How Indirect Taxes and GST Contribute to Economic Health

Indirect taxes, such as GST, play a vital role in the economic landscape of a country like India. One prominent indirect tax in the Indian market is the Goods and Services Tax (GST), which has aimed to address issues related to corruption, black money, and tax evasion. In this article, we will delve into the intricacies of indirect taxes, specifically focusing on the GST in India, using the example of a bar of Hamam soap purchased in a supermarket.

Understanding Indirect Taxes in India

Indirect taxes in India are levied on the sale of goods and services. These taxes include Value Added Tax (VAT), Central Sales Tax (CST), and Excise Duty. The introduction of GST in India was a significant shift aimed at reducing corruption and enhancing compliance.

The Hamam Soap Example

Let us consider the example of a bar of Hamam soap purchased in a local supermarket to understand how indirect taxes work in India.

Imagine you are buying a bar of Hamam soap in the local supermarket. The bar of soap is manufactured by Hindustan Unilever (HUL) and the base price is Rs. 100. The following costs are then added at different stages of the supply chain:

Manufacturing Stage: HUL adds a markup of 10% to cover raw material and other costs, raising the price to Rs. 110. Distributor Stage: The distributor adds a markup of 10%, raising the price to Rs. 121. Wholesaler Stage: The wholesaler adds a markup of 20%, raising the price to Rs. 140. Retailer Stage: The retailer/supermarket adds a markup of 20%, raising the final price to Rs. 160, which you pay for the soap.

At every stage of this supply chain, including the consumer purchase, taxes are required to be paid to the government. In the absence of GST, there are significant loopholes and irregularities:

The retailer may pocket extra cash from sales that should have been paid to the government in taxes. The wholesaler might not pay taxes due to non-billing, leading to a loss in tax revenue. These irregularities escalate through the supply chain, creating a black economy with unaccounted money.

Role of GST in Addressing these Issues

The Goods and Services Tax (GST) was introduced in India to address these issues by implementing several measures:

Transaction Registration

Each business entity, from small provision stores to large manufacturers, must register itself with the GST Network (GSTN) and obtain a unique GST Identification Number (GSTIN). This makes it easy to track every business transaction. For instance, a receipt from a small shop can be linked to its GSTIN, allowing anyone to check the shop’s business history and tax payment records.

Example: You can enter a GSTIN into the GST portal to retrieve the shop’s complete business history, including past fiscal year returns.

Input Tax Credit (ITC)

ITC provides an incentive for businesses to comply with GST by allowing them to offset input costs against their output tax liability. Let’s examine this through the same soap supply chain example:

At the manufacturing stage, HUL can subtract the input cost from the tax they pay, resulting in a lower overall tax liability. When the distributor sells to the wholesaler, they can bill properly to claim ITC on their storage and distribution costs. Similarly, if any stage in the supply chain does not bill correctly, they will face a loss due to already paid taxes.

Avoiding Cascading of Taxes

One of the main challenges in pre-GST regimes was the cascading effect of taxes. Each entity in the supply chain paid taxes on the previous entity’s purchase price, leading to higher final prices and unnecessary tax burdens. With GST, the system is designed to be transparent, ensuring that taxes are only paid once on the final value added at each stage of the supply chain. This system avoids the cascading of taxes and eliminates tax on tax scenarios, reducing incentives for tax evasion.

The introduction of GST not only curtails corruption but also significantly enhances compliance and positively impacts government revenues. By combining transaction registration, ITC, and the avoidance of cascading taxes, GST has emerged as a robust solution to improve the overall economic health of India.