An

Introduction
to
VAT & GST

Transactions with/without VAT

Transaction without VAT

Transaction with VAT

Details

Purchases

110

100

Value Added

100

40

100

40

Sub-total

100

150

100

140

Add tax 10%

10

15

10

14

Total

110

165

110

154

Value Added
Receipts
(Rs.)
Income from sale of output
10,000
(= gross value of output)

Expenditure
(Rs.)
Cost of bought out inputs
4,000
Wages and salaries
2,000
Rent
1,500
Interest
500
Depreciation
1,000
Surplus (Profits)
1,000

value added = Gross value of output - Cost of bought out inputs = Rs.10,000 Rs.4,000 = Rs.6,
10,000

10,000

alue added = Wages and salaries + Rent + Interest + Depreciation + Profits

ue added will exclude depreciation

Computation of VAT
VAT can be computed in one of two ways :
The Subtraction Method : The tax rate is applied to the difference between the value of
output and the cost of inputs.
The Addition Method : The value added is computed by adding all the payments to the
factors of production , namely, wages, rent, interest and profits .
According to the Subtraction Method :

VAT = t ( O I )

Where, t is the tax rate , O is the value of output and I is the value of inputs.
t ( O I ) may be rewritten as (tO tI )
So, VAT can be collected as the difference between the tax payable on output and the
tax paid on inputs.
This method is known as Input Tax Credit (ITC) method.

Computing VAT by two methods with a uniform tax rate of

10%

Raw materials
supplier

Manufacturer

Wholesaler

Retailer

Total economy

100

350

850

Value added

100

250

500

250

1100

Sales

100

350

850

1100

100

350

850

1100

2400

ii.Taxes
collected
iii.Purchases

10

35

85

110

240

100

350

850

1300

iv.Taxes paid

10

35

85

130

10

25

50

25

110

350 + 35=385

850 + 85=935

1100+110=1210

100

350

850

1100

100

350

850

100 x 0.1=10

250 x 0.1 =25

500 x 0.1 =50

250 x 0.1 = 25

110

Purchases

Input tax credit method

i. Sales

VAT (ii-iv)

Price of the
100+10 =110
good
Subtraction method
i.Sales
ii.Purchases
iii.Calculation
of tax due

Wholesaling stage is subject to 15% tax, and rest

is 10%

Raw
materials
supplier

Manufacturer

Wholesaler

Retailer

Total
economy

Effective
tax rate

100

350

850

Value added

100

250

500

250

1100

Sales

100

350

850

1100

Purchases

Input tax credit method

i. Sales

100

350

850

1100

2400

ii.Taxes
collected
iii.Purchases

10

35

127.5

110

282.5

100

350

850

1300

iv.Taxes paid

10

35

127.5

172.5

10

25

92.5

-17.5

110

10%

VAT (ii-iv)
Subtraction method
i.Sales
ii.Purchases
iii.Calculation
of tax due

100

350

850

1100

100

350

850

100 x 0.1=10

250 x 0.1 =25

500 x 0.15 =75

250 x 0.1 = 25

135

12.3%

Retailer is zero - rated

Raw materials
supplier

Manufacturer

Wholesaler

Retailer

100

350

850

Value added

100

250

500

250

Sales

100

350

850

1100

i. Sales

100

350

850

1100

10

35

85

iii.Purchases

100

350

850

iv.Taxes paid

10

35

85

10

25

50

-85

100+10 =110

350 + 35=385

850 + 85=935

1100 + 0 =1100

Purchases

ii.Taxes collected

VAT (ii-iv)
Price of the good

Retailer is exempt

Raw materials
supplier

Manufacturer

Wholesaler

Retailer

100

350

850

Value added

100

250

500

250

Sales

100

350

850

1100

i. Sales

100

350

850

1100

10

35

85

N.A.

iii.Purchases

100

350

850

iv.Taxes paid

10

35

85

10

25

50

85

100+10 =110

350 + 35=385

850 + 85=935

1100 + 85 =1185

Purchases

ii.Taxes collected

VAT (ii-iv)
Price of the good

Choosing a Base for VAT

Gross Product = Gross Value of Output All Current Inputs
Capital goods purchased by the dealer would not be treated as inputs.
Input tax credit will not be available on taxes paid on capital goods.

Net Income = Gross Value of Output All Current Inputs Depreciation

The credit for tax on capital goods will be spread over the life of the capital goods.

