Taxation · GST in India - An Introduction

Indirect Taxes Before GST and Need for GST

Updated 4 October 2026 · Fact-checked

Before GST, the Centre and States levied many separate indirect taxes on goods and services. Tax was charged on tax, credit chains broke, and rates and rules differed across States. GST replaced most of these with one destination-based tax on supply, with input tax credit across the chain. Answer by listing problems, then the fix.

Understand Indirect Taxes Before GST and Need for GST

A direct tax is paid by the person on whom it is levied, and the burden cannot be shifted. Income-tax is the example. An indirect tax is charged on goods or services. The seller collects it from the buyer and pays it to the government. The burden moves along the supply chain to the final consumer. GST is an indirect tax.

Before GST, the Constitution split the power to tax. The Centre could tax manufacture of goods (central excise) and, under its residuary power, services (service tax, which was levied under the Finance Act, 1994). It also levied customs duty and the central sales tax (CST) on inter-State sales. CST was levied by the Centre but collected and retained by the originating State. States taxed the sale of goods (VAT or sales tax), entry of goods into a local area (entry tax or octroi), luxury, entertainment and similar items. Each levy had its own law, rates, forms and officers.

The main problem was the cascading effect, or tax on tax. When a tax is paid on inputs and no credit is allowed against the next tax, the next tax is charged on a value that already includes the earlier tax. Credit was only partly available. Excise credit could not be set off against VAT. VAT credit could not be set off against service tax. CST on inter-State sales was not creditable. Entry tax and octroi were costs with no credit. So the final price carried hidden tax.

Other problems followed. Rates and procedures varied from State to State. Check posts and paperwork slowed trucks at borders. Dividing a transaction between goods and services caused disputes about which tax applied. Compliance was heavy, with many registrations and returns. Exporters carried some embedded taxes in their costs, which hurt competitiveness.

GST fixes this. It is a single, comprehensive, destination-based tax on supply of goods or services, charged at each stage with input tax credit for tax paid on inputs. Only value added is effectively taxed. The tax goes to the State where goods or services are consumed. The Constitution (One Hundred and First Amendment) Act, 2016 gave the Centre and States concurrent power to levy it. GST has been in force since 1 July 2017.

Key rules to remember

Tax payable with input credit: Output tax − Input tax credit = Net tax payable; Tax is effectively on value added at each stage, so there is no tax on tax.
Cascading (no credit) tax at a stage: Tax = Rate × (Cost of inputs including earlier tax + Value added); Earlier tax is inside the base, so the base is inflated.
Value added: Value added = Selling price (excl. tax) − Purchase cost of inputs (excl. tax); GST with full credit equals Rate × Value added.
Direct vs indirect tax: Direct: burden on the person taxed. Indirect: burden shifted to the consumer.; Income-tax is direct. GST, customs duty and the pre-GST excise and VAT are indirect.
Main pre-GST levies subsumed in GST: Central excise duty, service tax, additional customs duty (CVD) and special additional duty (SAD), VAT/sales tax, entry tax, octroi, luxury tax, entertainment tax levied by States (not that levied by local bodies), purchase tax, cesses and surcharges on supply; Basic customs duty, stamp duty, electricity duty and the sale of electricity are outside GST. Alcohol for human consumption is outside GST. Five petroleum products (crude petroleum, high speed diesel, petrol, natural gas and aviation turbine fuel) are outside GST until the Council recommends a date.

How to solve Indirect Taxes Before GST and Need for GST questions

Use this method for any question on the pre-GST structure, the need for GST, or cascading.

1Read the verb. 'Explain', 'discuss' or 'list' needs the structure and problems. 'Compute' needs numbers.
2State the pre-GST position first: who taxed what, under which levy (Centre: excise, service tax, CST; States: VAT, entry tax, luxury tax).
3Name the problem the question tests: cascading, no credit across goods and services, multiple taxes, State differences, or compliance burden.
4For a numerical, build a stage-wise table: purchase cost, value added, tax base, tax, total price. Do it once without credit and once with credit.
5With credit, tax at each stage = Rate × value added. Check that the total equals Rate × final price.
6Link to GST: single tax, input tax credit, destination-based, concurrent power under the 101st Amendment.
7Close with a one-line conclusion, for example 'GST removes tax on tax and creates one common market'.

Quickest way: Problem → Fix pairing, and a three-line cascading check

When to use it: Use for theory questions and for MCQs on cascading or subsumed taxes when time is short.

For theory, write each problem with its GST fix in pairs: cascading → input tax credit; many taxes → single tax; State barriers → common market; goods/services split → single supply concept.
For MCQs on subsumed taxes, ask: is it a tax on sale, manufacture, service or entry of goods? If yes, it is probably subsumed. Basic customs duty, stamp duty, electricity duty, alcohol for human consumption and the five petroleum products stay out.
For a cascading numerical, do the first stage tax, add it to cost, and tax the new base. Do not compute the final price directly.
For a credit numerical, tax only the value added at each stage and add the stage taxes.
Write answers in short points with headings you can underline. Show the table, because step marks are given for working.

