CDS Economics · Money, Banking and Public Finance
Taxes, GST and the Finance Commission
The principles of a good tax and who really pays it, how GST works and what it leaves out, and how the Finance Commission shares the Union's taxes with the States.
Why this matters
Thirteen CDS questions, six of them HARD. GST came up in five different papers from 2021 (II) to 2026 (II), and the Fourteenth Finance Commission's weights in 2017 (II) and 2018 (II), so these two topics carry most of the page.
Concept 1 of 4: Canons of taxation and the Union's tax mix
Adam Smith asked what makes a tax fair and workable. His answer was four rules: people should pay by their ability, know what they owe, pay at a convenient time, and the tax should cost little to collect. Later writers added more rules, such as raising enough money for the state.
Definition
The canons:
- Adam Smith's four canons (Wealth of Nations, 1776): equality, certainty, convenience and economy.
- Later writers added productivity, elasticity, fiscal adequacy, simplicity and diversity.
- Direct tax: paid by the person it is levied on (income tax, corporation tax). Indirect tax: can be passed on to buyers (GST, customs, excise).
- The Union's biggest taxes change places. In the 2019-20 Budget Estimates the order was corporation tax, then GST, then personal income tax, then Union excise. In most years since 2020-21 personal income tax has been larger than corporation tax, and in the 2025-26 Budget Estimates it was the largest.
| Canon | Meaning |
|---|---|
| Equality | Tax in proportion to ability to pay |
| Certainty | The amount, time and manner of payment are clear |
| Convenience | Collected at a time and in a way convenient to the taxpayer |
| Economy | Cost of collection is small |
| Fiscal adequacy (later writers) | Tax raises enough revenue for the state |
Practice this concept4 quick reps
The same idea in a real exam question:
CDS · 2019 · CDS (I) 2019 — General Knowledge · Q41Moderate
Example 1 · Money, Banking and Public Finance · Taxes, GST and Finance Commission
Which one of the following canons of taxation was not advocated by Adam Smith?
Fiscal adequacy is not one of Adam Smith's four
Smith's canons are equality, certainty, convenience and economy. Productivity, elasticity and fiscal adequacy were added by later writers.
The order of tax receipts depends on the year
Corporation tax led in 2019-20; personal income tax led in the 2025-26 Budget Estimates. Read which Budget the question names before ranking the taxes.
Concept 2 of 4: Who bears a tax: incidence
A tax is collected from one person but may be paid, in the end, by another. A seller taxed ₹10 a packet will try to raise the price. If buyers must have the good whatever its price, the seller can pass on almost all of it. If buyers walk away at the first rise, the seller has to absorb it. The side that cannot escape pays.
Definition
The rules:
- Impact: who the tax is legally collected from. Incidence: who finally bears it.
- The burden falls more on the less elastic side of the market.
- Demand more inelastic than supply: the tax is shifted forward to consumers through a higher price.
- Supply more inelastic than demand: the tax is shifted backward to producers through a lower price received.
- Equal elasticities: the burden is shared equally.
Share of a tax borne by buyers
- price elasticity of supply
- price elasticity of demand (without its minus sign)
Worked example
A tax of ₹10 is put on each unit of a good. The elasticity of supply is 2 and the elasticity of demand is 0.5. How much of the tax do buyers bear?
Practice this conceptself-check · 3 quick reps
The same idea in a real exam question:
CDS · 2018 · CDS (I) 2018 — General Knowledge · Q119Moderate
Example 2 · Money, Banking and Public Finance · Taxes, GST and Finance Commission
Consider the following statements about impact of tax :
1. A tax is shifted forward to consumers if the demand is inelastic relative to supply.
2. A tax is shifted backward to producers if the supply is relatively more inelastic than demand.
Which of the statements given above is/are correct?
The less elastic side pays
Students often think the side with more market power pays less. The rule is about elasticity: whichever side responds less to price bears more of the tax.
Concept 3 of 4: Goods and Services Tax
Before 2017 a good was taxed many times over: excise by the Centre, VAT by the State, entry tax at the border, service tax on the side. GST replaced most of these with one tax on each supply, shared by the Centre and the States. A few items were kept out, and taxes on imports stayed separate.
Definition
The structure:
- Constitution (101st Amendment) Act, 2016; GST began on 1 July 2017. The GST Council (Article 279A) recommends rates.
- Acts of Parliament (2017): the Central GST, Integrated GST, Union Territory GST and GST (Compensation to States) Acts. Each State GST Act is passed by that State's own legislature.
- Inter-State supply (Article 269A): GST is levied and collected by the Government of India, not by the States, and is then apportioned between the Union and the States.
- Subsumed: central excise duty (most of it), service tax, State VAT and entry tax. Not subsumed: basic customs duty on imports.
- Outside GST: alcohol for human consumption (by the Constitution) and five petroleum products (crude, petrol, diesel, aviation turbine fuel, natural gas) until the GST Council notifies a date.
- Special rates: gold, silver and other precious metals 3%; rough (unworked) diamonds 0.25%.
- Slabs (a figure that changed): 5%, 12%, 18% and 28% from 2017. From 22 September 2025 the main slabs became 5% and 18%, with 40% on luxury and sin goods.
| Item | Status under GST |
|---|---|
| Petrol and diesel | Not yet taxed under GSTQ CDS 2022 (I): petrol is the item not covered. |
| Alcohol for human consumption | Kept outside by the Constitution |
| Basic customs duty | Not subsumed; still levied on imports |
| Precious metals | Taxed at 3%, not 1%Q CDS 2024 (I), a HARD question. |
| Rough (unworked) diamonds | Taxed at 0.25% |
| Inter-State supply | Levied by the Union under Article 269A and shared with the StatesQ CDS 2026 (II): all three statements were correct (UPSC's provisional key). |
Practice this concept4 quick reps
The same idea in a real exam question:
CDS · 2021 · CDS (II) 2021 — General Knowledge · Q71Moderate
Example 3 · Money, Banking and Public Finance · Taxes, GST and Finance Commission
Following the Constitution (One Hundred and First Amendment) Act, 2016, the Parliament of India enacted quite a few GST Acts in the year 2017. Which one of the following does not fall in this category ?
