Indirect tax

Topic: Taxation: Direct and Indirect Taxes, GST and Global Tax Issues · NCERT: Class 11, Ch 3 "Liberalisation, Privatisation and Globalisation: An Appraisal"; Class 12, Ch 2 "National Income Accounting"; Class 12, Ch 5 "Government Budget and the Economy"

Meaning

An indirect tax is a tax on goods and services. The law makes one person pay it, usually the seller, but that person can pass the burden to someone else, usually the final buyer, through a higher price. NCERT (Class 11) defines indirect taxes as "taxes levied on goods and services".

• Why it matters: indirect taxes such as GST, customs duty and excise duty bring in a large share of India's tax money.
• The problem: they are generally regressive. A poor household pays a larger share of its income in these taxes than a rich household does.

Explanation

How the burden moves: impact, incidence, shifting

• Impact falls on the person the law makes pay the tax.
• Incidence falls on the person who finally bears the money burden.
• Shifting means passing the burden to someone else, usually through higher prices.
• In an indirect tax, impact and incidence fall on different people:
• A shop pays GST to the government, so the impact is on the shop.
• The shop adds GST to the bill, so the buyer pays more.

• The incidence therefore falls on the final consumer.

• In a direct tax, impact and incidence fall on the same person, so it cannot be shifted.

Types of indirect tax

• By what is taxed:
• GST (Goods and Services Tax): a tax on the supply of goods and services, introduced in 2017.
• Customs duty: a tax on goods coming into or going out of India.
• Excise duty: a tax on goods made inside India, e.g. petrol.

• Social Welfare Surcharge: an extra tax calculated on customs duty. A surcharge is a tax charged on the tax itself.

• By how the tax is worked out:

• Ad valorem tax is a percentage of the price.
  • 18% GST on a ₹100 item = ₹18. If the price rises to ₹200, the tax rises to ₹36.
  • Revenue rises on its own when prices rise, so the tax is inflation-proof.
• Specific tax is a fixed amount per unit, whatever the price.
  • Examples: per-litre excise on petrol, the old ₹400/tonne coal cess, and the per-machine levy on pan-masala units.
  • ₹10 per litre stays ₹10 whether petrol costs ₹90 or ₹110.
  • It is easy to calculate and hard to dodge by showing a lower value. But revenue does not rise with prices.

Why indirect taxes are regressive

• A regressive tax takes a larger share of income from the poor than from the rich.
• The reason:
• The same tax rate applies to what everyone buys.
• Poor households spend almost all their income. Rich households save part of it.

• So the tax takes a bigger part of a poor household's income.

• Worked example with 10% GST:

Household	Income (₹)	Consumption (₹)	GST paid (₹)	GST as % of income
Poor	10,000	10,000	1,000	10%
Rich	1,00,000	60,000	6,000	6%

• The rich household pays more rupees but a smaller share of its income. That is what makes the tax regressive.
• NCERT error: Class 12, Government Budget and the Economy says indirect taxes are regressive because "they impact all income groups equally". This is not the real reason. The real reason is the unequal share of income shown in the table.

Indirect taxes in national income accounts

• Most indirect taxes are product taxes, paid per unit of output. Examples: GST, excise, service tax, and import and export duties.
• Production taxes are paid whatever the volume of output. Examples: land revenue, and stamp and registration fees.
• Net taxes = taxes − subsidies.
• How we get from basic prices to market prices:
• GVA at basic prices + net product taxes = GDP at market prices.
• GVA (gross value added) is the value of output minus the value of inputs used up.

• Product taxes are why market prices are higher than basic prices.

• NCERT data, 2024-25 (constant prices): GVA at basic prices ₹1,71,87,446 crore + net taxes ₹16,09,509 crore = GDP ₹1,87,96,955 crore.

• The NCERT table labels this row "net production taxes". Under the formula above, this step should add net product taxes.

In India

• Legal basis: Article 265 says "No tax shall be levied or collected except by authority of law." [2]
• Every indirect tax, whether GST, customs or excise, needs a law passed by Parliament or a State Legislature.

• An executive order alone cannot impose it. [2]

• Main indirect taxes today: GST (since 2017), customs duty, excise duty on items such as petrol, and the Social Welfare Surcharge on customs.

• Union Budget 2025-26 (Budget Estimates):
• Total indirect taxes: ₹17,35,100 crore. [3]
• GST: ₹11,78,000 crore. [3]
  • CGST (the Centre's share of GST): ₹10,10,890 crore, which is 86%. [3]
  • GST compensation cess: ₹1,67,110 crore, which is 14%. [3]

• Gross tax revenue is budgeted to grow 10.8%. [3]

• Canons of taxation: these are the rules a good tax should follow. Indirect taxes do well on some and badly on one.

• Convenience: GST is paid along with the purchase price.
• Economy: a few sellers collect the tax from many buyers, so collection costs little.
• Equity: they do badly here, because they are regressive.

Don't confuse with

• Direct tax: impact and incidence fall on the same person, and it can be made progressive. Examples: income tax, corporation tax, capital gains tax, MAT and STT. STT is charged on each share trade, but it is still a direct tax.
• Production taxes: land revenue and stamp and registration fees are paid whatever the output. GST and excise are product taxes, paid per unit.
• Fee / user charge: a passport fee or court fee buys a specific service. It is non-tax revenue, not an indirect tax.
• Specific vs ad valorem: the ₹400/tonne coal cess is specific (a fixed amount per unit). 18% GST is ad valorem (a percentage of the price).

Prelims Hooks

• Indirect tax: the burden can be shifted through prices. Impact is on the seller, incidence is on the final buyer.
• Indirect taxes: GST, customs duty, excise duty and the Social Welfare Surcharge. Trap: STT and MAT are direct taxes.
• NCERT (Class 11) calls indirect taxes "taxes levied on goods and services". Direct taxes are "taxes on incomes of individuals, as well as, profits of business enterprises".
• Product taxes (GST, excise, import and export duties) are the bridge between prices: GVA at basic prices + net product taxes = GDP at market prices.
• BE 2025-26: total indirect taxes ₹17,35,100 crore. GST ₹11,78,000 crore, of which CGST is 86% and compensation cess is 14%. [3]
• Article 265: no tax, direct or indirect, can be levied or collected except by authority of law. [2]

Mains Points

• Equity vs efficiency:
• Indirect taxes are cheap and easy to collect. GST alone is budgeted at ₹11,78,000 crore in BE 2025-26. [3]
• But they take a larger share of poor households' incomes (10% against 6% in the example above).

• Moving the tax mix towards progressive direct taxes serves the canons of equity and elasticity (revenue rising on its own as incomes rise).

• Designing indirect taxes to hurt the poor less:

• Choosing between ad valorem and specific duties decides whether revenue keeps pace with inflation.

• Taxing basic items less and luxury items more can soften the regressive effect.

• Rule of law and certainty:

• Article 265 requires a law behind every levy. [2]
• Stable, predictable rates of GST, customs and excise support the canon of certainty (clear amount, time and manner of payment).
• Frequent or backdated changes in rates hurt business planning and investor confidence.

Related concepts

• Taxes
• Direct tax
• Ad valorem and specific tax
• Progressive taxation
• Proportional tax
• Regressive tax

Read more

• Taxes: meaning, canons and classification