Hypothecated taxation — illustrated by the Health Security se National Security Cess — offers both promise and pitfalls for governance. Discuss with reference to India's experience.

Hypothecated (earmarked) taxation ring-fences the proceeds of a specific levy for a named purpose instead of pooling them in the Consolidated Fund. The Health Security se National Security Cess Act, 2025 — a levy on pan masala manufacturing capacity, effective 1 February 2026 — revives this rare device in Indian fiscal practice, and illustrates both its appeal and its risks.

The promise

• Corrective logic: it taxes a demerit good and routes the money to the harm it causes — health infrastructure and national security [1][2]. WHO holds tobacco taxation the single most cost-effective demand-reduction measure [5].
• Predictable, protected financing: a dedicated stream insulates health capital spending from annual budgetary competition; the Government has indicated proceeds will support health schemes with states [1].
• Political acceptability and accountability: a named purpose makes the levy easier to justify, and lets citizens ask whether the promised outcome was delivered.
• Fiscal continuity: paired with the Central Excise (Amendment) Act, 2025, it preserved tax incidence on sin goods as the GST Compensation Cess lapsed [3][4].

The pitfalls

• Federal strain: cesses and surcharges lie outside the divisible pool under Article 270, so revenue raised this way is not shared through the Finance Commission formula — a long-standing state grievance.
• Rigidity: earmarking locks funds to one head irrespective of shifting priorities, and creates a risk of accumulated, unspent balances.
• Permanence of the "temporary": the GST Compensation Cess, legislated in 2017 for five years, ran until 2026 to service COVID-era borrowings — a caution against open-ended levies.
• Narrow, self-eroding base: if the health objective succeeds, consumption and revenue fall; evasion and illicit trade compound the instability.

Hypothecation is therefore a useful instrument, not a fiscal principle. Its promise is realised when the earmark is time-bound, audited, transparently reported, and designed with state consultation — so that a health-and-security cess strengthens cooperative federalism and the Article 47 duty to improve public health, rather than quietly narrowing the divisible pool.