Indirect Taxes and the Goods and Services Tax

In one line

An indirect tax is one the seller pays and the buyer bears, and since 2017 almost all of India's indirect taxes on goods and services have been merged into one tax levied simultaneously by the Union and the States.

In the wording a student can write in an exam: an indirect tax is one in which the impact falls on one person and the incidence on another, the person legally liable recovering it from the consumer in the price; India's principal indirect taxes are the goods and services tax introduced with effect from 1 July 2017, customs duties on imports, and Union excise duties which survive only on five petroleum products and tobacco, alcoholic liquor for human consumption having been kept outside the goods and services tax altogether.

The general characteristics of an indirect tax

Merits.

1. Convenient. Paid in small amounts as part of a price, and the payer often does not notice.
2. Difficult to evade where the tax is embedded in the price of a good that must be bought.
3. Wide coverage. Everybody who buys contributes, including those outside the income tax net, which matters in an economy where much income is undocumented.
4. They can be selective. A high rate on tobacco or on a luxury discourages what policy wishes to discourage, which is the elasticity reasoning of [Elasticity of Demand].
5. Elastic in yield where they fall on goods whose consumption grows with income.

Demerits.

1. Regressive. A poor household spends a larger share of its income on taxed goods, so it pays a larger share of its income in tax. This is the central objection.
2. Inflationary. They enter prices directly.
3. Uncertain in yield, because consumption can fall.
4. They do not create civic awareness, since the payer often does not know what they have paid.
5. Cascading, in the old structure, which is what the goods and services tax was designed to end.

What cascading was, and why it mattered

The old structure. The Union levied excise on manufacture and service tax on services; States levied value added tax on sale within the State; the Union levied central sales tax on inter State sale and assigned it to the States; and there were entry tax, octroi, luxury tax, entertainment tax and several cesses.

The defect. A manufacturer paid excise; the wholesaler paid value added tax on a price that already contained the excise; a State could not give credit for a Union tax nor a Union authority for a State tax. Tax was charged on tax, which is cascading, and its effects were that the final price contained an unknown amount of tax, that a longer supply chain was taxed more heavily than a short one, and that an exporter could not be relieved of tax they could not identify.