ill-effects-of-cesses-surcharges-on-state-finances

Context: The latest audit of the Union Government’s accounts tabled in Parliament this week reveals that the Finance Ministry quietly retained over 40% of all cess collections in 2018-19 in the Consolidated Fund of India (CFI). 

More about news:

  • The share of states in the Centre's gross tax revenue (GTR) fell sharply from 36.6% in FY19 to 32.4% in FY20.
  • It is well below the 14th Finance Commission recommendation of 42%, with transfers plummeting to 32.4% in FY20.
  • It is mostly due to over-reliance of the Centre on cesses and surcharges that are not shared with state governments.

Levy of cess and surcharges by the central govt.

  • The goods and services tax (GST) has subsumed many cesses, but the government has imposed fresh cesses such as Swachh Bharat cess and Krishi Kalyan cess to finance Swachh Bharat initiatives and to promote agriculture, respectively.
  • In FY20, the central government increased the rate of road and infrastructure cess and the special additional excise duty on the central excise on petroleum products.

Rationale behind cesses: 

  • Central transfers to the states have increased due to the recommendations of the 14th Finance Commission which  increased the tax devolution of the divisible pool to states to 42% for years 2015 to 2020.
  • Compensating for loss to states: Since cesses and surcharges don’t have to be shared with the states, it partially helps the Centre get out of its cash crunch.
  • Falling tax buoyancy of the Centre: Due to lack of enough tax buoyancy, the Centre has relied relatively more on cesses and surcharges to meet its own expenses. 
    • A tax is said to be buoyant if the tax revenues increase more than proportionately in response to a rise in national income or output.

Concerns with the govt’s move: The Union government is now relying more and more on cesses and surcharges which are not shared with the states. It reduces the sharable portion of Centre’s gross tax revenue (GTR).

  • Cesses not being used for their earmarked purpose:  As many as 35 different cesses, levies and charges yielded ₹2.75-lakh crore in the year, but just around ₹1.64-lakh crore was remitted to the specific reserve funds for which these cesses were levied. 
    • This helped in minimising India’s revenue and fiscal deficit numbers. 
    • But the purposes for which Parliament approved such cesses — be it health, education or infrastructure development — were not met. 
    • Over 10 years, not a paisa of the ₹1.25-lakh crore of cess collected on crude oil was transferred to an oil industry development body it was meant to finance. 
    • Part of the GST Compensation Cess fund, was not remitted to the states over the first two years of GST. 
    • A new 4% Health and Education Cess on income tax was partly deployed towards education, but no fund was created for health. 
    • Social Welfare surcharge levied on customs also remains unutilized. 
  • The permanent nature of cesses: A majority of state governments requested  the 14th Finance Commission to eliminate cesses and surcharges. If continued beyond a specified period, they  should form part of the divisible pool.
  • Fiscal federalism: Since the revenue from cesses is not shared with the states, this might have a negative impact on India’s structure of fiscal federalism and curb the fiscal space of state governments.
    • Falling states share: As a result, the share of states in the Centre’s GTR fell sharply from 36.6% in FY19 to 32.4% in FY20.  
    • This has compounded the problem as the states’ own tax revenues are suffering due to the economic slowdown.
    • Meddling with state list: Using cesses on agriculture [Krishi Kalyan cess] and sanitation [Swachh Bharat cess], the Union is entering domains that are a part of the state list.
    • Implementation of GST: States don’t have any autonomy on GST rates and, therefore, their taxation authority has squeezed further. 

Way forward: Revenue buoyancy, end of GST compensation period and Centre’s increasing reliance on cesses and surcharges—all should be considered together because they are interlinked.

  • Rationalization of cesses: Cesses on the excise duties on petrol and diesel, need to be rationalised to provide succour to a citizenry whose incomes and job prospects have been hit by the pandemic and a shrinking economy. 
  • Abolition of cesses: Sarkaria Commission had recommended that cesses “should be for limited duration and for specific purposes only”.
    • Vidhi Centre for Legal Policy suggested that all cesses in force for a long duration or where there is evidence of non-utilization and diversion of funds should be abolished. 
    • The Finance Commission may recommend inclusion of sunset clauses in the relevant legislations to ensure that cesses do not continue for an indefinite period. 
  • Clear estimation: In future, cesses should be imposed for a narrowly defined purpose and with a clear estimation of the amount of money that the Union government aims to raise through the cesses. 
  • For surcharges, income tax rates should be rationalized instead of using surcharge as a proxy for a progressive tax to impose additional burden on relatively richer taxpayers.
  • Tax reforms: The underlying tax revenue situation is grim, it is the right time to initiate much needed reforms in the taxation structure.

Finally, absolute transparency is needed in the management of cess receipts so that Parliament and the people do not need to wait for audit findings to learn of this subterfuge.

About cess and surcharges: The Constitution allows the Centre to levy cess and surcharge which the Centre need not share with state governments. Both cess and surcharge are meant to be temporary in nature.

  • Cess: Governments use Cess to fulfill a particular objective. Article 270 of the Constitution describes a cess. 
    • Cesses may be levied by the union or state governments.
    • Cess example:  an additional 4% Health & education cess is applicable on the income tax amount.It is also typically imposed as a tax on tax – the Swachh Bharat Cess was a 0.5?d on to Service Tax.
    • In 2000, upon the recommendation of the Tenth Finance Commission, the Constitution was amended to provide, for the first time, legal backing for cesses and surcharges which would not be shared with the states. The logic of it was: since the purpose of the money was already earmarked, it made no sense to hand it over to the states.
  • Surcharge: A surcharge is a tax on tax imposed for the purposes of the union. A surcharge is dealt with under Article 271 of the Constitution.
    • A surcharge of 10% on a tax rate of 30?fectively raises the combined tax burden to 33%. 
    • In the case of individuals earning a net taxable salary of more than Rs 1 crore, a surcharge of 10% is levied on tax liability.
    • The amount recovered in the form of surcharge also reaches the Consolidated Fund of India (CFI), and it can be spent for any purpose, just like the normal tax.
    • Occasionally, the surcharge is also levied on a certain amount of expenditure. It applies in the form of a percentage on the amount of expenditure.

Transparency issues: If the levy is in the nature of a cess, we can demand transparency and accountability on the usage of the proceeds for the end purpose. If it is a surcharge, the government may just say that the money can be used for any purpose.

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Sources:

https://www.thehindu.com/opinion/editorial/cess-pool-the-hindu-editorial-on-cag-report-of-centres-accounts/article32699214.ece

https://www.livemint.com/news/india/centre-s-over-reliance-on-cesses-surcharges-put-state-finances-at-risk-11594081142572.html

https://scroll.in/article/932674/modi-government-is-relying-on-cesses-to-collect-tax-revenue-what-does-this-mean-for-federalism