What Happened
- During a Lok Sabha discussion on central finances, Finance Minister Nirmala Sitharaman defended the Centre's practice of levying cess and surcharges, asserting that the framers of the Constitution deliberately designed the fiscal architecture to allow such levies outside the divisible pool.
- The Opposition had argued that by expanding cess and surcharge collections — which are not shared with states — the Centre effectively reduces the pool of revenues available for devolution, undermining cooperative federalism.
- The Finance Minister cited data to argue that the Centre transfers more to states than it collects from cesses and surcharges, countering the narrative that states are being short-changed.
- The debate touches on the structural tension in Indian fiscal federalism between the Centre's need for earmarked revenues for specific programmes and states' demand for unconditional, untied transfers.
Static Topic Bridges
Divisible Pool and Revenue Devolution: Constitutional Basis
The divisible pool is the total pool of central taxes that must be shared between the Centre and the states as determined by the Finance Commission. Under Article 270 of the Constitution, proceeds of taxes levied and collected by the Union — with certain exceptions — are distributed between the Union and the states. The key exception: cesses and surcharges are explicitly excluded from this divisible pool under the 80th Constitutional Amendment (2000).
- Article 268: Duties levied by Union but collected and retained by states (e.g., stamp duties on bills of exchange).
- Article 269: Taxes levied and collected by Union but assigned to states (e.g., taxes on sale/purchase of goods in inter-state trade).
- Article 270: Taxes levied and collected by Union, distributed between Union and states — the bulk of tax sharing.
- Article 271: Surcharges on taxes may be levied by Parliament; proceeds go to the Union only (no sharing with states).
- The 80th Amendment (2000) replaced the old allocation of specific taxes with a composite sharing of the Union's total tax revenue — but explicitly kept cess and surcharge outside this pool.
- Finance Commission (15th, 2021–26): Recommended 41% of divisible pool to states; earlier 14th FC had recommended 42%.
Connection to this news: The Opposition's concern is that the Centre's expanding cess regime (education cess, health cess, infrastructure cess, GST compensation cess) effectively shrinks the pool of taxes subject to mandatory devolution — depriving states of revenues that would otherwise be theirs under the Finance Commission award.
Cess vs. Surcharge: Definition and Fiscal Architecture
Cess and surcharge are both supplemental levies on existing taxes, but they differ fundamentally in their legal character and fiscal destination. A cess is levied for a specific designated purpose (e.g., education, health, infrastructure). Its proceeds are credited to a dedicated fund and must be spent only on that purpose. A surcharge is an additional charge on income/wealth for high-income earners or specific categories; it goes to the Consolidated Fund of India (CFI) and can be used for general purposes.
- Major cesses currently in force: Health and Education Cess (4% on income tax), Road and Infrastructure Cess, Agriculture Infrastructure and Development Cess (AIDC, on fuel imports), GST Compensation Cess.
- Major surcharges: Surcharge on income tax (varies by income slab — 10% to 37%), Surcharge on corporate tax.
- Cess proceeds go to specific funds (e.g., Prarambhik Shiksha Kosh for education cess), not the CFI — theoretically ringfenced.
- Neither cess nor surcharge forms part of the divisible pool, so states receive no direct share.
- Cess and surcharge as a percentage of gross tax revenue: rose from about 10.4% in 2011–12 to approximately 20% in 2021–22, before the GST Compensation Cess was wound down progressively.
- States are constitutionally barred from levying a surcharge on taxes assigned to them under Article 271.
Connection to this news: The Finance Minister's defence hinges on the constitutional validity of these exclusions (the 80th Amendment was deliberate) and a counter-claim that the total transfers to states — including grants-in-aid, CSS, and cesses spent in states — exceed what cess collections represent.
Finance Commission: Mandate and the Devolution Question
The Finance Commission is a constitutional body under Article 280, established every five years. Its core function is to recommend the distribution of net tax proceeds between the Union and the states, and among the states themselves. The 15th Finance Commission (2021–26) submitted its report in 2020 and recommended 41% devolution — down from the 42% awarded by the 14th Finance Commission, primarily due to the J&K reorganisation. The 16th Finance Commission is currently constituted and will give its award for 2026–31.
- Article 280(1): President constitutes Finance Commission every five years (or earlier if needed).
- Finance Commission recommends: (a) distribution of net proceeds of taxes between Union and states; (b) grants-in-aid to states from CFI; (c) any other matter referred by the President.
- The Commission's recommendations are not binding in law — but are conventionally accepted.
- The Commission cannot recommend sharing of cess/surcharge proceeds — that requires a constitutional amendment.
- Southern states (Tamil Nadu, Kerala, Karnataka) have consistently argued that the population-based allocation criteria used by Finance Commissions penalises states that performed better on demographic transitions.
- 16th Finance Commission: chaired by Arvind Panagariya; expected to recommend new vertical and horizontal devolution formula for 2026–31.
Connection to this news: The debate over cess exclusion is central to Finance Commission deliberations — states routinely demand either (a) inclusion of cess in the divisible pool or (b) a cap on cess/surcharge to prevent artificial reduction of the pool. The Centre has consistently resisted both, citing the 80th Amendment and the specific-purpose nature of cess collections.
Centrally Sponsored Schemes (CSS) vs. Untied Devolution
A structural tension in Indian federalism is the proliferation of Centrally Sponsored Schemes — where the Centre provides funds to states for specific programmes with attached conditions — versus untied devolution through the Finance Commission. States prefer higher Finance Commission devolution (no strings attached) while the Centre uses CSS as a mechanism to pursue national priorities with some influence over state spending.
- CSS (e.g., PMAY, PM Poshan, MGNREGS) come with Centre-state cost-sharing ratios — often 60:40 or 70:30 for general states, more favourable for special category/Himalayan states.
- In 2015–16, the 14th Finance Commission's sharply higher devolution (42%) was accompanied by a reduction in CSS to avoid double-counting — but CSS proliferated again subsequently.
- Tied versus untied: Finance Commission grants are constitutionally mandated and largely untied; CSS grants come with conditions on spending, beneficiary targeting, and monitoring.
- States in Southern and Western India (higher fiscal capacity) often argue they are net losers under devolution formulas that over-weight population and backwardness criteria.
- The Centre earns political credit for spending cess funds (e.g., education, health) in states without sharing fiscal space with state governments.
Connection to this news: FM Sitharaman's argument that the Centre sends more to states than it collects from cesses is essentially a CSS-and-grants-in-aid defence — the aggregate transfer includes tied funds managed by central programmes, which states consider a different category from their own constitutional entitlement under Article 270.
Key Facts & Data
- Cess and surcharge as % of gross tax revenue: ~10.4% (2011–12) → ~20% (2021–22)
- Divisible pool share to states: 42% (14th Finance Commission, 2015–20) → 41% (15th Finance Commission, 2021–26)
- 80th Constitutional Amendment (2000): Excluded cess and surcharge from divisible pool
- Article 270: Main provision for Centre-state tax sharing
- Article 271: Parliament may levy surcharges; proceeds go entirely to Union
- Major cess categories: Health & Education Cess (4%), Road & Infrastructure Cess, AIDC
- GST Compensation Cess: collected to compensate states for GST transition revenue loss (now winding down post-2026)
- 16th Finance Commission: Chaired by Arvind Panagariya; will recommend devolution for 2026–31