to traders. It's not that every small trader is going to be caught in VAT's net. Most states have exempted traders with annual sales of Rs 2-5 lakh from the tax. Traders with annual sales of Rs 25 lakh need not keep any record if they agree to pay 1 per cent of their sales as VAT. But even the big traders have some genuine grievance against VAT in its present form.

In Europe and South America, where VAT is most popular, the tax is all inclusive-it includes sales tax, octroi, luxury tax, other inter-state taxes and most importantly the excise duty. VAT in these countries is truly a single point tax that encompasses all indirect taxes. But not in India. The proposed VAT will replace only sales tax and some minor taxes like work contract tax, lease tax, turnover tax and luxury tax. Octroi, central sales tax (CST), service tax and, of course, excise duties will have to be paid separately. Besides, under VAT, inter-state movement of inputs will be taxed. So companies buying all their inputs within a state will have unfair advantage over companies sourcing inputs from several states. That defeats the basic purpose of VAT-a common market for the whole of India. "We are not opposed to a true VAT as is prevalent in other countries. But the half-baked tax being implemented in India will only hurt business and consumers," claims Suresh Bindal, secretary-general of a body of textile merchants.

Bindal isn't very hopeful about the prospects of VAT reducing tax evasion. He claims traders are unnecessarily treated with suspicion when it's the tax officials who actually harass them for bribes and even suggest ways of evading taxes. Chandra admits that VAT in its current form isn't perfect, but he is hopeful that the Government will eventually work towards a unified VAT. "Let there be no doubt that this is only a first step towards the final journey of a single unified VAT," he claims. CST has already been halved from 4 per cent to 2 per cent in Budget 2003 and will eventually be phased out after VAT is fully implemented.

Traders and some manufacturers have also warned of a price hike if VAT is implemented. But barring a very few products, the hike is likely to be marginal, restricted only to a few states and a few products (where current taxes are lower than the proposed VAT). However, medicines could be an exception. Chemists and druggists warn of a price rise of 8-9 per cent post VAT. That is because, the pharmaceutical industry claims, the average sales tax on drugs will rise from about 7 per cent at present to 12.5 per cent under VAT. And the industry is in no state to absorb the cost. "The consumer will have to bear the burden," says Hari Mundra, vice-chairman, Wockhardt.

The blackmail by the traders apart, states are not adequately prepared for the April 1 deadline. Most states-barring Madhya Pradesh and Chhattisgarh-were hurrying through their VAT legislations in assemblies in the last week of March even though they had had more than two years to prepare. Andhra Pradesh, which remained committed to implementing VAT from April 1, didn't know till the last week of March how to deal with crores of rupees of investments it has received on the promise of sales tax exemptions. Under VAT, it will be difficult to retain sales tax exemptions.

Even the revenue gains will be uneven among states. In states where the average current sales tax rates are lower than proposed VAT rates, the revenue gains will be higher. States with an average sales tax higher than VAT rates may suffer a loss initially. But all states are betting on big gains by reducing the currently rampant (5-to-85 per cent of potential tax revenue) tax evasion through VAT. Add to that the larger economic gains of having uniform tax rates for each product all over India and the efficiency and revenue gains from VAT could be reaped for all times to come. Of course, that will happen only after the immediate obstacles of resistance from traders are overcome.

— with Vivek Law and bureau reports