With the new GST scheme for 2025 now in effect, it’s more important than ever to get a clear answer to the question: What is GST? It’s a term we hear and complain about in our daily lives, often without a full grasp of how the system works. But no matter your opinion, understanding the basics of this major tax reform in India is crucial. This article provides a straightforward explanation of GST, showing why it is a solution instead of a problem.
To truly understand the impact of this tax reform, let’s compare two clear scenarios. First, we’ll look at the pre-GST tax structure in India with all its hidden charges, and then we’ll see how things work after GST implementation.
Scenario 1 : Before GST: Explaining the “Tax on Tax” Problem
This example shows the old tax system in India and explains the cascading effect, where you paid tax on top of tax. For more details on historical rates, you can visit the official [CBIC GST portal (External Link)]. Let’s assume a 10% Excise Duty and 10% VAT for this calculation.
1. Manufacturer to Wholesaler
- Base Price: ₹100
- Add 10% Excise Duty: ₹100 + ₹10 = ₹110
- Add 10% VAT on ₹110 (tax on tax!): ₹110 + ₹11 = ₹121
2. Wholesaler to Retailer
- Wholesaler’s Cost: ₹110 (the price with Excise tax hidden inside)
- Add Profit: ₹110 + ₹10 = ₹120 (new base price)
- Add 10% VAT on ₹120: ₹120 + ₹12 = ₹132
3. Retailer to You
- Retailer’s Cost: ₹120
- Add Profit: ₹120 + ₹10 = ₹130 (final base price)
- Add 10% VAT on ₹130: ₹130 + ₹13 = ₹143
- Final Price You Paid: ₹143
The final price was high because the tax kept getting added to a price that already included previous taxes.
Scenario 2 : After GST: How Input Tax Credit (ITC) Solves the Problem
This example shows how the new GST system works. It uses Input Tax Credit (ITC) to avoid the “tax on tax” problem. Let’s use a single GST rate of 20% for comparison.
1. Manufacturer to Wholesaler
- Base Price: ₹100
- Add 20% GST: ₹100 + ₹20 = ₹120
- (Manufacturer pays ₹20 tax to the government)
2. Wholesaler to Retailer
- Wholesaler’s Cost: ₹100
- Add Profit: ₹100 + ₹10 = ₹110 (new base price)
- Add 20% GST on ₹110: ₹110 + ₹22 = ₹132
- Tax Credit Magic: The wholesaler collected ₹22 in tax but already paid ₹20. So, they only pay the difference: ₹22 – ₹20 = ₹2 tax to the government.
3. Retailer to You
- Retailer’s Cost: ₹110
- Add Profit: ₹110 + ₹10 = ₹120 (final base price)
- Add 20% GST on ₹120: ₹120 + ₹24 = ₹144
- Tax Credit Magic: The retailer collected ₹24 in tax but already paid ₹22. They only pay the difference: ₹24 – ₹22 = ₹2 tax to the government.
- Final Price You Paid: ₹144
Even though the final price is similar in this example, the GST system is transparent. The total tax collected by the government is exactly what the consumer pays (₹20 + ₹2 + ₹2 = ₹24), and there is no hidden “tax on tax.”
You can clearly see that GST is actually a solution to the tax on tax problem.