Consumption = Gross Value of Output All Current Inputs Gross Capital Formation
Full input tax credit is given for taxes paid on capital goods as well in the year of
purchase

Comparison of VAT on alternative bases

(computation of VAT at 10%)

Value of output

Consumption type

Income type

Gross product type

200

20

20

20

Output

150

15

15

15

Inputs

100

-10

-10

-10

Output

300

30

30

30

Inputs

100

-10

-10

-10

Capital

150

-15

-1.5

Tax paid

18.5

20

Tax collection

30

43.5

45

Intermediate inputs
Output
Capital goods

Tax paid
Consumption goods

Three producers producing consumption goods, intermediate inputs and capital goods. Both consumption goods
and capital goods require
intermediate goods for production. Capital goods are used for producing consumption goods. It is assumed that

Goods and Services Tax

(GST)

GST : An Example
A plastic manufacturing company has consumed the following goods
and services
Description

Amount
(Rs.in Lakhs)

Rate of
Tax (%)

Tax Paid
(Rs.in Lakhs)

Raw
materials

50

12

Stores &
spares

10

12

1.2

Services

15

12

1.8

Total Input
Tax
Selling price of the product is Rs.100 lakhs

GST : An Example
Output tax :
Descripti
on
Sale

Amount (Rs. in
Lakhs)

Rate of
Tax (%)

100

Tax Collected(Rs.in
Lakhs)

12

12

Total Output
Tax
Net tax payable by manufacturer :
Description

Amount (Rs. in
Lakhs)

Total Output
Tax

12

Total Input
Tax

Net GST
Payable

12

GST : An Example
Goods are sold to a trader who uses services amounting to Rs. 5 lakhs.
Descripti
on
Goods
sold
Services

Amount (Rs.
in Lakhs)

Rate of
Tax (%)

Tax Paid (Rs.in

Lakhs)

100

12

12

12

0.60

Total Input

12.60

Tax

Traders profit margin is Rs.10 lakhs. So, output tax for trader is :
Description

Amount (Rs. in
Lakhs)

Goods sold

115

Add : Tax @
12%

13.80
128.80

GST : An Example
Net tax payable by the trader is :

Description

Amount (Rs. in Lakhs)

Total Output Tax

13.80

Total Input Tax

12.60

Net GST Payable

1.20

GST : An Example
Tax collected by the government :
Description
From the sellers of raw materials

Amount (Rs. in
Lakhs)
6

From the suppliers of stores & spares

1.20

From the service providers of the

services consumed by the manufacturer

1.80

From the manufacturer

3.00

From the service providers of the

services consumed by the dealer

0.60

From the dealer

1.20

Total GST received

Rs.115 lakh @ 12% = Rs.13.80

13.80

Public Debt

Revenue Deficit = Revenue Exp.

(Plan+ Non - Plan)

Revenue Receipts
(Tax+Non -Tax)

Fiscal Deficit = Total Expenditure ( Revenue Receipts

(Rev.+ Cap. Exp.)

+Recovery of Loans
+Receipts from PSU

Disinvestment)

Primary Deficit = Fiscal Deficit Interest Payments

Primary deficit represents the extent of borrowing used by the government in the current
year.

The Burden of the Debt

Lerners view
- An internal debt creates no burden for the future generation. Members of
the future
generation simply owe it to each Other. When debt is paid off , there is a
transfer of income from one group of citizens (those who do not hold bonds)
to another (bondholders)- right hand owes to the left. The future
generation as a whole is not worse off in the sense that its consumption level
is the same as it would have been.
- In the case of external debt ( i.e. when a country borrows from abroad to
finance current consumption ) the future generation certainly bears a burden ,
because its consumption level is reduced by an amount equal to the loan plus
the accrued interest that must be sent to foreign lenders.

An Overlapping Generations Model

Young
12,000
-6,000
4,000

wing
ded consumption

s taxes to pay back

back the debt

The Period 2015-2035

Middle-Aged
12,000
-6,000
4,000
The Year 2035

Young
- 4,000

Middle-Aged
- 4,000
+ 6,000

Old
- 4,000
+ 6,000

Internal debt creates a burden for the future generation

12,0
4,000

Neoclassical Model

government initiates a project, whether financed by taxes or borrowing , resources are removed
ctor.

finance is used , most of the resources removed come at the expense of consumption.

government borrows, it competes for funds with individuals and firms who want the money for
nt projects.

has most of its effect on private investment debt finance leaves the future generation with a s
ock.

mposes a burden on future generations through its impact on capital formation.

ent that the public sector undertakes productive investment with the resources it extracts from t
e total capital stock increases.

Ricardian Model

vernment borrows, members of the old generation realize that their heirs wil
orse off.

ple care about the welfare of their descendants and therefore, do not want their
ants consumption level reduced.

ple increase their bequests by an amount sufficient to pay the extra taxes that w
ture.

pping generation model, the old generation in 2015 saves Rs.4,000 to transfer t
2035 so that the consumption of each generation is unchanged.

Review

Incidence of specific and ad valorem taxes

Elasticity of demand and supply

Taxes on factors Payroll tax, taxation of capital, profit tax and land/property tax
Taxation under monopoly & oligopoly
General equilibrium models
Excess burden of taxation commodity tax, lump-sum tax & income tax
Measurement of excess burden
Optimal commodity taxation Ramsey rule
Inverse elasticity rule
Introduction to VAT & GST
Deficit and Public Debt

Syllabus

Text book : Public Finance by H.S.Rosen & T. Gayer , eighth edition

Ch. 14, Ch. 15 ( pp.331- 340 ), Ch. 16 (pp.353 359 ), Ch. 20 (pp.462- 472)
Notes on VAT
Class discussion