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Budget 2021: The year 2020 21 and growing share of cess and surcharge revenue

Budget 2021: The year 2020-21 and growing share of cess and surcharge revenue

Budget 2021: The year 2020-21 and growing share of cess and surcharge revenue
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By Suyash Tiwari  Jan 31, 2021 1:41:49 PM IST (Updated)

Recently, various news reports have speculated that a new COVID-19 cess may be announced in the upcoming Union Budget to help the government finance its COVID-19 related expenditure.

Recently, various news reports have speculated that a new COVID-19 cess may be announced in the upcoming Union Budget to help the government finance its COVID-19 related expenditure.

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A cess is an additional tax levied by the government to raise funds for a specific purpose. Some reports have also talked about raising funds through a surcharge to balance the revenue shortfall faced by the government this year. Similar to a cess, a surcharge is also an additional tax levied on top of a base tax, but its revenue is not earmarked for any specific purpose.
One could argue that this can also be achieved by increasing existing tax rates. What makes cess and surcharge different from a ‘tax’ (such as income tax or GST) is the way in which revenue is shared between the Centre and states. The Centre is required to share a certain part of its ‘tax’ revenue with states as per the recommendations of the Finance Commission. On the other hand, it need not share the cess and surcharge revenue with states. In this article, we discuss the growth of cess and surcharge revenue in recent years and how it impacts states.
The entire revenue collected from all central taxes and cesses and surcharges levied by the Centre is called gross tax revenue (GTR). The Centre is mandated to share a portion of the GTR with states (also known as the divisible pool). Article 270 of the Constitution specifies the taxes that form the divisible pool, out of which states get their share. Cesses and surcharges are excluded from the divisible pool, due to which their entire revenue forms part of the Centre’s net tax revenue. When the Finance Commission suggests 42 percent of central tax revenue to be shared with states, this is only out of the divisible pool.
Therefore, the actual devolution to states from the GTR is close to 35 percent.
The share of cess and surcharge revenue in GTR has increased significantly, from nearly 9 percent of GTR in 2012-13 to more than 15 percent in 2018-19. A growing share of cess and surcharge revenue can relatively reduce the size of the divisible pool.
In terms of GDP, during the period 2012-20, Centre’s cess and surcharge revenue is estimated to nearly double from 0.9 percent of GDP to 1.7 percent of GDP. In comparison, GTR declined from 10.4 percent of GDP in 2012-13 to 9.9 percent of GDP in 2019-20. This implies that while the cess and surcharge component has significantly increased, the tax component of GTR (which is shared with states) has not seen a similar increase.
A relatively higher increase in cess and surcharge revenue may be due to an increase in their rates or levy over a wider range of income/ goods/ services through new levies, or both. However, note that in case of taxes on petrol and diesel, the Centre replaced a portion of the tax component with cess or surcharge. Under the Finance Act, 2018, the tax component of both customs and excise duties on petrol and diesel was reduced by Rs 2 per litre and the cess component was increased by an equivalent amount.
So, the overall tax rate on petrol and diesel remained the same, but after this shift, the Centre did not have to share the revenue earned from the cess and surcharge with states, resulting in a loss of Rs 0.84 per litre to states (42 percent of Rs 2 per litre).
The Centre has increasingly used cess and surcharge on petrol and diesel to generate its revenue. In 2018-19, 45 percent of its cess and surcharge revenue came from petrol and diesel. This was generated through the surcharge on petrol and diesel, and the road and infrastructure cess. The cess is levied to generate funds for financing infrastructure projects. Between April 2017 and May 2020, the cess and surcharge component of the excise duty increased by 150 percent in case of petrol and 350 percent in case of diesel. Meanwhile, the tax component (i.e., excise duty going to the divisible pool) reduced by 69% in case of petrol and 57 percent in case of diesel.
The latest increase in cess and surcharge on petrol and diesel was made in May 2020, after Parliament increased the maximum permissible rate through the Finance Act, 2020. As a result, when revenue from most taxes has declined in 2020-21, excise duty revenue (which largely consists of cess and surcharge revenue from petrol and diesel) has increased by 48 percent during Apr-Nov 2020 over the same period the previous year.
This growth is despite an 18% fall in the consumption of petrol and diesel during this period. Fuelled by this growth in cess and surcharge revenue, the Centre’s net tax revenue has declined by merely 8 percent during Apr-Nov 2020, whereas devolution to states has declined by 21 percent during the same period.
Of the total excise duty revenue from petrol and diesel, roughly 55 percent is being collected through the road and infrastructure cess, which will be used for financing infrastructure projects. While auditing the 2018-19 finances of the Centre, the CAG (2020) observed that an amount of Rs 10,157 crore collected through the road and infrastructure cess remained unutilised that year. Similar observations have been made regarding some other cesses as well. In an audit for the year 2016-17, the CAG (2019) observed that cess revenue of Rs 31,156 crore was not transferred to the funds set up for utilisation towards their specific purposes. It noted that Parliament’s mandate for levying a cess is to serve a specific purpose and provide necessary financial impetus to a particular sector of the economy. Since these funds were not spent for the specified purposes, this indicates that cesses are being levied without corresponding expenditure requirements or with no capacity to spend these funds.
Finance Commissions determining the sharing of resources between the Centre and states have also taken cognisance of such issues with cesses and surcharges. The 13th Finance Commission (2010) recommended the Centre to review the levy of cesses and surcharges with a view to reducing their share in its gross tax revenue. The 14th Finance Commission (2015) observed that increasing cesses and surcharges are eroding transferable resources to states and thus, factored in this as one of the reasons for increasing the share of states in the divisible pool.
The author is Senior Analyst at PRS Legislative Research. Views are personal
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