The Kelkar Committee on Fiscal Responsibility and Budget Management has taken a huge leap of faith in suggesting a radical tax system that would at once bind all goods and service providers in one simple Value Added Tax (VAT) regime, levying 20% Central and state VAT at each stage of value addition.

This will be combined with an even lower direct tax regime across the board for the salaried class. The Committee thus attempts to impose an equitable consumption-based tax across all goods and services(GST) while putting more money in the hands of wage earners.

What's more, the task force seeks to win popular support for the proposed tax regime by seeking to exempt from VAT all small businesses, whether in manufacturing or services, with a turnover of up to Rs 25 lakh. This is expected to hugely reduce administrative hassels in tracking small businesses.

If accepted, the GST could usher in a seamless common market and bring a large number of new businesses into the VAT chain. It projects an additional annual income in the hands of wage earners of Rs 80,000 crore by '08-09, and an incremental growth in the economy's GDP by Rs 1,31,000 crore, purely on account of the changed tax regime.

The Kelkar committee on Fiscal Responsibility and Budget Management has recommended a 12% goods and services tax (GST) replacing the current Cenvat and service tax, a state-level GST of 8%, cut in peak customs duty to 10% and a sharp reduction in income tax rates to 20% for those earning less than Rs 4 lakh per annum.

The FRBM committee has also suggested scrapping of exemptions, removal of state-level taxes like octroi and stamp duty and toning up the tax administration to enhance revenue collections so that the social sector objectives mentioned in the Common Minimum Programme (CMP) can be funded.

Instead of the existing 16% Cenvat, the panel favours a uniform 12% GST on both goods and services, while allowing the state governments to tax these goods with an 8% state-level GST. The net impact would be a 20% levy on all goods & services, which is the same level as the VAT imposed by OECD countries.

For merit goods like mass consumption items, the committee has advocated a lower rate of 6% central levy, coupled with a 4% state-level levy. For demerit goods like luxury items, the suggestion is a 20% GST by the centre, followed by another 14% by state governments.

While the combined impact of 20% through the proposed goods & service tax is higher than current tax levels, the committee has offered a compensation to domestic industry and consumers by recommending withdrawal of all 'cascading' taxes like octroi, central sales tax, entry tax, stamp duties, telecom license fees, turnover taxes, tax on consumption of electricity, taxes on transportation and all other state-level levies.

The 'grand bargain' to states is the flexibility to levy GST on all goods and services. As of now, the centre imposes Cenvat and service tax, respectively, on most goods and services, while the state governments are left with little leeway on these levies.

"The right strategy is to have a Central VAT and a state VAT initially and then combine them both to evolve a national VAT," said Arvind Virmani of ICIRIER who had proposed the existing Cenvat in 1998-99. The Cenvat was supposed to be a goods & services tax, he added.

In case of customs, Kelkar's prescription is to slash the peak duty to 10% as compared to the current level of 30%. The other two rates suggested in the three-slab customs structure are 8% and 5%, bringing India closer to the Asean's import duty levels. While acknowledging that the reduction in customs duties would lead to revenue loss, the committee feels that the other measures prescribed for the medium-term would compensate for this loss.

In the case of income-tax, Dr Kelkar has backed Mr Chidambaram's plan to exempt those earning up to Rs 1 lakh from the tax net. The two-slab I-T structure advocated by the task force calls for a 20% income-tax for those earning up to Rs 4 lakh. As of now, those earning more than Rs 1.5 lakh have to pay income-tax at the rate of 30%.

For income above Rs 4 lakh, the committee has called for 30% income-tax. The recommendations mean scrapping of the existing 10% and removal of the distortion faced by those earning marginally above Rs 1 lakh (in such cases only Rs 50,000 is exempted and the reminder is taxed).

While Dr Kelkar - advisor to the finance minister - has favoured removal of exemptions, he has recommended retention of sops relating to housing loans and those available to senior citizens and women.
The task force has also recommended scrapping of stranded deduction and prospective withdrawal of exemption available to interest earned from PPF deposits. Implementation of these recommendations would lead to tax buoyancy and better compliance. The other recommendations include modernisation of the tax treatment of fund management, zero coupon bonds and 'speculative' transactions on financial derivatives.

The task force has called for a reduction in the corporate tax rate to 30%, as compared to the current rate of 35%. Simultaneously, the general depreciation rate should be cut to 15%, as compared to the current rate of 25% since interest rates have fallen.

"While a reduction in tax rates and a simultaneous cut in depreciation rates and scrapping of exemptions is fine, the most important aspect is to expand the tax base. A vary large section of the population is still not paying tax, despite having substantial income. Unless this issue is addressed, revenue generation will not improve," said Shyamal Mukherjee, executive director at PricewarehouseCoopers.

The Kelkar report is in favour of eliminating distribution tax and phasing out all existing tax incentives within two years. The task force has recommended that key exemptions, like those provided under Section 10A and 10B (available to software technology park units and export-oriented units) should be withdrawn. As of now, these incentives are available till '09. Also on the chopping block are incentives available for infrastructure projects like those in the power sector.