Despite a 41% vertical share, States' complaints about shrinking fiscal space persist. Analyse the role of cesses and surcharges in this context.

Under Article 270, Union taxes are shared with States, but cesses and surcharges are kept out of the divisible pool [3]. The 16th Finance Commission (2026-31) kept States' vertical share at 41% [1]. The share has not changed, but the base it applies to keeps shrinking, so the headline figure overstates what States actually receive.

How cesses and surcharges shrink the pool

Gross Central Tax Revenue
   − Cesses & Surcharges (not shared)
   − Cost of collection
   = Divisible Pool ──► 41% to States

Fig: The 41% applies only to what remains after these deductions

• Rising share: cesses and surcharges have doubled since 2011 to about 18% of gross central tax revenue [2].
• Effective devolution: States' actual share of the Centre's gross tax revenue was only about 29% in 2020-21, against the recommended 41% [3].
• Shift in tax mix: when the Centre raises money through a cess instead of income tax or GST, States get nothing from it, however strong collections are.

Impact on States' fiscal space

• Rupee gains hide the erosion: devolution up to September 2026 rose by ₹67,658 crore year-on-year [4]. This came from higher tax collection, not from a larger share.
• Persistent demand: most States visited by the 16th FC asked for a 50% share [5].
• Unpredictability: the size of the divisible pool depends on the Centre's choice of tax mix. This makes it hard for States to plan their own budgets.

The Centre's rationale and its limits

• Constitutional backing: the Constitution allows cesses for specific purposes to stay outside the pool [3].
• Weak earmarking in practice: the CAG found that ₹31,156 crore of cess revenue in 2016-17 was never moved into the designated Public Account funds [6]. This undercuts the claim that cesses are earmarked for a specific purpose.

The dispute, therefore, is less about the 41% figure than about the shrinking base it applies to. Three steps would help: a ceiling on cesses and surcharges as a share of gross tax revenue, transfer of cess money to its earmarked funds every year as the CAG recommended [6], and merging long-running levies into the regular tax base. Together they would bring the 41% on paper closer to what States receive and strengthen cooperative fiscal federalism.