Taxation and the goods and services tax

The first principle

A tax moves purchasing power from people to the state without anything being given in exchange, so a good tax system raises the money needed while changing people's choices as little as possible and treating people with equal ability to pay equally. Taxes on income are judged by fairness, because they can rise with ability to pay, and taxes on spending are judged by neutrality, because a tax that piles on itself at each stage distorts what is made and where. The goods and services tax (GST) was built to fix exactly that second problem.

The core

Kinds of tax

• Direct and indirect. A direct tax, such as income or corporation tax, is borne by the person the law places it on, while an indirect tax, such as GST or customs duty, is collected from a seller and passed on in the price. Who finally bears a tax, its incidence, depends on how easily buyers and sellers can switch.
• Progressive and regressive. A progressive tax takes a larger share of income as income rises, as income tax slabs do, while a tax on spending is regressive in relation to income because poorer households spend more of what they earn; GST softens this by exempting or lightly taxing essentials.
• The constitutional split. The Union taxes income other than agricultural income, corporations and customs, the States tax land, alcohol for human consumption and electricity, and since 2017 both levy GST together under Article 246A.

Buoyancy and elasticity

• Tax buoyancy = percentage change in tax revenue ÷ percentage change in nominal GDP. It measures how revenue actually responds to growth, including the effect of any changes in rates or base made during the year.
• Tax elasticity is the same ratio after removing the effect of such discretionary changes, so it shows how the tax system itself responds to growth. A value above 1 means revenue grows faster than the economy.
• Worked example (Union Budget 2026-27). Gross tax revenue is budgeted to rise from Rs 40.78 lakh crore (2025-26 revised estimate) to Rs 44.04 lakh crore, which is (44.04 − 40.78) ÷ 40.78 = 8.0 per cent, while the nominal gross domestic product (GDP) assumed rises from Rs 357.14 lakh crore to Rs 393.00 lakh crore, which is 10.0 per cent. Buoyancy is 8.0 ÷ 10.0 = 0.80, so the tax take is expected to grow more slowly than the economy.
• Separating elasticity (illustration). Suppose rate cuts made during the year cost Rs 1 lakh crore. Without them revenue would have been Rs 45.04 lakh crore, a rise of 10.4 per cent, so elasticity would be 10.4 ÷ 10.0 = 1.04: the underlying system would still be keeping pace with growth even though buoyancy shows less than 1.

How GST works

• A tax on value added, collected at every stage. Each seller charges GST on its full sale price but deducts the GST it has already paid on its inputs, called input tax credit, and pays only the difference. Because each stage pays tax only on the value it adds, the total tax equals the GST rate on the final price, and the burden falls on the final consumer.
• Worked example at 18 per cent. A supplier sells material for Rs 40 and pays Rs 7.20; a manufacturer sells the product for Rs 100, charges Rs 18 and pays Rs 18 − 7.20 = Rs 10.80; a retailer sells for Rs 150, charges Rs 27 and pays Rs 27 − 18 = Rs 9. The government receives 7.20 + 10.80 + 9 = Rs 27, which is 18 per cent of the final price of Rs 150, with no tax charged on tax.
• Dual and destination based. On a sale within a State the Centre levies central GST and the State levies State GST, and on a sale between States the Centre levies integrated GST (Article 269A), which is shared so that the tax goes to the State where the good is consumed, not where it is made.

Dimensions

• Fiscal. The Union's gross tax revenue of Rs 44.04 lakh crore in 2026-27 is about 11.2 per cent of GDP, low for a country that wants to spend more on health, education and defence.
• Equity. Direct taxes are about 61 per cent of the Union's gross tax revenue in 2026-27, so taxes on income now bring in more than taxes on spending, which makes the system more progressive; a high exemption threshold, however, means only a small share of adults pay income tax.
• Federal. GST pooled the taxing powers of the Centre and States, and about a third of the Union's gross tax revenue is then shared with States under the Finance Commission formula, so tax design is also a question of cooperative federalism; the fiscal federalism note covers devolution.
• Growth. Removing tax on tax and State border check posts lowered costs and made India one market.
• Administrative. Electronic invoices and return matching through the Goods and Services Tax Network (GSTN) have widened the base, but load small firms with compliance.

In practice

Direct taxes

• Corporation tax. In September 2019 the base rate for domestic companies that give up exemptions was cut to 22 per cent (about 25.17 per cent with surcharge and cess), and to 15 per cent for new manufacturing companies.
• Personal income tax. The new regime, with lower rates and few deductions, became the default from 2023-24, and from 2025-26 no tax is payable on income up to Rs 12 lakh because of a rebate, with slabs rising from 5 to 30 per cent above Rs 4 lakh.
• The Income Tax Act, 2025. Passed by Parliament in August 2025 and assented on 21 August 2025, it replaced the Income-tax Act, 1961 from 1 April 2026. It cuts the law from 819 sections to 536, replaces the pair of previous year and assessment year with a single tax year, and is meant to simplify language without changing rates.

