Q.Explain the cascading effect of tax with a simple example. How does GST remove this problem?

The cascading effect means tax gets charged again on a value that already includes an earlier tax, so the burden compounds through the supply chain instead of applying only to real value added.

What cascading means. The cascading effect of tax occurs when a tax is levied on a price that already includes a tax charged at an earlier stage of production or sale, so the final tax burden is higher than the sum of the genuine tax rates would suggest — tax has, in effect, been charged on tax.

A simple example. Suppose a manufacturer produces goods costing ₹1,000 and pays excise duty of 10%, so the goods leave the factory priced at ₹1,100. Under the older system, when a wholesaler purchased these goods and VAT of, say, 10% was applied, VAT under many state laws was computed on the full ₹1,100 (which already included the ₹100 excise duty), giving VAT of ₹110. The wholesaler's cost is now ₹1,210, of which ₹110 of that VAT was partly calculated on the excise duty itself, not purely on the goods' value — this ₹10 extra (10% of the ₹100 excise) is the cascading component. As the goods pass through further stages (say, a retailer buying from the wholesaler), the same problem can repeat, each time inflating the base on which the next tax is calculated.

Why this matters. Cascading raises the final price to the consumer beyond what the combined nominal tax rates would suggest, distorts business choices (for instance, encouraging in-state purchases purely to avoid a non-creditable inter-state tax), and makes the true effective tax rate on a good hard to determine, since it depends on how many stages the goods passed through.

How GST fixes it. GST solves this by granting Input Tax Credit at every stage: a business does not treat the GST paid on its purchases as a cost baked into the next selling price — instead it is a recoverable credit set off against the GST collected on sales, and only the shortfall is paid to the government. Because every link in the chain gets credit for the tax the previous link already paid, no stage ever calculates its tax on a value that includes an earlier, uncredited tax. This is exactly why GST is described as a value-added tax: cascading is removed by design, not merely reduced.