Concerns regarding fiscal federalism in India, focusing on the devolution of resources from the central government to the states
The net divisible pool, or net proceeds, is that part of the gross tax revenue from which a share would have to be vertically devolved by the Union to all States.
Such shares are assigned by each FC for a five-year period.
Earlier, all corporation taxes and customs duties were fully absorbed by the Union, and only income taxes and excise duties were shared with the States.
However, with changes over the years, culminating in a constitutional amendment in 2000, all taxes of the Union were added to the net proceeds.
But there was a catch — cesses and surcharges under Article 270 and Article 271 were kept out of the net proceeds.
In the past, such exclusion of cesses and surcharges were based on specific FC recommendations.
But the amendment in 2000 provided a constitutional basis for it.
Presently, the net proceeds consists of the gross tax revenue after the deduction of cesses, surcharges and the cost of collection of taxes.
Over the past decade or more, several cesses and surcharges were introduced by the Union government.
When the Goods and Services Tax was initiated in 2017, the expectation was that many cesses and surcharges would be discarded and subsumed into the GST system.
On the contrary, new cesses and surcharges continued to be introduced, and many old cesses and surcharges remained outside the GST system.
For instance, the Agriculture Infrastructure and Development Cess was introduced as recent as in 2021-22.
Similarly, when the Health and Education Cess was introduced in 2017-18, it just replaced the Primary Education and Secondary Education cess on direct taxes.
The expansion of cesses and surcharges have led to the exclusion of an increasing share of the gross tax revenue from net proceeds.
Interestingly, there is conflicting information released by the government on the quantum of cesses and surcharges.
In December 2022, responding to a question raised in the Rajya Sabha, the government stated that the share of cesses and surcharges in the gross tax revenue was 18.2% in 2019-20, 25.1% in 2020-21 and 28.1% in 2021-22.
But responding to another question in the Lok Sabha in March 2023, the government stated that the corresponding shares were 15.6% in 2019-20, 20.5% in 2020-21 and 18.4% in 2021-22.
To obtain more accurate estimates of cesses and surcharges, this article uses disaggregated data from budget documents between 2009-10 and 2024-25.
The collection of each type of cess and surcharge was separately recorded and added up, after giving due consideration to their occasional abolishment and/or merger with other taxes.
The total collection of cesses and surcharges rose from ₹70,559 crore in 2009-10 to ₹6.6 lakh crore in 2023-24 (RE) and ₹7 lakh crore in 2024-25 (BE).
These collections include the GST compensation cess, which is given to the States as per statutory requirements.
If we deduct the GST compensation cess, the collection of cesses and surcharges rose from ₹70,559 crore in 2009-10 to ₹5.1 lakh crore in 2023-24 (RE) and ₹5.5 lakh crore in 2024-25 (BE).
Considered as a share of the gross tax revenue, cesses and surcharges fell from 11.3% in 2009-10 to 9.5% in 2014-15.
But then rose to 15.3% in 2018-19, a peak of 20.2% in 2020-21 and 16.3% in 2022-23.
As per the tentative figures for 2023-24, cesses and surcharges are estimated at 14.8% of the gross tax revenue.
Which is still higher than the corresponding shares in 2009-10 or 2014-15.
Between 2009-10 and 2023-24, a cumulative total of ₹36.6 lakh crore was collected by the Union government as cesses and surcharges.
An additional ₹5.5 lakh crore is projected to be collected as cesses and surcharges in 2024-25.
Issues with Vertical Devolution
The Union government may argue that a part of this amount was used to finance centrally sponsored schemes and central sector schemes, while another part was used to provide non-plan grants or capital transfers to States.
The problem, however, is that such transfers are not untied as is the case with the devolution of State’s share in central taxes.
In centrally sponsored schemes, about 40% of the cost must be borne by the State governments.
Even in central sector schemes, the contribution of the Union government is often meagre, and the State governments are forced to contribute significantly larger amounts to run the schemes meaningfully.
Even when State governments contribute a lion’s share in implementing a central project.
The Union government often tries to usurp credit by insisting on displaying the Prime Minister’s photograph or other forms of labelling.
Recent disputes over labelling in the Ayushman Bharat wellness centres is one such example.
Similarly, several grants given to the States are contingent on fulfilment of conditionalities —
and some of these conditionalities include the insistence on labelling.
Finally, most capital transfers given to the States are loans, which must be repaid to the Union government.
The bottom line is that none of the transfers to the States outside the FC recommendations are either unconditional or suitable to meet their context-specific needs.
Instead, they tend to reaffirm a centralising tendency in the fiscal realm — one that effectively tends to push the Union-State relationship into a patron-client relationship.
Any purported deviation from the guidelines or a failure to meet the imposed conditionalities can lead to the denial of such resources.
The share of States in central taxes is, thus, a gold standard in any assessment of fiscal federalism.
It is a matter of deep worry, then, that the Union government increasingly pays less of untied transfers to States and retains more of the gross tax revenue as cesses and surcharges.
Issues with Centralized Control
Cesses and surcharges have also been subjected to critical scrutiny by the Comptroller and Auditor General (CAG).
All cesses must be transferred to a reserve fund in the Public Account of India after their collection.
In its reports the CAG has uncovered numerous instances of either non-transfer or short transfer of the collected amounts to the respective funds.
A CAG report in 2023 noted that if ₹52,732 crore was collected towards the Health and Education Cess in 2021-22, only ₹31,788 crore (or 60%) was
transferred to the reserve fund of Prarambhik Shikha Kosh.
The Research and Development Cess must be transferred to the Fund for Technology Development and Application.
A CAG report in 2019 noted that the total collection of Research and Development Cess between 1996-97 and 2017-18 was ₹8,077 crore, but only ₹779 crore (or 9.6%) was transferred to the Fund.
The extent of short transfer to the Kosh between 2015–16 and 2017–18 was ₹4,891 crore.
The extent of short transfer between 2010–11 and 2017–18 under the Road Cess was ₹72,726 crore and under the Clean Energy Cess was ₹44,505 crore.
Non-transfers and short transfers of cesses defeat the logic of their collection.
COMMENTS