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Centre’s over-reliance on cesses, surcharges put state finances at risk

The Constitution allows the Centre to levy cess and surcharge which the Centre need not share with the state governments (Since the IL&FS defaults, it can be noted that NBFCs and housing finance companies (HFCs) were facing a crisis of confidence, sending call money rates higher and overall liquidity tight.)Premium
The Constitution allows the Centre to levy cess and surcharge which the Centre need not share with the state governments (Since the IL&FS defaults, it can be noted that NBFCs and housing finance companies (HFCs) were facing a crisis of confidence, sending call money rates higher and overall liquidity tight.)

  • A majority of state governments had told the 14th Finance Commission that cesses and surcharges should either be eliminated or, if continued beyond a specified period, should form part of the divisible pool

NEW DELHI: The share of states from the divisible pool of central taxes during the five year period to FY20 have remained well below the 14th Finance Commission recommendation of 42% with transfers plummeting to 32.4% in FY20, mostly due to over-reliance of the Centre on cesses and surcharges which are not shared with state governments.

The Constitution allows the Centre to levy cess and surcharge which the Centre need not share with the state governments. While cesses are imposed for specific purposes, surcharges are tax on taxes, both meant to be temporary in nature.

Though the introduction of Goods and Services Tax has subsumed many cesses, the government has imposed fresh cesses such as Swachh Bharat cess and Krishi Kalyan cess to finance Swachh Bharat initiatives and to promote initiatives to improve agriculture, respectively. The matter has been contentious with states opposing the permanent nature of such cesses. The Comptroller and Auditor General has also pointed out the lack of transparency and incomplete reporting in accounts on the utilisation of amounts collected under cesses. A majority of state governments had told the 14th Finance Commission that cesses and surcharges should either be eliminated or, if continued beyond a specified period, should form part of the divisible pool.

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, reducing the shareable portion of Centre’s gross tax revenue (GTR). As a result, the share of states in center’s GTR fell sharply from 36.6% in FY19 to 32.4% in FY20. These changes have happened at a time when states’ own tax revenues are also suffering on account of the ongoing economic slowdown.

DK Srivastava, chief policy adviser at EY India said, the problem has become serious after the implementation of GST and more recently due to the falling tax buoyancy of the Centre. States don’t have any autonomy on GST rates and therefore their taxation authority has squeezed further. Due to lack of enough tax buoyancy, the Centre has relied relatively more on cesses and surcharges to meet its own expenses, he said.

"FY20 was particularly difficult because gross tax revenue contracted on account of falling nominal GDP growth and corporate tax reforms. Revenue bouyancy, end GST compensation period and centre’s increasing reliance on cesses and surcharges-- all should be considered together because they are inter-linked," he added.

The 15th Finance Commission had commissioned a study on the matter from Vidhi Centre for Legal Policy. The legal think tank in its report submitted to the Commission has suggested that all cesses in force for a long duration or where there is evidence of non-utilisation and diversion of funds should be abolished.

“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. The Finance Commission may recommend inclusion of sunset clauses in the relevant legislations to ensure that cesses do not continue for an indefinite period," it said.

For surcharges, the think tank said income tax rates should be rationalised instead of using surcharge as a proxy for a progressive tax to impose additional burden on relatively richer taxpayers.

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