The introduction of CENVAT removed to a great extent cascading burden by expanding the coverage of credit for all inputs, including capital goods. CENVAT scheme later also allowed a credit of services and the basket of inputs, capital goods, and input services could be used for payment of both central excise duty and service tax. Similarly, the introduction of VAT in the States has removed the cascading effect by giving a set-off for tax paid on inputs as well as tax paid on previous purchases and has again been an improvement over the previous sales tax regime.
But both the CENVAT and the State VAT have certain incompleteness. The incompleteness in CENVAT is that it has yet not been extended to include a chain of value addition in the distributive trade below the stage of production. Similarly, in the State-level VAT, the CENVAT load on the goods has not yet been removed and the cascading effect of that part of the tax burden has remained unrelieved. Moreover, there are several taxes in the States, such as Luxury Tax, Entertainment Tax, etc. which have still not been subsumed in the VAT. Further, there has also not been any integration of VAT on goods with a tax on services at the State level with the removal of cascading effect of service tax.
CST was another source of distortion in terms of its cascading nature. It was also against one of the basic principles of consumption taxes that tax should accrue to the jurisdiction where consumption takes place. Despite remarkable harmonization in VAT regimes under the auspices of the EC, the national market was fragmented with too many obstacles to the free movement of goods necessitated by the procedural requirements under VAT and CST.
In the constitutional scheme, taxation powers on goods were with Central Government but it was limited up to the stage of manufacture and production while States have powers to tax the sale and purchase of goods. The Centre had powers to tax services and States also had powers to tax certain services specified in clause (29A) of Article 366 of the Constitution. This sort of division of taxing powers created a grey zone that led to legal disputes. Determination of what constitutes a good or service is difficult because, in the modern complex system of production, a product is normally a mixture of goods and services.
As can be seen from the previous paragraphs, India moved towards value-added taxation both at the Central and State levels, and this process was complete by 2005. Integration of Central VAT and State VAT, therefore, is nothing but an inevitable consequence of the reform process. The Constitution of India envisages a federal nature of power bestowed upon both Union and States in the Constitution itself. As a natural corollary of this, any unification of the taxation system required a dual GST, levied and collected both by the Union and the States.
