Cesses and surcharges: earmarked and unshared levies

Detail

1. The basic idea: two levies the Centre does not share

• The Centre collects gross tax revenue (GTR), which is all the tax the Union collects before giving anything to states.
• Most of the GTR goes into the divisible pool. This is the part of central taxes that the Centre must share with states on the Finance Commission's advice.
• Cesses and surcharges are kept out of the divisible pool. The Centre keeps 100% of this money.
• The 16th Finance Commission (2026-31) uses the same definition: the divisible pool is GTR minus the cost of collection minus cesses and surcharges [3].

	Cess	Surcharge
What it is	A separate tax collected for a stated purpose	An extra tax charged as a % of the tax already payable ("tax on tax")
Constitutional basis	Kept out of the divisible pool under Art. 270	Art. 271: levied "for the purposes of the Union"
Earmarked?	Yes. It must be spent on the stated purpose	No. It goes to the general fund
Levied on	Income (direct) or goods and services (indirect)	Income tax (individuals, companies) or customs duty
Shared with states?	No	No

2. Constitutional mechanics

• Art. 270 covers the taxes the Union shares with states. It excludes:
• surcharges under Art. 271, and

• cesses levied for specific purposes.

• Because of this, all cess and surcharge revenue stays in the Centre's net tax revenue. None of it is devolved (passed down) to states [2].

• Art. 271 lets Parliament raise the Art. 269 and Art. 270 taxes by a surcharge "for Union purposes". The whole surcharge goes to the Union.
• Key difference:
• A surcharge has no stated purpose. The Centre can spend it on anything.
• A cess carries a promise to spend it on one named purpose, such as health, education or roads.

3. Cess: definition and examples

Cess is a tax levied for one specific, named purpose. Its money is earmarked, meaning set aside only for that purpose.

• How the money should flow:
• Cess money first goes into the Consolidated Fund of India (the government's main account).

• It should then be moved to a dedicated fund in the Public Account, and spent only from that fund.

• Health and Education Cess (2018):

• Rate: 4% on income tax plus surcharge.

• It replaced the 2% education cess and the 1% secondary and higher education cess (3% in total).

• Road and Infrastructure Cess: charged on petrol and diesel. It pays for road and infrastructure projects.

• Agriculture Infrastructure and Development Cess (AIDC), 2021: pays for farm infrastructure.
• GST compensation cess: pays states for revenue they lost after GST came in. See Section 7.
• Health Security se National Security (HSNS) Cess:
• The Bill was introduced in Lok Sabha on 1 December 2025 and passed by Parliament [4][5].
• Base: the production of pan masala and any other goods the Centre notifies later. The tax falls on the person who owns or runs the machines or processes, not on each packet sold [4][5].
• How it is calculated: per machine installed or per unit of manual production. It is collected monthly [4].
• Rates:
  • ₹1.01 crore per month per machine for machines with a maximum speed of up to 500 pouches a minute, where each pouch weighs up to 2.5 g [4].
  • ₹25.47 crore per month per machine for machines running at 1,001 to 1,500 pouches a minute, where each pouch weighs more than 10 g [4].
  • ₹11 lakh per month per factory where production is fully manual [4].
• Use of the money: spending on public health and national security [4][5].
• Why tax capacity and not sales: machine capacity is hard to hide. Declared sales are easy to under-report.

4. Surcharge: definition, rates and a worked example

Surcharge is an extra tax charged as a percentage of the tax already payable. It is not a percentage of income.

• Formula:
• Surcharge = Surcharge rate × Income tax payable
• Cess = 4% × (Income tax + Surcharge)

• Total tax = Income tax + Surcharge + Cess

• Individuals:

Income	Surcharge rate
Above ₹50 lakh	10%
Above ₹1 crore	15%
Above ₹2 crore	25%
Above ₹5 crore	37% (capped at 25% in the new regime)

• Companies:
• 7% on income above ₹1 crore.
• 12% on income above ₹10 crore.

• Section 115BAA firms (companies that chose the lower-rate corporate tax regime) pay a flat 10%.

• Social Welfare Surcharge (SWS), 2018:

• It is levied on customs duty, the tax on imports.

• So it is an indirect tax, not a direct one.

• Worked example (illustrative):

• A person's income is ₹60 lakh and the income tax on it is ₹15 lakh.
• Surcharge = 10% × ₹15 lakh = ₹1.5 lakh.
• Cess = 4% × (₹15 lakh + ₹1.5 lakh) = ₹66,000.
• Total tax = ₹15 lakh + ₹1.5 lakh + ₹0.66 lakh = ₹17.16 lakh.
• Who keeps what: the Centre keeps all ₹2.16 lakh of surcharge and cess. States get a share only of the ₹15 lakh base tax.

