The switchover from the existing sales tax system to the value-added tax regime will entail a substantial loss of revenue to states, say experts.

When the introduction of VAT was contemplated, the focus was on its merits -- how it would lead to reduction in the cost of goods to the consumers.

But now the attention is on measures to protect states' revenue.

According to experts, in order to make VAT effective, all existing state level taxes -- sales tax, surcharge on sales tax, central sales tax, turn over tax, entry tax and octroi -- should be abolished.

But the government agreed to retain CST, and tactically allowed sates to continue with municipal taxes such as octroi, effectively nullifying the benefits of VAT.

The new regime will force manufacturing units to source raw materials from outside the states of their operation, hampering interstate trade.

Besides protecting their revenues, states, especially the more influential ones like Maharashtra and Gujarat, do not want to displease industries.

In the past, states introduced a plethora of incentives like exemption and deferral to attract investment and promote industrialisation.

Such schemes either exempted the industrial undertakings from tax on local purchase of inputs and sale of output, or allowed them to collect tax and retain the proceeds over a specified period.

Now the government wants to continue with these schemes despite them being incompatible with VAT.

For example, natural gas is a major feed stock/fuel used by industries like power, fertilizers, petrochemicals and sponge-iron.

The draft VAT legislation of Uttar Pradesh does not provide for credit in respect of tax paid on natural gas. Such selective exclusions will undermine VAT's effectiveness, experts say.

By raising the threshold limit -- a trader having turnover below this level can opt out of VAT -- from Rs 2.5 million to Rs 4 million, the government proved that it was not ready to tap a major source of revenue.  With the revised limit, about 90 per cent of the traders will go out of the VAT.

While making a bid to embrace VAT, both the Centre and the states do not want their existing resource position to be eroded.

They want neither to displease industries and trading community nor to annoy political class. And yet, they are keen that VAT comes into force and brings the desired results.