Too much cess

| Updated on February 24, 2021

Reliance on cess and surcharge in tax revenues should be reduced

The rising component of cess and surcharges — a part of gross tax revenue that need not be shared with the States — could heighten Centre-State frictions in times of macroeconomic and fiscal stress. These levies appear to short-change both the States and the consumer, who coughs up these sums through public goods, only to be left in the dark on how these proceeds are used. As the chairman of the Fifteenth Finance Commission (FC) NK Singh has explained in interactions with the media, cesses have reduced the estimated divisible pool over the next five years by about ₹32 lakh crore to ₹103 lakh crore from ₹135.4 lakh crore. Over the years, the share of cesses and surcharges in gross tax revenue has increased from 10.4 per cent in 2011-12 to 19.9 per cent 2020-21 (BE). Even if we deduct the GST compensation cess, which accrues entirely to the States, the share of cess/surcharge would amount to 16 per cent today, Singh points out — which still works out to a significant increase over the years. Cesses and surcharges have become a revenue impounding mechanism for the Centre, although they are projected as a means of raising funds to meet specific objectives, such as Swachh Bharat Cess, Health Cess, Education Cess and the Road and Infrastructure Fund. There are some 35 cesses in operation, despite the GST having subsumed many of them. What’s worse, as a CAG report released last September observed, of the ₹2.74 lakh crore collected from such levies in 2018-19, about 40 per cent was not transferred to the specific funds; they remained with the Consolidated Fund of India. Clearly, cesses are too opaque for anyone’s comfort.

However, the Centre has argued that it has been forced to rely more on such levies in the wake of the 14th FC award, which ramped up the States’ share from 32 per cent to 42 per cent of the divisible pool. The Centre had urged a reduction in the 42 per cent share probably as a sort of quid pro quo for reducing cesses. Meanwhile, the States had argued for a 50:50 share because of the shrinking divisible pool. The 15th FC, while keeping the status quo on devolution to balance these contrary pressures, has rightly said that the proportion of cesses and surcharges be brought down to 18.4 per cent of the gross tax revenues in five years (20 per cent now). This seems like a modest goal.

The real issue here, as the 15th FC report observes, is the low revenue to GDP ratio of 20 per cent for the Centre and States combined, which compares poorly with the 27.2 per cent average for emerging economies. The direct tax base leaves much to be desired. While measures to expand the tax base need to be considered, the States can also do with some reforms, including a rationalisation of rates on property registrations, which can help push up collections. The overall kitty can be expanded without resorting to controversial levies.

Published on February 24, 2021

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