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The use of Value Added Tax in India

Before we mention the function and duties of this public policy, we will try to mention what is value added tax. The word Value Added Tax (VAT) refers to "a tax levied on the difference between a commodity's price before taxes and its cost of production". (World Economic Outlook 2006, May 25). This is the general definition mentioned in the most of the country. the value added tax mentioned in India as "Value Added Tax is a multi point sales tax with set off for tax paid on purchases". (Taxing time. 2005, April).

The value added tax in India has been repeatedly postponed for almost 50 years. This policy has been postponed of variety of reasons such as limitations, opposition from the opposite leaders and so on. The system had been postponed many times, mainly because of opposition from the powerful trading. India has agreed the launch of its much-delayed Value Added Tax (VAT) from 1st April 2005. At a rate of 12.5%, The tax, agreed after state finance ministers met in New Delhi, is designed to make accounting more transparent, cut trade barriers and boost tax revenues.

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This policy will be further mentioned in the following ways:


Value Added Tax (VAT) is basically a tax on the value addition on the product. The burden of tax is ultimately born by the consumer of goods. In many aspects it is equivalent to last point sales tax. It can also be called as a multi point sales tax levied as a proportion of Valued Added. India has a large un-organized market, especially agro-based industries and here a large number of transactions go unrecorded. The menace of stock transfers adds to the problem of tax evasion. In India, introduction of VAT will only change the collection methods for sales tax rather than reform the indirect tax system.

   VAT is nothing but sales tax at source. Instead of collecting it after five months or so, the state governments would collect the same in advance and then allow set-offs to the businessmen. All tax paid on inputs, subject to rules made, shall be allowed to set-off against the tax on output.

Some analyst believe that value added tax is essentially used to tackle the problem of tax evasion. For example: "In India, all the state governments collect over Rs 85,000 crore (Rs 850 billion) by way of sales tax and further over 20,000 crore (Rs 200 billion) by way of Central Sales Tax. This is what officially comes mostly from petroleum, liquor, iron and steel and cement companies. Rough estimates suggest that these industries account for over 50 per cent sales tax for the states and the Centre. Majority of the officials in sales tax departments believe that what they actually collect is less than 50 per cent of the revenue that should otherwise accrue to them if all transactions are accounted for by the businessmen." (India,2003).

Advantages and Disadvantages

According to the Gagan Malik.(2007, July) who mentions different advantages and limitation of the value added tax in India:


The value added tax would increase investment, output, and real wages. He mentions that "If the tax on the return from capital investments--such as stock purchases, new business start-ups, and new plant and equipment for existing firms--is reduced, more of those types of investments will be made." (Gagan Malik,2007, July).Those risk-taking activities and investments are the key to generating productivity improvements, real capital formation, increased national output, and higher living standards.

2. The value added tax would liberate locked-up capital for new investment.

3. The value added tax would produce more tax revenue for the government.

4. The value added tax would eliminate the unfairness of taxing capital gains due to inflation. He mentions that "A large share of the capital gains that are taxed is not real gains but inflationary gains." (Gagan Malik,2007, July).


1. Provide a large tax for the wealthiest citizens.

2. Have very little positive impact on the economy. Many argue that taxes do not influence investment decisions and that even if there were an unlocking effect.

3. Increase the budget deficit. If the value added tax reduces revenues and increases the budget deficit, then savings and investment might actually fall after the tax initiation. That would only worsen reported capital shortage.

Impact of Value Added Tax (VAT)

VAT is most certainly a more transparent and accurate system of taxation. The existing sales tax structure allows for double taxation thereby cascading the tax burden. For example "Before a commodity is produced, inputs are first taxed, the produced commodity is then taxed and finally at the time of sale, the entire commodity is taxed once again. By taxing the commodity multiple times, it has in effect increased the cost of the goods and therefore the price the end consumer will pay for it." (Singh, S., & Gupta, V..2009).

Necessity of VAT in India

India, particularly the trading community, has believed in accepting and adopting loopholes in any system administered by the state or the Centre. If a well-administered system comes in, it will close avenues for traders and businessmen to evade paying taxes. They will also be compelled to keep proper records of their sales and purchases. Many sections hold the view that the trading community has been amongst the biggest offenders when it comes to evading taxes.

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Under the VAT system, no exemptions will be given and a tax will be levied at each stage of manufacture of a product. At each stage of value-addition, the tax levied on the inputs can be claimed back from the tax authorities.

At a macro level, there are two issues, which make the introduction of VAT critical for India. Industry watchers say that the VAT system, if enforced properly, forms part of the fiscal consolidation strategy for the country. It could, in fact, help address the fiscal deficit problem and the revenues estimated to be collected could actually mean lowering of the fiscal deficit burden for the government.

The International Monetary Fund (IMF), in its semi-annual World Economic Outlook released on April 9, expressed its concern over India's large fiscal deficit - at 10 per cent of the GDP.

Further any globally accepted tax administrative system will only help India integrate better in the World Trade Organization regime.


VAT would change the nature of trade in the coming years, but the medium level of trade that is agents, distributors, etc. would face problems as the companies would reduced the tier of marketing. Similarly small retail dealers would be required to maintain more accounts or pay composition money which cannot be collected from the customers. But in short the value added tax is one best public policy which is imitated by the Indian government as it can avoid one of the major issues in which government faces today which is tax evasion or inflation.

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