GST

• Design and law. The Kelkar Task Force of 2004 first proposed a national GST, and the Constitution (One Hundred and First Amendment) Act, 2016 created it; GST began on 1 July 2017, replacing central excise, service tax, value added tax, entry tax and several other levies. Alcohol for human consumption is outside it by the Constitution, and five petroleum products (crude oil, petrol, diesel, natural gas and aviation turbine fuel) stay outside until the GST Council decides otherwise.
• The GST Council (Article 279A). It is chaired by the Union Finance Minister with State finance ministers as members; a decision needs three fourths of the weighted votes, with the Centre holding one third and the States together two thirds. In Union of India v Mohit Minerals (2022) the Supreme Court held that its recommendations are persuasive, not binding, on Parliament and the State legislatures.
• Compensation. The GST (Compensation to States) Act, 2017 guaranteed States 14 per cent annual growth in revenue over 2015-16 for five years, to June 2022, funded by a compensation cess on luxury and sin goods. To repay about Rs 2.69 lakh crore borrowed to compensate States in the pandemic, the cess was extended to March 2026.
• The September 2025 rationalisation. The 56th GST Council meeting on 3 September 2025 replaced the four main rates of 5, 12, 18 and 28 per cent with two, 5 and 18 per cent, and a 40 per cent rate for a small list of luxury and sin goods, effective 22 September 2025. Most goods at 12 per cent moved to 5 per cent and most at 28 per cent to 18 per cent, individual life and health insurance were exempted, and the compensation cess ended on all goods except tobacco products and pan masala.
• The end of the cess. From 1 February 2026 the compensation cess ended on tobacco too, replaced by an additional central excise duty on tobacco products and a new health and national security cess on pan masala, both levied by laws passed in December 2025.

Issues and way forward

• A narrow base. Agricultural income is exempt, much work is informal and the threshold is high, so few people pay income tax; third party data from banks, property registries and GST returns, rather than higher rates, is the route taken.
• Low buoyancy after rate cuts. The GST and income tax cuts of 2025 lower revenue in the short run, which is why the 2026-27 Budget assumes buoyancy below 1; the bet is that consumption and compliance will widen the base.
• Unfinished GST. Petroleum, electricity and alcohol remain outside, so input tax credit breaks in sectors that use them heavily; bringing petroleum in, as long recommended, needs a deal with States on lost revenue.
• Trust between Centre and States. With compensation gone, States have little independent tax power left beyond petroleum, alcohol, stamp duty, vehicles and electricity, so the Council's consensus culture and timely settlement of integrated GST are the guarantee of cooperative federalism.
• Disputes and compliance. Litigation over classification and refunds is large; the GST Appellate Tribunal working at full strength, simpler returns for small firms and faster refunds for exporters are the remedies.

Common confusions

• Buoyancy and elasticity. Buoyancy includes the effect of rate and base changes, while elasticity removes them; a government that keeps cutting rates can show low buoyancy with a healthy elasticity.
• Impact and incidence. Impact is on whoever pays the government; incidence is on whoever finally bears the cost, so GST has its impact on sellers but its incidence mostly on consumers.
• Cess and surcharge. Both are levied by the Union over and above a tax and are not shared with States, but a cess is raised for a stated purpose, such as the health and education cess, while a surcharge is a general addition to the tax.

For the exam

• Keyword bank: direct and indirect taxes, progressive taxation, tax incidence, tax buoyancy, tax elasticity, tax to GDP ratio, tax base, Income Tax Act 2025, tax year, input tax credit, destination principle, integrated GST, GST Council (Article 279A), compensation cess, rate rationalisation.
• Previous year questions: Practise the previous year questions on this topic →
• Use in an answer:
  • Introduction with data: The Union expects gross tax revenue of Rs 44.04 lakh crore in 2026-27, about 11.2 per cent of GDP, with direct taxes making up about 61 per cent (Union Budget 2026-27).
  • Introduction with a source: In Union of India v Mohit Minerals (2022) the Supreme Court held that GST Council recommendations are persuasive, not binding, because they are the product of dialogue between the Centre and the States.
  • Conclusion: Rate cuts and simpler laws can raise revenue only if the base widens, so the success of the 2025 GST reform and the new Income Tax Act will be judged by buoyancy over the next few years.
  • Conclusion: A tax system earns compliance when it is simple, stable and fair, and a two rate GST with petroleum inside it would complete the single market that 2017 began.