Just VAT is services all about?

An economy comprises three broad sectors: Agriculture, industry and services. Initially, agriculture predominates. As countries develop, the share of agriculture in GDP declines and the share of industry builds up. Thereafter, services take over.
The share of agriculture in India’s GDP has fallen from close to 60 per cent in 1950-51 to around 22 per cent in 2002-03.Over the same period, the share of industry almost doubled from 15 per cent to about 27 per cent while that of services has also gone up from 28 per cent to slightly over 50 per cent.
It would appear that India has already become a developed country. This shift appears even more unusual when compared to China where industry accounts for a half and services for another third of national income. Apart from the smaller states like Goa and those in the northeast, Kerala and Maharashtra are two states where services already accounts for half of state GDP. In four other states — West Bengal, Tamil Nadu, Andhra Pradesh and Karnataka — the share is approaching 50 per cent rapidly.
What is the services sector in India all about? A recent paper by two IMF economists Jim Gordon and Poonam Gupta attempts to fill the knowledge gap. Its main findings are:
• Wholesale and retail trade is by far the most important service activity in India accounting for almost 14 per cent of overall GDP in 2000, followed by banking (6 per cent), health, education and other community services (5.5 per cent), transport (5.5 per cent) and real estate (4.5 per cent).
• Business services which includes software and IT-enabled services was the fastest growing sector in the 1990s but its overall GDP share is still low at about one per cent. Another fast-growing sector has been communications which has only 2 per cent in total GDP.
• While its share in national output has expanded significantly, service sector growth in India has been relatively jobless. When compared to other countries, India has an exceptionally low share of services employment, not all of which is explained by the limitations of employment data.
• Value-added by services exports made a contribution to services growth of 0.2-0.6 percentage points per year in the past two decades.
During 1992-93 to 1996-97, GDP growth averaged 6.7 per cent per year. During 1998-99 to 2003-04 — the period of a “shining India� — this would have declined to around 5.3 per cent per year. The decline would have been more precipitous were it not for the services sector that has averaged a 8 per cent annual growth in the last five years. There are even greater hopes in the future from this sector. But the IMF analysis should certainly induce some sobriety.
The continued growth of services has major implications on fiscal policy. Agriculture not being taxed, services being under-taxed and the existing service taxes suffering from low revenue productivity, the brunt of the burden is borne by industry, eroding its global competitive advantage. Effective taxation of services and its integration with the value-added tax (VAT) both at the centre and in states is essential. A Constitutional Amendment will be required to give the centre and states sufficient powers to levy and collect service taxes.
It should not be too difficult to get this done. An overall tax: GDP ratio of around 14-15 per cent that we have at the present is among the lowest in the world. This has to increase to at least 18 per cent over the next five years through comprehensive tax reforms.
VAT holds the key. With Madanlal Khurana out of the way, will the Union finance minister show the courage to move forward, when most states — even West Bengal — have shown their willingness?
kautilya.jairam@indiatimes.com