To GST or not to GST

We are losing touch with the soul of the indirect tax

- AJAY SHAH, VIJAY KELKAR & ARBIND MODI

Indirect taxation, when designed poorly, is an enemy of economic growth. We were part of the early dreams of cleaning this up by going to the “value-added tax” (VAT), an internationally established idea, which was rebranded for India by us as goods and services tax (GST).

This is intended to be a clean consumption tax, which is neutral to the methods of production or international trade. It is the right way to do indirect taxation in any country.

The engine of GST is the input tax credit (ITC). Comprehensive ITC eliminates the cascading of taxes, ensures that taxis are levied only on the value added at each stage of production and therefore (ultimately) only on consumption, and creates a unified national market.

Today’s GST, however, repeatedly violates this core principle. The system has become an example of what Lant Pritchett calls “isomorphic mimicry”: Ithas adopted the external form of a modern GST to seek the legitimacy that comes with the name, but without the underlying function. The ITC mechanism has been increasingly obstructed by legal and procedural blockages. In many respects, the Indian GST has become a tax on production, similar to the previous system of excise and service tax.

A functional GST is built on a seamless ITC system. When a business pays tax on its inputs — materials, services, or capital goods — it should receive full and immediate credit. This ensures the tax is a pass-through. When ITC is blocked, the economic logic is undermined. The tax ceases to be a levy on consumption and becomes a tax on business inputs, embedding itself as a cost that cascades through the supply chain. The effective level of taxation can become very high.