Common mistakes in Indirect Taxes Before GST and Need for GST

Saying GST subsumed all indirect taxes.
Students remember 'one nation, one tax' too literally.
Fix: Remember that basic customs duty, stamp duty, electricity duty and alcohol for human consumption remain outside GST. Five petroleum products (crude petroleum, high speed diesel, petrol, natural gas and aviation turbine fuel) are also outside GST until the Council recommends a date.
Calling cascading effect 'double taxation of income'.
It is confused with income-tax concepts.
Fix: Define it as tax charged on a value that already includes an earlier tax because no credit is allowed.
Taxing the full selling price at every stage in a credit-based example.
Students forget that input tax is deducted.
Fix: Net tax = output tax − input tax. This equals the rate times the value added.
Saying GST is levied on the place of production.
Excise was tied to manufacture, so students carry the idea over.
Fix: GST is destination-based and levied on supply. The tax accrues to the State of consumption.
Mixing up direct and indirect tax by the name of the payer.
In indirect tax the seller deposits the tax, so students call it direct.
Fix: Ask who bears the burden. If it can be shifted to the consumer, it is indirect.

Worked examples

Example 1

A manufacturer buys raw material for ₹1,00,000 and adds value of ₹50,000, selling at ₹1,50,000 before tax. A wholesaler adds ₹20,000 value and sells to a retailer. The retailer adds ₹30,000 value and sells to the consumer. A tax of 10% is levied at each stage, with no credit for tax on inputs. Assume the raw material price of ₹1,00,000 is before any tax. Find total tax and the final price.

Show the solution

Stage 1, manufacturer: base = ₹1,50,000. Tax = 10% × 1,50,000 = ₹15,000. Price = ₹1,65,000.
Stage 2, wholesaler: cost including tax = ₹1,65,000. Add value ₹20,000. Base = ₹1,85,000. Tax = ₹18,500. Price = ₹2,03,500.
Stage 3, retailer: cost including tax = ₹2,03,500. Add value ₹30,000. Base = ₹2,33,500. Tax = ₹23,350. Price = ₹2,56,850.
Total tax at three stages = 15,000 + 18,500 + 23,350 = ₹56,850.
Check: final price 2,56,850 − pre-tax price (1,00,000 + 50,000 + 20,000 + 30,000 = 2,00,000) = ₹56,850.

Answer: Total tax is ₹56,850 and the final price is ₹2,56,850. The tax is 28.4% of the pre-tax price of ₹2,00,000, although the rate is 10%, because of cascading.

Example 2

Use the same facts as the previous question, but now input tax credit is allowed at every stage. Find the tax paid at each stage, the total tax and the final price.

Show the solution

Stage 1: output tax = 10% × ₹1,50,000 = ₹15,000. Input tax on raw material is taken as nil, as the ₹1,00,000 price was before tax in the facts. Net tax = ₹15,000.
Stage 2: wholesaler's sale price before tax = 1,50,000 + 20,000 = ₹1,70,000. Output tax = ₹17,000. Input credit = ₹15,000. Net tax = ₹2,000.
Stage 3: retailer's sale price before tax = 1,70,000 + 30,000 = ₹2,00,000. Output tax = ₹20,000. Input credit = ₹17,000. Net tax = ₹3,000.
Total tax = 15,000 + 2,000 + 3,000 = ₹20,000.
Check: 10% of ₹2,00,000 = ₹20,000. Final price = ₹2,20,000.

Answer: Total tax is ₹20,000 and the final price is ₹2,20,000. With credit, the tax equals 10% of the final pre-tax price. The saving over the no-credit case is ₹56,850 − ₹20,000 = ₹36,850.

Exam tips

Theory questions on 'need for GST' reward a pairing of problem and remedy. Write 5 to 6 points, each with its fix.
Memorise the subsumed taxes in three groups: Central (excise, service tax, additional customs duties, cesses and surcharges), State (VAT, entry tax, luxury tax, purchase tax, entertainment tax levied by States) and local (octroi). Entertainment tax levied by local bodies stays outside GST.
MCQs often ask what is not subsumed. Remember basic customs duty, stamp duty, alcohol for human consumption, electricity duty and the sale of electricity, and the five petroleum products (crude petroleum, high speed diesel, petrol, natural gas and aviation turbine fuel) until the Council recommends a date.
Always draw the stage-wise table in cascading numericals. Marks are given for the working even if the arithmetic slips.
Write the year and amendment: 101st Constitution Amendment Act, 2016, and GST effective 1 July 2017.

Practice questions from GST in India - An Introduction

Indirect Taxes Before GST and Need for GST in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

CS ExecutiveIntroduction to GST and Indirect Tax Background

Indirect Taxes Before GST and Need for GST: frequently asked questions

What is the cascading effect of taxes before GST?

It means tax is charged on a value that already includes an earlier tax. This happened because credit of excise, service tax, VAT, CST and entry tax could not be fully set off against one another. The final price therefore carried hidden tax.

Which indirect taxes were subsumed in GST?

Main ones are central excise duty, service tax, additional customs duties (CVD and SAD), VAT or sales tax, entry tax, octroi, luxury tax, entertainment tax levied by States and purchase tax, along with related cesses and surcharges. Basic customs duty and stamp duty were not subsumed.

What is the difference between direct and indirect tax in India?

A direct tax, such as income-tax, is borne by the person on whom it is levied. An indirect tax, such as GST or customs duty, is collected by the seller and its burden passes to the consumer. The test is whether the burden can be shifted.

Why is GST called a destination-based tax?

GST is levied where goods or services are consumed, not where they are produced. Revenue goes to the consuming State. This is different from the old excise duty, which was linked to manufacture.