Centre’s cess cleverness is taxing states

The 17th Lok Sabha has come to an end practically, without, as PRS Legislative Research has pointed out, an elected Deputy Speaker.  Article 93 of the Constitution requires that the Lok Sabha elect a Speaker and a Deputy Speaker. The stage has also been set for the general election with papers -- White and Black -- having been released, proclaiming achievements and alleging mismanagement. Without getting into the merits of the ‘White Paper-Black Paper war’, let me focus on an area of concern expressed by some states about how they are denied their rightful share of taxes by the central government. Constitutional institutions such as the CAG and the RBI, too, have noted the ill-effects of the phenomenon of the Centre collecting revenues by way of cess and surcharges, rather than as taxes that have to be shared with the states.

By way of background, and to put matters in perspective, while the framers of the Constitution had assigned the taxation powers to both the Centre and the states, very many of the responsibilities in the social and economic spheres were given to the states. There was thus a mismatch between resources and responsibilities. It was to address this situation that the Constitution, under Article 280, provided for a Finance Commission to be set up periodically to review and recommend the transfer of resources from the divisible pool of the Union to the states and the formulas that would govern the relative shares of states. The divisible pool is the gross tax revenue (GTR) collected, net of cess and surcharges (excluding the GST compensation cess after the GST came into effect). Thus, the more the cess and surcharges imposed and collected as a proportion of all tax revenues, the less is the amount available for the states in the divisible pool.

Article 270 of the Constitution enables the Union government to levy cess for a “specific purpose under any law made by parliament”. The cess itself is levied under the specific provisions of each Act, such as, for instance, the Road & Infrastructure Fund Act or, unless specifically mentioned otherwise, when it is collected as a duty of central excise or customs. Article 271 empowers parliament to levy a surcharge on any taxes that fall within the Union government's taxing powers. 

The introduction of the Goods & Services Tax (GST) in July 2017 was expected to end all other taxes and cesses with their getting subsumed in the new levy. That was the promise of GST -- ‘One Nation, One Tax’, if you will. Hence, in the days leading up to the roll-out of GST from July 1, 2017, the budget exercise witnessed the abolishing of certain cesses. Subsequent developments have shown, however, that they weren’t going away forever. 

The Centre had to resort to the GST Compensation Cess along with the advent of GST. While the need to levy this particular cess was understandable and was a necessary sweetener to bring all states on board the transformational GST train, the continuation of some other cesses and the introduction of new cesses was not. 

The very next Union budget of 2018-19 saw ‘Road Cess’ being enlarged and rechristened to ‘Road and Infrastructure Cess’, and the 3 per cent ‘Education Cess’ being replaced by a 4 per cent ‘Health and Education Cess’, and also the introduction of a ‘Social Welfare Surcharge’. This trend has continued and only grown. In the year immediately after the introduction of GST, Rs 1,52,677 crore was collected from various cesses – and this is in addition to the cess collected toward GST compensation for the states. A total of Rs 2,37,500 crore has been the contribution from cesses as per the revised budget for 2023-24. For 2024-25, the Union government expects to collect an even higher Rs 2,49,180 crore in the form of cesses.  

The Report of the Auditor General of the accounts of the Union government -- Report No 21 of 2023 (Financial Audit) -- gives the details of cess collection as part of the total collection of revenue. A humongous 17.67 per cent (inclusive of the GST Compensation Cess) of the total gross revenue was the cess component in FY2021-22. The Report of the Comptroller & Auditor General of India (CAG) on the accounts of the Union government (No 4 of 2020) had pointed out that in respect of the Road & Infrastructure Cess, Health & Education Cess, and cess on crude oil, there was no proper framework nor any assurance that cess/levies collected would be used for the purpose for which these were collected. The CAG had observed that the Union government had withheld more than Rs 1.1 lakh crore collected through various cesses in 2018-19. The CAG also pointed out that over Rs 1.24 lakh crore collected as cess on crude oil over the last decade had not been transferred to the designated Reserve Fund. In 2019, the Reserve Bank of India (RBI) noted that levying cesses and surcharges neutralises the increase in tax devolution recommended by successive Finance Commissions. While cesses were being collected for specific purposes, these purposes, however, seem to continue forever. Thus, it is estimated that the Finance Commission formula for devolving 41per cent of the divisible pool has in reality translated into only 32 per cent of the gross tax revenue in 2024-25 as per budget estimates.   

The 14th Finance Commission had disapproved of the continuing tendency to levy cesses. Similarly, the 15th Finance Commission report has commented adversely on the increase in collections under cess. The 69th Report of the Public Accounts Committee 2023-24 has made several observations in its report on ‘Issues Relating to Accounting of Cess/Levies’. The Union government has simply asserted that it is not keeping cesses for itself.

The discussions and findings of reports above suggest, however, that that is not true. Cess has become for the Union government an important means of revenue collection that it can keep for itself. The recently constituted 16th Finance Commission therefore has its work cut out for it. It should strongly recommend that all cesses be stopped, or, alternatively, that the amounts so collected be made part of the devolution principle. Doing so would strengthen “cooperative federalism”.

(The writer is a former Chairman of the Central Board of Indirect Taxes & Customs)