Understanding Cascading Effect
Cascading effect is a situation of taxation over taxes. The tax is imposed on every stage of production and distribution which leads to multiple taxes on the same goods and services. Cascading effects can increase the final price of the goods or services. One of the major concerns regarding taxations is the removal of the “cascading effect” to lower down the taxation burden on individuals and entities.
Example of Cascading Effect
Imagine a textile manufacturer who buys raw cotton for ₹100 per kg and pays a 10% tax, so the cost becomes ₹110 per kg.
Later, the manufacturer processes the cotton into fabric and sells it to a wholesaler for ₹200 per kg, adding another 10% tax, making the total cost ₹220 per kg.
The wholesaler then sells the fabric to a retailer for ₹300 per kg, with a 10% tax added, resulting in a final price of ₹330 per kg.
Each stage compounds the tax on the previous tax, leading to a higher final price for the consumer due to the cascading effect.
Hence the Indian government and the Tax Department of India found out a way to remove the cascading effect on taxation.
How did India Remove Cascading Effect on Taxation?
India followed the lead of several other countries and introduced GST (Goods and services tax) in 2017, in order to remove cascading effects. Before GST, the taxation system of India was complex with multiple layers of tax imposed on every level. With GST, a unified taxation structure is formed to streamline the tax process.
GST is based on the value-added tax (VAT) principle, where tax is levied only on the value added at each stage of the supply chain. Unlike the previous system where taxes were imposed on the total price at each stage (including previous taxes), GST ensures that businesses can claim credit for the tax paid on inputs. This means that the tax is only applied to the additional value added by each business, effectively removing the cascading effect.
- GST also has input credit tax (ITC) which means that businesses are also allowed to claim credit on tax paid on the inputs (goods and services purchases).
- Input Credit Tax Under GST= Outward GST payable – Input tax (GST on purchase).