5. Issue 1: a rising share

• Long-term trend: cesses and surcharges were 2.3% of the Centre's GTR in 1980-81 and 15% in 2019-20 [2].
• 2020-21 to 2022-23: more than 15% of GTR each year came from cesses and surcharges [6].
• Scaffold figure: about 10% of GTR in the early 2010s, rising to a peak of about 18-20% in 2020-22. The scaffold marks this as "verify current". The PRS data above gives a lower figure of >15% for 2020-23 [6], so treat 18-20% as an upper estimate.
• Why the share rose:
• The 14th Finance Commission raised states' share to 42% (2015-20).
• The Centre then leaned more on levies it did not have to share, especially cesses on fuel.

6. Issue 2: weak earmarking

• CAG finding for 2016-17: ₹31,156 crore of cess revenue was not moved to the dedicated funds in the Public Account [7].
• What this means:
• The money stayed in the Consolidated Fund.

• It was used like general revenue, which defeats the purpose of earmarking.

• Why it matters:

• A cess can be justified only because it is tied to a purpose.
• If the money is not tied in practice, a cess works like an unshared surcharge.

7. Issue 3: the federal cost (the "devolution gap")

Devolution means the Centre passing a share of its tax revenue to states.

• The formula states see: states get 41% of the divisible pool.
• This rate applied under the 15th Finance Commission.

• The 16th Finance Commission kept it at 41% for 2026-31 [3].

• What states actually get:

• 2019-20: only 85% of GTR formed the divisible pool. The 42% share therefore worked out to 35.7% of GTR [2].

• 2024-25 (Budget Estimates): the 41% share worked out to only 32% of GTR [6].

• Worked example (illustrative):

• GTR = ₹100.
• Cesses and surcharges = ₹15 (collection cost ignored for simplicity).
• Divisible pool = ₹100 − ₹15 = ₹85.

• States' share = 41% × ₹85 = ₹34.85, which is about 35% of GTR and not 41%.

• The chain of cause and effect:

• The Centre raises more money through cesses and surcharges.
• The divisible pool shrinks as a share of GTR.

• States get less money, even though their percentage share has not changed.

• What the 16th Finance Commission did: it made no recommendation to cap cesses and surcharges [3].

• The fuller discussion is in the Fiscal Federalism note.

Prelims Hooks

• Cess: earmarked for a stated purpose. Surcharge: not earmarked. Neither is shared with states.
• Art. 271 covers the surcharge for Union purposes. Art. 270 covers the shared taxes and leaves out cesses and surcharges.
• Surcharge is a % of the tax payable ("tax on tax"). The Health and Education Cess (4%, 2018) is charged on income tax plus surcharge.
• The 4% Health and Education Cess replaced the 2% education cess + 1% secondary and higher education cess.
• Social Welfare Surcharge is levied on customs duty, so it is an indirect tax. Watch for the trap that calls it direct.
• HSNS Cess (2025) is levied on machine capacity or production of pan masala, not on each packet. It pays for public health and national security [4].
• The top individual surcharge of 37% is capped at 25% in the new regime. 115BAA firms pay a flat 10% surcharge.
• 16th Finance Commission (2026-31): states get 41% of the divisible pool, and the pool excludes cesses, surcharges and collection cost [3].
• Cess and surcharge share of GTR: 2.3% (1980-81) → 15% (2019-20) [2].

Mains Points

• Fiscal federalism (GS-II/III):
• The headline share of 41% becomes about 32% of GTR (2024-25 BE) [6], because more revenue is raised through unshared cesses and surcharges.
• This weakens the Finance Commission's role and cuts states' money without any change to the formula.

• Possible fixes: cap cesses and surcharges at a set % of GTR, add them to the divisible pool after a time limit, or amend Art. 270.

• Accountability:

• The CAG found ₹31,156 crore (2016-17) of cess money not moved to the dedicated funds [7].
• This shows earmarking is weak.

• Possible fixes: automatic transfer to Public Account funds, a sunset (end) date for each cess, and reporting to Parliament on how the money was spent.

• The case for the Centre:

• Surcharges add progressivity, meaning the richest pay a higher share of their income as tax.
• Cesses can fund national priorities, such as health, defence and roads, when the Centre's fiscal space is tight.

• The HSNS cess also works as a Pigouvian (corrective) tax on a harmful product. It taxes production capacity to stop evasion [4].

• Tax design:

• Many cesses and surcharges add layers to the tax system, make it harder to understand, and blur the line between direct and indirect taxes.
• This goes against the aim of a simple, broad-based system with low rates, which was the idea behind GST and the new income tax regime.