by Arbind Modi and Ajay Shah
In 2017, the Goods and Services Tax (GST) replaced the fragmented indirect tax structure of excise duties, service tax and state-level value added tax (VAT) with a unified, destination-based value-added tax. GST was conceived in Kelkar 2003, as an Indian adaptation of the global idea of the value added tax, which has the desirable features of having no cascading effects and being neutral to international trade.
Input tax credit is the beating heart of the GST: the tax paid on inputs must be credited against output tax liability. In a new XKDR Forum Working Paper, Input Tax Credit and refunds under GST in India: Conceptual and legal framework, we show that many features of the modern Indian GST interfere with input tax credit. In this, we combine the strategic sense of modern public economics coupled with a detailed reading of the law.
We worry that the Indian GST is a case of isomorphic mimicry: it resembles the external form of a modern VAT in form but lacks its underlying function. While Section 16 of the CGST Act establishes foundation of ITC entitlement, Section 17 narrows the scope through apportionment and blocked credits. Section 17(5) explicitly denies ITC for business inputs such as motor vehicles and works contracts. Furthermore, the refund framework under Rule 89 limits refunds to Net ITC and embedding revenue safeguards at the expense of neutrality. Critically, the law excludes capital goods and services from refund calculations in these cases. This breaks the credit chain.
When credit is denied, the tax on inputs becomes a cost. This creates a cascading tax through the supply chain. The tax system functions as a tax on intermediate production rather than on consumption. By blocking input tax credit for capital goods, the GST acts as an incentive for reduced investment.
This is not how the value added tax works internationally. India stands as an outlier relying on a narrow refund design, heavy compliance preconditions, and extensive exclusion. The current system minimizes administrative risk by denying refunds ex-ante, rather than managing risk through ex-post verification. The recent movements on `GST 2.0' do not deliver an improved GST as they actually worsen the blockage of input tax credit.
These flaws in tax policy have harmful effects for India: (a) Reduced capital deepening and reduced investment that hampers the emergence of high productivity and high wage firms; (b) Unfair competition from imports against domestic producers; (c) Reduced export competitiveness. The paper proposes a reform path focused on three pillars: guaranteeing full flow-based ITC across all inputs, rationalising rates to a single band, and automating refund administration.
The authors are researchers at XKDR Forum.
