What is the Goods and Services Tax (GST)?
The goods and services tax (GST) is a value-added tax levied on most goods and services sold for domestic consumption. The GST is paid by consumers, but it is remitted to the government by the businesses selling the goods and services. In effect, GST provides revenue for the government.
Breaking Down the Goods and Services Tax (GST)
The goods and services tax (GST) is an indirect federal sales tax that is applied to the cost of certain goods and services. The business adds the GST to the price of the product, and a customer who buys the product pays the sales price plus GST. The GST portion is collected by the business or seller and forwarded to the government. It is also referred to as Value-Added Tax (VAT) in some countries.
Which Countries Collect the GST?
France was the first country to implement the GST in 1954, and since then an estimated 160 countries have adopted this tax system in some form or another. Some of the countries with a GST include Canada, Vietnam, Australia, Singapore, United Kingdom, Monaco, Spain, Italy, Nigeria, Brazil, South Korea, and India.
How the GST Systems Work
Most countries with a GST have a single unified GST system, which means that a single tax rate is applied throughout the country. A country with a unified GST platform merges central taxes (e.g. sales tax, excise duty tax, and service tax) with state-level taxes (e.g. entertainment tax, entry tax, transfer tax, sin tax, and luxury tax) and collects them as one single tax. These countries tax virtually everything at a single rate.
Dual GST Structures: Canada
Only a handful of countries, such as Canada and Brazil, have a dual GST structure. Compared to a unified GST economy where tax is collected by the federal government and then distributed to the states, in a dual system, the federal GST is applied in addition to the state sales tax. In Canada, for example, the federal government levies a 5% tax and some provinces/states also levy a provincial state tax (PST), which varies from 7% to 10%. In this case, a consumer’s receipt will clearly have the GST and PST rate that was applied to his or purchase value.
More recently, the GST and PST have been combined in some provinces into a single tax known as the Harmonized Sales Tax (HST). Prince Edward Island was the first to adopt the HST in 2013, combining its federal and provincial sales taxes to a single tax at 14%, which was raised to 15% in 2016. Since then, several other provinces have followed suit, including New Brunswick, Newfoundland and Labrador, Nova Scotia and Ontario.
India's Adoption of the GST
India established a dual GST structure in 2017, which was the biggest reform in the country's tax structure in decades. The main objective of incorporating the GST is to eliminate tax on tax or double taxation, which cascades from the manufacturing level to the consumption level. For example, a manufacturer that makes notebooks obtains the raw materials for, say, Rs. 10, which includes a 10% tax. This means that he pays Rs. 1 in tax for Rs. 9 worth of materials. In the process of manufacturing the notebook, he adds value to the original materials of Rs. 5, for a total value of Rs. 10 + Rs. 5 = Rs. 15. The 10% tax due on the finished good will be Rs. 1.50. Under a GST system, this additional tax can be applied against the previous tax he paid to bring his effective tax rate to Rs. 1.50 - Rs. 1.00 = Rs. 0.50.
The wholesaler purchases the notebook for Rs. 15 and sells it to the retailer at a Rs. 2.50 markup value for Rs. 17.50. The 10% tax on the gross value of the good will be Rs. 1.75, which he can apply against the tax on the original cost price from the manufacturer i.e. Rs. 15. The wholesaler’s effective tax rate will, thus, be Rs. 1.75 - Rs. 1.50 = Rs. 0.25.
If the retailer’s margin is Rs. 1.50, his effective tax rate will be (10% x Rs. 19) - Rs. 1.75 = Rs. 0.15. Total tax that cascades from manufacturer to retailer will be Rs. 1 + Rs. 0.50 + Rs. 0.25 + Rs. 0.15 = Rs. 1.90.
India has, since launching the GST on July 1, 2017, implemented five different tax rates.
- A 0% tax rate applied to certain foods, books, newspapers, homespun cotton cloth and hotel services under Rs. 1000.
- A rate of 0.25% applied to rough industrial diamonds.
- A 5% tax rate applied to apparel below Rs. 1000, packaged food items, footwear under Rs. 500, etc.
- A 12% tax rate applied to apparel over Rs. 1000, frozen meats, cutlery, sugar, bio-diesel, etc.
- An 18% tax rate applied to certain luxury items including makeup, pastries, swimming pools, footwear costing more than Rs. 500, etc.
- The final bracket, taxing goods at 28%, applied to 50 luxury products and those deemed “sinful,” including sunscreen, ceramic tiles, bidis (Indian cigarettes), cars, motorcycles, etc.
The previous system with no GST implies that tax is paid on the value of goods and margin at every stage of the production process. This would translate to a higher amount of total taxes paid, which is carried down to the end consumer in the form of higher costs for goods and services. The implementation of the GST system in India is, therefore, a measure that is used to reduce inflation in the long run, as prices for goods will be lower.