By Paranjoy Guha Thakurta India economic analyst in Delhi

VAT imposition has seen a spurt in inflation in most countries

Unlike in most countries, VAT in India is not meant to be a federal tax but a state-level tax that will be implemented by a diverse bunch of 28 provincial governments and the administrations of eight Union territories.

Representatives of traders contend that VAT will increase bureaucratic control over their activities, involve more form-filling and force them to pay higher taxes that will invariably be passed on to consumers, spurring inflation.

Economists and government officials, on the other hand, argue that VAT is better than the current cascading type tax (CTT) system that results in multiple layers of taxation on raw materials, intermediate inputs and finished products.

Compensation

By doing away with the "tax on tax" element of the existing CTT system, it is claimed the proposed new VAT will actually bring prices down in the medium term and create a tax system that is less discretionary, more transparent and consumer-friendly.

Seven out of the 28 state governments have not yet agreed to implement VAT from 1 April

VAT seeks to replace a host of local levies that includes taxes like octroi (which is levied at border check posts when goods move from one state to another) and mandi (marketplace) tax that is imposed when commodities are sold at particular markets.

Proponents of VAT argue that traders would like the inefficient system to continue as it helps them evade taxes.

At present, in many Indian states, one-third or more of the taxes levied on sales of goods are not paid by trade intermediaries, in collusion with corrupt government officials.

VAT is meant to increase the revenues of financially strapped state governments, though not all are convinced this will actually take place.

Large states like Uttar Pradesh are wary of the system

The Union government has assured states they will be fully compensated for revenue losses, if any, during the fiscal year that ends in March 2006.

Seven out of the 28 state governments have not yet agreed to implement VAT from 1 April.

These include Uttar Pradesh, the largest state in India, besides five states ruled by the opposition Bharatiya Janata Party (BJP) that had, ironically, supported VAT wholeheartedly when it was heading the ruling coalition in Delhi.

"There is nothing political about introducing VAT," says Asim Dasgupta, the finance minister of West Bengal, the communist-ruled eastern Indian state, who heads an "empowered committee" of state finance ministers spearheading VAT implementation.

Mr Dasgupta says the BJP is being hypocritical in saying that the state governments it controls will not implement VAT until the entire country agrees to abide by the new system as this will result in an un-level playing with traders in one state paying lower taxes than those elsewhere.

He is, however, hopeful that all states will eventually fall in line very soon.

Haryana's system

A year ago, Jaswant Singh, finance minister in the BJP-led government, extolled the virtues of VAT and described it as a shining example of "cooperative federalism".

The current centre-left coalition headed by Congress has called VAT the "most significant" tax reforms undertaken since the country became politically independent in 1947.

The BJP's Jaswant Singh had championed VAT when in power

Over the past three years, the implementation of VAT has been postponed no fewer than five times because state governments have said they were not prepared.

When the last deadline for implementation was set for 1 April, 2004, only one economically advanced state in northern India - Haryana - went ahead.

The state government's tax collections have gone up over the past 12 months.

However, large states like Uttar Pradesh that "import" substantial quantities of goods from other states are apprehensive about revenues being adversely affected.

Under the proposed VAT system, only two rates of 4% and 12.5% will be imposed on most of the products on which various kinds of sales taxes are levied at present.

Certain commodities like petroleum products, alcohol and lottery tickets have been exempted.

It has also been proposed that small traders will need to pay a small flat tax of 0.25% - against 1% proposed earlier - on their annual turnover.

The world's two largest democracies, India and the United States, happen to be among the few countries in the world that do not have a VAT system.

In many countries, the transition from CTT to VAT has witnessed a spurt in inflation. To prevent this from happening is the real challenge that India's policy-makers face.