13-December-2024-Editorial

DISPUTE OVER CESSES AND SURCHARGES A COMPLICATED ISSUE: ARVIND PANAGARIYA

Cesses and surcharges are important tools in India’s taxation system, allowing the government to raise additional revenue for specific purposes or to address fiscal challenges. However, their growing use by the central government has raised concerns about fiscal federalism, transparency, and equity.

What are Cess and Surcharge?

Cess:

• A cess is an additional tax imposed for a specific purpose, such as funding education or infrastructure projects.
• It is levied on top of existing taxes like income tax or excise duty.
• Cess collections are earmarked for particular objectives and must be utilized exclusively for that purpose.
• It is typically introduced for a limited duration until sufficient funds are raised.
• The Constitution (80th Amendment) excluded cesses and surcharges from the divisible pool of taxes, meaning the revenue is not shared with states.
• Articles 270 and 277 of the Constitution provide for the imposition and usage of cesses.
• Examples:

• Education Cess: Funds primary education.
• Swachh Bharat Cess: Supports cleanliness initiatives.
• Fuel Cess: Aids road development.

Surcharge:

• A surcharge is an additional charge imposed on existing taxes, targeting individuals or entities with higher income levels.
• It increases the total tax liability of taxpayers, particularly higher-income groups, ensuring progressive taxation.
• Unlike cess, surcharge collections are not restricted to specific uses and are added to the government’s general fund.
• Articles 270 and 271 of the Constitution govern surcharges.
• Examples: Income tax surcharge for high-income individuals or corporate surcharge.

Differences Between Cess and Surcharge

• Usage: Cess is dedicated to a specific purpose, while surcharge funds can be used for any government expenditure.
• Duration: Cess is often time-bound, while surcharges are sometimes extended indefinitely.
• Sharing with States: Both go into the Consolidated Fund of India (CFI), but only cess usage is earmarked, and neither is shared with states.

Concerns Regarding Cess and Surcharges

Increased Reliance by the Centre:

• With the states’ share in the divisible pool increasing from 32% (13th Finance Commission) to 42% (14th Finance Commission) and later to 41% (15th Finance Commission), the Centre has limited fiscal space.
• To compensate, it relies heavily on cesses and surcharges, which are not shared with states.
• Originally temporary measures, these levies have become permanent features in India’s tax system.

Fiscal Federalism Challenges:

• Cess and surcharge collections increased from 10.4% of gross tax revenue in 2011-12 to 20% in 2021-22, reducing the pool shared with states.
• States argue that this trend undermines fiscal federalism and limits their ability to fund development programs.

Lack of Transparency:

• Cesses are intended for specific purposes, but their usage often lacks clarity and accountability.
• Funds from certain cesses have been diverted for unrelated purposes, such as using the Research and Development Cess to cover revenue deficits.
• Parliamentary oversight of these collections is limited compared to general taxes.

Inequitable Taxation:

• Surcharges disproportionately target high-income groups, potentially discouraging investment and driving wealthier individuals or businesses to relocate to tax-friendlier jurisdictions.

International Practices on Cess and Surcharges

• Germany: Introduced a “solidarity surcharge” to fund reunification costs; initially temporary, it continues today.
• France: Temporarily imposes surcharges to address fiscal issues.
• United States: State-specific taxes are earmarked for specific purposes, like Alabama’s targeted levies.
• Australia: Introduced a Medicare Levy for healthcare funding, demonstrating that earmarked taxes can be temporary and limited.

Suggestions to Address Concerns

For Cesses:

• Imposition Guidelines: Limit cesses to Union subjects; avoid levying them on state subjects like health and education. Introduce a cap on cess collections to ensure fiscal discipline.
• Transparency: Clearly outline cess usage, with periodic reviews to evaluate their effectiveness. Unused funds should be reallocated to the divisible pool for states.
• Abolition: Discontinue low-revenue cesses and include sunset clauses in legislation to ensure their temporary nature.

For Surcharges:

• Rationalization: Streamline the income tax structure to reduce reliance on surcharges, especially for high-income earners.
• Temporary Nature: Surcharges should be used only during financial emergencies, with sunset clauses to prevent indefinite continuation.

Conclusion

Cesses and surcharges play a significant role in India’s fiscal system but raise concerns about transparency, fairness, and federalism. Addressing these issues requires clear guidelines, better accountability, and ensuring that these levies remain temporary. By fostering cooperative federalism and equitable resource sharing, India can achieve a more balanced and efficient tax system.