Is India's GST a real VAT — or “VAT in form, not in function”?

India’s GST has the shape of a modern value-added tax: tax at every stage, with credit for the tax paid on inputs, so the burden is meant to land only on final consumption (see “How does GST work?”). The economists Arbind Modi, Vijay Kelkar, and Ajay Shah argue that the actual implementation is the trouble: that India built the outward form of a clean VAT without its working parts, leaving “a VAT in form, not in function.” The charge is about the functioning of the input tax credit, the very heart of the VAT.

A tax levied at every stage but reclaimed on every input never accumulates inside production. It passes down the chain and its burden falls, as intended, on the final consumer, leaving a firm’s own choices, what to make, what to buy, whether to export, undistorted. When the credit flows, GST is a tax on consumption. When it is blocked or delayed, the unrecovered tax becomes a cost trapped in the business, and a consumption tax turns into a tax on production: the cascade GST was built to end.

India’s current GST breaks that flow in several places. Normally a firm uses its credit by setting it against the tax due on its own sales; only when the credit runs bigger than that bill must it ask the government to refund the difference in cash. GST pays such refunds in only two situations: exports, and the “inverted duty” case, where a firm’s inputs are taxed more heavily than the good it sells. Anywhere else, credit a firm cannot use simply stays stuck. Even in those two cases the refund is document-heavy, slow, and unpredictable, with money locked up for months.

The inverted-duty problem is large and concrete. In textiles, one of India’s biggest employers, inputs are taxed at 12 to 18% but the cloth at 5%; fertiliser makers pay 18% on ammonia to sell a product taxed at 5%. By one industry estimate, ₹2 to 3 lakh crore of working capital sat trapped this way before the 2025 reforms tried to release it (Business Today). Meanwhile big inputs such as fuel and electricity sit outside GST altogether, so the tax on them cannot be credited at all and sticks inside prices (see “Why are petrol, power and property still outside GST?”). And a buyer’s credit is capped to what his suppliers actually upload to the system, so an honest firm can lose credit because someone upstream filed late, a burden that falls hardest on the smallest firms (see “Does GST help small businesses, or crush them with compliance?”).

That last point deserves some pause. A large firm can wait out a delayed refund or borrow against it; a small one on thin margins cannot. So blocked credit makes India’s GST regressive in an unusual way: the smaller the business, the higher its real rate of tax. The same mechanics weigh most on services and on investment in machinery, exactly the activities India most needs to grow.

The remedy the critics propose is not to abandon GST but to finish it. Kelkar and Shah argue that one well-designed reform would do most of the work: a single-rate GST on a broad base, credit that is full and near-automatic, and refunds paid fast and by default rather than as a favour. There has been movement: from November 2025, exporters and inverted-duty firms can claim 90% of a refund up front within a week. Whether that becomes the rule or stays the exception is the test of whether GST has delivered on its promise (see “Has GST delivered on its promise?”).