Goods and Services Tax (GST): Definition, Types, and How It's Calculated

What Is the Goods and Services Tax (GST)?

The goods and services tax (GST) is a value-added tax (VAT) 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.

Critics point out, however, that the GST may disproportionately burden people whose self-reported income are in the lowest and middle income brackets, making it a regressive tax. These critics argue that GST can therefore exacerbate income inequality and contribute to social and economic disparities. In order to address these concerns, some countries have introduced GST exemptions or reduced GST rates on essential goods and services, such as food and healthcare. Others have implemented GST credits or rebates to help offset the impact of GST on lower-income households.

Goods and services tax should not be confused with the generation-skipping trust, also abbreviated GST (and its related taxation, GSTT).

Understanding 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 inclusive of the 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.

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 Goods and Services Tax Structures

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 8% to 10%. In this case, a consumer's receipt will clearly have the GST and PST rate that was applied to their 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 into a single tax. Since then, several other provinces have followed suit, including New Brunswick, Newfoundland and Labrador, Nova Scotia, and Ontario. 

Critiques of the GST

A GST is generally considered to be a regressive tax, meaning that it takes a relatively larger percentage of income from lower-income households compared to higher-income households. This is because GST is levied uniformly on the consumption of goods and services, rather than on income or wealth.

Lower-income households tend to spend a larger proportion of their income on consumables, such as food and household goods, which are subject to GST. As a result, GST can disproportionately burden lower-income households.

Because of this. some countries with GST are discussing possible adjustments that might make the tax more progressive, which takes a larger percentage from higher-income earners.  

Example: 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 was 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 they pay Rs. 1 in tax for Rs. 9 worth of materials. In the process of manufacturing the notebook, the manufacturer 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, the previous tax paid can be applied against this additional tax to bring the effective tax rate to Rs. 1.50 – Rs. 1.00 = Rs. 0.50.

In turn, 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 the wholesaler 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.

Similarly, 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 the following tax rates: 

• A 0% tax rate applied to certain foods, books, newspapers, homespun cotton cloth, and hotel services.
• A rate of 0.25% applied to cut and semi-polished stones.
• A 5% tax on household necessities such as sugar, spices, tea, and coffee.
• A 12% tax on computers and processed food.
• An 18% tax on hair oil, toothpaste, soap, and industrial intermediaries.
• The final bracket, taxing goods at 28%, applies to luxury products, including refrigerators, ceramic tiles, cigarettes, cars, and motorcycles.

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.

Goods and Services Tax vs. Generation-Skipping Transfer Tax

The goods and services tax (GST) should not be confused with the generation-skipping transfer tax (GSTT Tax), and they are not at all related to one another.

The former is a sort of VAT tax added to the purchase of goods or serves. Meanwhile, the generation skipping transfer tax (GST Tax) is a flat 40% federal tax on the transfer of inheritances from one's estate to a beneficiary who is at least 37½ years younger than the donor. The GST Tax prevents wealthy individuals from avoiding estate taxes through naming younger beneficiaries (e.g., grandchildren).

The Bottom Line

The goods and services tax (GST) is a type of tax levied on most goods and services sold for domestic consumption in many countries. It is paid by consumers and remitted to the government by the businesses selling the goods and services. Some countries have introduced GST exemptions or reduced GST rates on essential goods and services or have implemented GST credits or rebates to help offset the impact of GST on lower-income households. The GST is often a single rate tax applied throughout a country and is preferred by governments because it simplifies the taxation system and reduces tax avoidance. In dual GST systems, such as those in Canada and Brazil, the federal GST is applied in addition to a state sales tax. The GST has been identified by critics as regressive and can potentially place a relatively higher burden on lower-income households.