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May 2, 2024

Indirect Taxes: The Taxes You Pay Without Realizing It

Ankit Virani



Taxes. The word itself might muster up feelings of filling out complex forms or a chunk of your paycheck disappearing. But taxes play an essential role in any economy. They're essentially contributions we make to the government, used to fund vital public services like roads, schools, and hospitals.

Now, there are different ways the government collects these contributions. This blog will focus on a specific type: indirect taxes. These are levies on the consumption of goods and services, rather than directly on your income.

Think of it this way: when you buy a new phone, the price you pay likely includes an indirect tax. The seller collects this tax from you at the checkout, and then they're responsible for sending it on to the government. So, in reality, you're the one who ends up paying the tax, but it's kind of hidden within the final price.

Indirect taxes are different from direct taxes, which you might be more familiar with. Direct taxes are levied directly on your income, like income tax or property tax.

Understanding the Benefits of Indirect Taxes

As we saw, indirect taxes are a sneaky way for the government to collect revenue. But what exactly do they do with all that money? Here's where things get interesting.

The biggest benefit of indirect taxes is their ability to generate a steady stream of income for the government. Since we're constantly buying things, there's a consistent flow of tax revenue. This allows the government to plan and invest in essential areas.

Imagine a giant piggy bank filled with indirect tax money. This piggy bank gets pretty full because everyone, regardless of income level, contributes a little bit each time they buy something. This broad participation helps fund essential public programs.

Think about things like social security for retirees, healthcare initiatives, or free public education. These programs all require significant resources, and indirect taxes play a vital role in ensuring they're available for those who need them.

But indirect taxes aren't just about funding social programs. They can also be used to develop infrastructure. Every time you drive on a smooth road or cross a sturdy bridge, remember that indirect taxes might have helped pay for it!

Finally, indirect taxes can be a tool for regulating specific industries. For example, governments might impose higher taxes on cigarettes or sugary drinks. This discourages people from buying these products, promoting healthier choices and potentially reducing healthcare costs in the long run.

So, the next time you pay an indirect tax, remember that it's not just about the government taking money. It's about collectively contributing to a better society with improved infrastructure, social programs, and even public health initiatives.

Common Types of Indirect Taxes (Before GST)

Before GST came along and streamlined things, the world of indirect taxes was a bit of a zoo. Here are some of the common creatures you might have encountered:

Sales Tax:

This one's pretty clear. It's a tax levied on the sale of goods within a state. Every time you bought clothes, groceries, or any other taxable item, you likely paid sales tax on top of the base price.

Example: Let's say you buy a new pair of shoes for ₹1000. The state might have a sales tax of 5%. In this case, you'd pay an additional ₹50 (₹1000 * 5%) as sales tax, bringing the final price to ₹1050.

Excise Duty:

This tax is levied on specific goods produced within the country. So, things like tobacco products, alcohol, and fuel would often have an excise duty added to their price tag.

Example: Imagine buying a pack of cigarettes. The government might add an excise duty of ₹50 per pack on top of the manufacturing cost. This increases the price you pay at the store.

Value Added Tax (VAT):

Unlike sales tax on the final product, VAT is a tax levied on the value added at each stage of production and distribution. It can get a little technical, but the basic idea is that businesses pay VAT on the difference between the price they buy something for and the price they sell it for.

Example: Imagine a cotton t-shirt goes through stages of manufacturing and then retailing. VAT would be applied at each stage based on the increased value (e.g., cost of raw cotton vs. cost of finished t-shirt).

Customs Duty:

This tax is levied on imported goods. So, whenever you buy something from another country, there might be a customs duty added to the price, making it more expensive.

Example: Let's say you order a phone from overseas. The government might impose a customs duty of 10% on its value. This adds to the overall cost you pay when you receive the phone.

These are just a few examples, and there were other indirect taxes as well. The pre-GST system could be quite complex, with different taxes applied at different stages and varying depending on the product category.

The Rise of GST: A Game Changer

The pre-GST tax zoo, as we saw, could be a confusing maze for businesses and consumers alike. Recognizing this, India introduced a revolutionary reform in 2017: the Goods and Services Tax (GST).

Think of GST as a streamlining superhero for indirect taxes. It replaced a multitude of pre-existing taxes like sales tax, excise duty, VAT, and others with a single, unified tax system. This simplified the process significantly, making it easier for businesses to comply and navigate the tax landscape.

Here's what makes GST a game-changer:

  • One Nation, One Tax: Instead of juggling various taxes at different levels, GST applies a single tax on the entire supply chain of goods and services. This eliminates the confusion and complexities of the earlier system.

  • Cascading Effect Buster: Before GST, taxes were often layered on top of each other, leading to a cascading effect. Imagine a tax on the raw materials used to make a shirt, then another tax on the manufactured shirt, and finally a sales tax when you buy it. GST eliminates this by taxing only the value added at each stage.

There are different components to GST, but we won't delve too deep into the specifics. Here's a quick mention:

  • CGST (Central GST): This component goes to the central government.

  • SGST (State GST): This component goes to the state government.

  • IGST (Integrated GST): This applies to interstate transactions and is a combination of CGST and SGST.

Overall, GST brought about a much-needed simplification and introduced more transparency into the indirect tax system. How will businesses and consumers be affected? We'll delve into this in the next section.

Impact of GST on Businesses and Consumers: A Win-Win (to an Extent)?

The introduction of GST wasn't just about streamlining government revenue collection. It aimed to benefit both businesses and consumers in significant ways.

For businesses, GST brought much-needed relief from the complexities of the pre-GST era. Here's how:

Reduced Compliance Burden:

Remember all those different indirect taxes businesses had to deal with? GST significantly reduced that burden. Now, businesses have a single tax system to comply with, making things simpler and less time-consuming.

Streamlined Processes:

With GST, filing tax returns and claiming input tax credits (utilizing taxes paid on purchases to reduce tax liability on sales) became a more streamlined process. This can lead to improved cash flow and operational efficiency for businesses.

But what about consumers? While the initial transition to GST might have caused some price fluctuations, the long-term benefits are promising:

Potentially Lower Prices:

By eliminating the cascading effect of pre-GST taxes, GST can potentially lead to lower prices for consumers. Businesses can claim credit for taxes paid on inputs, reducing their overall tax burden and potentially translating to lower final product prices.

More Transparency:

GST promotes a more transparent tax structure. With a single tax system, it's easier for consumers to understand what portion of the price they pay goes towards taxes. This can help build trust and confidence in the marketplace.

Of course, the impact of GST on consumer prices can vary depending on the product category and other factors. However, the potential for a more streamlined and transparent system with potentially lower prices is a positive step forward.

A Look Ahead

The GST journey isn't over. Discussions are on simplifying the tax structure by potentially reducing brackets and expanding the scope of GST to include more items. As the economy evolves, so too will indirect taxes, aiming for a future that's efficient and fair for all.

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