A decision is likely to be made within this year so that the states are able to pass their tax laws through their legislatures, accordingly. At present, it is only the Centre which levies service tax on 96 categories of business.

But states have been clamouring to get a part of the Rs 34,500-crore corpus (Budget estimates for '06-07). They have linked the roadmap for the phase out of the Central sales tax with the demand to impose service tax on several categories of enterprise.

Taxation of services of high net worth individuals like doctors and lawyers has been a controversial subject. While the government has been able to impose a service tax on some services provided by private hospitals, legal services are totally exempt.

The officials said they expect to pass an administrative order by October this year to ensure that the issue is sorted out. By handing over the sensitive tax questions to the state governments, the Centre is also making sure that these two communities will have no common "enemy" to fight with.

Opening dialogues with about 35 state governments will not be easy. The official also said the government is working on a reduction of the mean 16% rate of Cenvat excise duty next year.

The impact of the 16% Cenvat and 12 % service tax creates a heavy tax burden on goods and services. A goods and services tax (GST) regime will not be sustainable with such high rates. The GST is expected to begin by '10.

"It would be better to reduce the Cenvat rate so that the dependence on indirect taxes in the fisc comes down," an official said. But he said this does not mean the rate of income and corporate tax need to be raised to compensate the loss. Instead, the percentage contribution of direct tax to the total tax receipts could rise much more by doing away with the sops, they said.

The Centre has already floated a plan to eliminate about 100 direct and indirect tax exemptions. The official said they have received 8,000 responses from firms, industry bodies and affected firms, asking for continuing the exemptions, but many are likely to be pruned.