The State GST Act is not Parliament's
Parliament passed the Central, Integrated and Union Territory GST Acts and the Compensation Act. Each State GST Act is passed by the State legislature.
Inter-State GST is collected by the Centre
On supplies between States, GST is levied and collected by the Government of India (Article 269A) and only then apportioned. A State cannot levy it.
Know which year's slabs a question means
The four slabs of 5, 12, 18 and 28% applied from 2017. Since 22 September 2025 the main slabs are 5% and 18%, with 40% for luxury and sin goods.
Concept 4 of 4: Finance Commission and the divisible pool
The Centre collects most of the big taxes, but the States do most of the spending on schools, hospitals and police. Every five years a Finance Commission decides how much of the Centre's tax money goes to the States, and how that share is split among them. Poorer States get more, because they are further from the richest State's income.
Definition
The rules:
- Finance Commission: set up every five years under Article 280.
- Divisible pool: central taxes shared with States. Cesses and surcharges are excluded (Articles 270 and 271), so the Union keeps them in full.
- On petroleum: the basic excise duty is shared; the additional excise duty (road and infrastructure cess) and the special additional excise duty are not.
- 14th Finance Commission (2015-20): 42% of the pool to States. Weights: income distance 50%, population of 1971 17.5%, area 15%, demographic change 10%, forest cover 7.5%.
- 15th Finance Commission (2021-26): 41%. Weights: income distance 45%, population of 2011 15%, area 15%, forest and ecology 10%, demographic performance 12.5%, tax and fiscal effort 2.5%.
- The 16th Finance Commission, chaired by Arvind Panagariya, covers 2026-31.
| 14th FC criterion | Weight |
|---|---|
| Income distance | 50%Q Asked twice: CDS 2017 (II) wanted the highest weight, CDS 2018 (II) the descending order. |
| Population (1971) | 17.5% |
| Area | 15% |
| Demographic change | 10% |
| Forest cover | 7.5% |
Practice this concept4 quick reps
The same idea in a real exam question:
CDS · 2024 · CDS (II) 2024 — General Knowledge · Q98Moderate
Example 4 · Money, Banking and Public Finance · Taxes, GST and Finance Commission
Which one of the following taxes is not included in the Central Pool to be shared with the States according to the recommendations of Finance Commission of India ?
Cesses and surcharges stay with the Centre
Income tax, corporation tax and basic excise duty go into the divisible pool. Cesses and surcharges do not, which is why the Centre's road cess on petrol is not shared.
14th and 15th Commission weights differ
Income distance was 50% under the 14th and 45% under the 15th Commission, and the 15th used the 2011 population instead of 1971. Check which Commission the question names.
Summary — formulas & gotchas at a glance
A revision cheat-sheet for the formulas and gotchas above. Click any concept name to jump back to its full explanation.
Formulas (1)
- Who bears a tax: incidence
Share of a tax borne by buyers
Reference tables (3)
Canons of taxation and the Union's tax mix5 rows
| Canon | Meaning |
|---|---|
| Equality | Tax in proportion to ability to pay |
| Certainty | The amount, time and manner of payment are clear |
| Convenience | Collected at a time and in a way convenient to the taxpayer |
| Economy | Cost of collection is small |
| Fiscal adequacy (later writers) | Tax raises enough revenue for the state |
Goods and Services Tax6 rows
| Item | Status under GST |
|---|---|
| Petrol and diesel | Not yet taxed under GSTQ CDS 2022 (I): petrol is the item not covered. |
| Alcohol for human consumption | Kept outside by the Constitution |
| Basic customs duty | Not subsumed; still levied on imports |
| Precious metals | Taxed at 3%, not 1%Q CDS 2024 (I), a HARD question. |
| Rough (unworked) diamonds | Taxed at 0.25% |
| Inter-State supply | Levied by the Union under Article 269A and shared with the StatesQ CDS 2026 (II): all three statements were correct (UPSC's provisional key). |
Finance Commission and the divisible pool5 rows
| 14th FC criterion | Weight |
|---|---|
| Income distance | 50%Q Asked twice: CDS 2017 (II) wanted the highest weight, CDS 2018 (II) the descending order. |
| Population (1971) | 17.5% |
| Area | 15% |
| Demographic change | 10% |
| Forest cover | 7.5% |
Watch out for (8)
- Fiscal adequacy is not one of Adam Smith's four→ Canons of taxation and the Union's tax mix
- The order of tax receipts depends on the year→ Canons of taxation and the Union's tax mix
- The less elastic side pays→ Who bears a tax: incidence
- The State GST Act is not Parliament's→ Goods and Services Tax
- Inter-State GST is collected by the Centre→ Goods and Services Tax
- Know which year's slabs a question means→ Goods and Services Tax
- Cesses and surcharges stay with the Centre→ Finance Commission and the divisible pool
- 14th and 15th Commission weights differ→ Finance Commission and the divisible pool
Test yourself on Money, Banking and Public Finance
20 past CDS questions from this chapter, timed at 20 minutes and marked the way the exam marks it. You see your score and every answer the moment you finish. Free to start.