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Most
of the state sales tax has been on a First Point basis, though some
states, notably Kerala, Karnataka and Tamilnadu of late have a Multi-point
system of taxation covering certain limited commodities.
In view of the independence of the States to frame their Sales tax
systems, every state had its own system, with no uniformity or
coordination with other states, and used the power to tax, purely as a
revenue raising exercise with no regard for economic efficiency.
Generally the following adverse characteristics marked the State
Sales tax regime:
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Multiplicity of rates
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Numerous
exemptions for commodities.
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Wide
spread between the rates, resulting in classification difficulties
and attendant legal issues.
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Incentive
schemes such as Tax Holidays and Tax deferrals for New Industrial
Undertakings with a view to promote industrialisation, even at loss
of revenue
These
features resulted in difficulty in compliance and administration;
excessive litigation on classification; and unhealthy competition among
states to corner new investments by offering all sorts of tax holidays and
deferrals, resulting in what is called as the 'race to the bottom'.
The
Sales tax systems in various states also resulted in a cascading effect of
sales tax when tax was levied on output manufactured out of tax-paid
inputs. There never used to be any rebate for input taxes in the
matter of collection of sales tax on the final product. Attempts to introduce some kind of rebating by some states
have also failed for a number of reasons.
Lately,
States have agreed to abolish Sales tax incentives in the form of holidays
and deferrals for new industry in order to stop the 'race to the bottom'. To also put an end to the rate war, States have agreed to
Floor rates of taxes for various commodities, below which taxes would not
be fixed.
But,
beyond such agreements, there was no reform, much less towards a true
system of Value Added Tax, similar to Excise duty with a view to
eliminating the cascading and pyramiding effects of the existing system.
All
these deficiencies in the indirect taxation system of the country called
for a comprehensive reform and an introduction of a simple taxation
system. Further, what was important was that the new system should ensure
that the taxation was not cascading. It is in this connection that the
Government of India has introduced a Value Added Tax (VAT) system which
sought to do away with the cascading features of the existing system.
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