Public Finance & Government Debt
Cesses and Surcharges: Taxes the States Don't Share
Why the central government increasingly collects revenue through cesses and surcharges, which are not shared with states, and why this worries state governments.
India’s Constitution requires the central government to share a large part of its tax revenue with the states. But not all central taxes are shared. Cesses and surcharges are kept entirely by the centre, and their growing use has sparked debate.
The divisible pool
Most central taxes, such as income tax and corporate tax, go into a divisible pool. The Finance Commission recommends what share goes to states. The Fifteenth Finance Commission set the states’ share at 41 percent.
What are cesses and surcharges?
- A cess is a tax levied for a specific purpose, such as the health and education cess on income tax, or cesses on fuel, and the money is meant to be used for that purpose.
- A surcharge is an additional tax on a tax, such as the surcharge on income tax for high earners.
Neither is part of the divisible pool, so states receive no share.
The growing share
The share of cesses and surcharges in the centre’s gross tax revenue rose significantly in the late 2010s and early 2020s, at times reaching around a fifth. Fuel taxes, in particular, relied heavily on cesses.
Why states object
- It reduces the effective share of central taxes going to states, even if the formal share stays at 41 percent.
- States have major spending responsibilities, such as health, education and police.
- Some cesses have not been fully spent on their stated purposes, as reports by the Comptroller and Auditor General have noted.
The centre’s view
The centre argues that cesses fund national priorities, such as infrastructure, health and education, and that surcharges on high earners support progressive taxation.
The GST compensation cess
When GST was introduced in 2017, a compensation cess on luxury and sin goods funded payments to states for revenue losses. It was later extended to repay loans taken during the pandemic, and GST reforms in 2025 moved to phase it out.
Reform ideas
- Limiting cesses and surcharges to a set share of revenue.
- Including them in the divisible pool after a period.
- Greater transparency on how cess money is used.
When petrol prices are high, much of the price is taxes. If the centre raises revenue through cesses on fuel rather than basic excise duty, states receive nothing from the increase, even though fuel is consumed in their territory.
States get 41 percent of the divisible pool, which excludes cesses and surcharges. Their share of total central revenue is lower.
- States get a share of central taxes in the divisible pool, set at 41 percent by the Fifteenth Finance Commission.
- Cesses and surcharges are excluded from the divisible pool.
- Their growing share has reduced states' effective share of central revenue.
- States seek limits and more transparency on cess use.
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