Concerns Over Cess and Surcharges in India | 12 Dec 2024

Source: TH 

Why in News?

Arvind Panagariya, Chairman of the 16th Finance Commission, recently called the issue of the Centre's increasing reliance on cesses and surcharges a "complicated issue."  

What are Cess and Surcharges? 

• Cess:  A cess is a form of tax that is levied for a specific purpose. It is a tax on tax, imposed in addition to an existing tax like excise or income tax, and the revenue is earmarked for a particular use.  
  • Cesses are typically charged for a specific time period, or until the government has gathered enough funds for the designated purpose. 
  • The 80th Amendment formally amended Article 270, explicitly excluding cesses and surcharges from the divisible pool (revenue from cesses is not shared with states).  
    • Cesses are recognized in the Constitution under Article 277 and Article 270 (which outlines the revenue-sharing framework between the Union and States).  
  • Examples: Education Cess (for financing primary education), Swachh Bharat Cess (for cleanliness initiatives), and Fuel Cess (for road development).  
• Surcharge: A surcharge is an additional tax or levy imposed on existing duties or taxes. It is essentially a "tax on tax" and is discussed under Articles 270 and 271 of the Indian Constitution. 
  • Surcharges are often applied to individuals, companies, and other taxpayers who fall within income brackets. The rate of surcharge can vary based on income level. 
    • They are designed to be progressive, ensuring that higher earners contribute more, promoting social equity and addressing income disparity.  
  • Surcharge increases the total tax liability of individuals or entities who are already subject to tax, particularly higher-income earners or certain sectors. 
  • The funds collected from surcharges go into the government’s general fund and can be used for a variety of purposes, such as financing infrastructure projects, social welfare programs, and other governmental activities. 
  • 13^th and 14^th Finance Commissions upheld exclusion of surcharges from the divisible pool; recommended reducing Centre's reliance on these levies. 
• Cess vs. Surcharge: Cess and surcharge both go to the Consolidated Fund of India (CFI) but differ in usage. Surcharge is spent like other taxes, while cess must be allocated separately and used only for its specific purpose.  

What are the Concerns Regarding Cess and Surcharges? 

• Centre's Fiscal Constraints: The increase in the share of states in the divisible tax pool from 32% under the 13th Finance Commission to 42% under the 14th and 41% under the 15th Finance Commission has reduced the Centre's fiscal space. 
  • To counterbalance this, the Centre increasingly relies on cesses and surcharges, which are not shared with the States. 
  • Originally envisioned as a temporary measure, surcharges and cesses have become a permanent fixture in India’s tax system, which has raised concerns about their long-term impact on fiscal federalism. 
• State Concerns: Cesses and surcharges increased from 10.4% in 2011-12 to 20% in 2021-22. This trend effectively shrinks the pool of taxes that are shared with States, limiting their fiscal flexibility and undermining the spirit of fiscal federalism. 
  • States have consistently demanded a cap on cesses and surcharges, and the inclusion of any excess collections into the divisible pool to ensure fairer revenue distribution. 
  • This issue underscores the challenge of balancing power and financial autonomy between the Centre and States, potentially impacting states' ability to fund critical programs and achieve developmental goals. 
• Lack of Transparency and Vagueness: Since cesses are collected for specific purposes, they reduce transparency in the allocation and distribution of tax revenues. 
  • States argue that this method of taxation bypasses the principles of equitable revenue sharing.  
  • Many cesses, like the Swachh Bharat and Krishi Kalyan Cess, are broadly defined. They aren't subject to the same parliamentary oversight as general taxes. 
    • There are discrepancies in how cess proceeds are used. For example, the Research and Development Cess was partly used to finance the Union’s revenue deficit rather than its intended purpose. 
• Inequitable Taxation: Cesses and surcharges tend to disproportionately affect the wealthier segments of society, as they are the primary contributors.  
  • Critics argue that this creates fairness issues and may drive wealthy individuals and businesses to relocate to more tax-friendly countries.

What is the Divisible Pool of Taxes?

• About: The Divisible Pool of Taxes refers to the portion of the total tax revenue collected by the Union government that is shared with the States in India.  
  • It is a key component of fiscal federalism, ensuring that both the Centre and the States have access to resources for their respective functions. 
• Key Features:  
  • Taxes: The divisible pool includes taxes that are collected by the Union government such as Corporation Tax, Personal Income Tax, Central  and Goods and Services Tax (GST). 
  • Finance Commission: The distribution of the divisible pool is based on the recommendations of the Finance Commission, which is constituted every five years.   
    • The Commission suggests the percentage share for both the Union and the States. 
    • The 15th Finance Commission recommended that states receive 41% of the divisible pool of central taxes for the period 2021–2026 
  • Vertical and Horizontal Devolution: 
    • Vertical Devolution: Refers to the proportion of the divisible pool allocated between the Union and the States. 
    • Horizontal Devolution: Refers to how the States' share of the divisible pool is distributed among the individual States, based on factors such as population, income disparity, and tax efforts. 
• Exclusion of Cesses and Surcharges: Cesses and surcharges levied by the Union are excluded from the divisible pool.

What Can be Done to Address Concerns Regarding Cess and Surcharges? 

• For Cesses: 
  • Imposition: The Union Government should refrain from levying cesses for issues under the State List, such as health and education, as it undermines federal principles.  
    • Set a ceiling on cess collection and avoid exceeding it. 
  • Transparency: Ensure clear allocation of funds and transparency in cess collection. A structured, periodic review process should be instituted to evaluate the effectiveness and necessity of cesses. 
    • If misuse occurs, shift cess funds to a general tax, allowing states a share based on Finance Commission recommendations. 
  • Abolition: Cesses that generate very minimal revenue  can be abolished, as they are economically inefficient and add to tax complexity. 
    • Impose cesses for a maximum of 5 years, with one possible extension, after which they should be abolished. Include sunset clauses in cess legislation to limit indefinite continuation. 
• For Surcharges: 
  • Rationalization of Income Tax: Surcharges often act as a proxy for progressive income tax. This can be addressed by  rationalizing the income tax structure itself, rather than adding surcharges, especially on higher income slabs. 
  • Temporary Nature of Surcharges: Surcharges can be made temporary, used only during financial distress, with sunset clauses to prevent their perpetual use and become permanent tax instruments. 

Conclusion 

The reliance on cesses and surcharges in India has raised efficiency, and transparency concerns. Clear guidelines, periodic reviews, are needed to limit their use and prevent permanence. Surcharges should be used only in exceptional circumstances. Accountability must be enhanced to ensure they serve their intended purposes.