Cess and surcharge continue to shrink States’ tax share

Of every ₹100 that the Union government collects as tax, ₹10-11 is collected as cesses and surcharges, a trend unchanged since the pandemic year 2020-21. Also, the government spends ₹1-2 in collecting every ₹100 of tax; this is called the cost of collection. The amount collected as cesses and surcharges, along with the cost of collection, is not included in the divisible pool of taxes, a portion of which is meant to be shared with the States.

The share of cesses and surcharges, along with the cost of collection, reached a high of ₹13.5 for every ₹100 collected as taxes by the Centre in 2021-22 — the highest ratio in at least over a decade. Since then, it has gradually declined and is expected to be around ₹10.97 according to the latest Budget Estimates (BE) for 2025-26. In contrast, in many years before the pandemic, this figure ranged only between ₹5 and ₹7.

Divisible pool has shrunk.

Let us now look at these figures from the perspective of the divisible pool. Given that the share of cesses and surcharges has increased over the years, the divisible pool has shrunk. Since the pandemic year 2020-21, the divisible pool has fallen to less than ₹90 for every ₹100 that the Centre collects. It is expected to remain below ₹90, according to BE for 2025-26, presented on February 1. In contrast, in many years before the pandemic, this figure ranged between ₹91 and ₹95.

Chart 1 shows the share (in %) of the divisible pool in the Centre’s gross tax collection over the years (left axis). It also shows cesses, surcharges, and the cost of collection of taxes as a share of the Centre’s gross tax collection over the years (right axis).

Currently, all the States put together get 41% of the divisible pool, a figure arrived at as per the recommendations of the 15th Finance Commission for the FY 21-26 period. Before that, the share was pegged at 42% of the divisible pool between FY16 and FY20, a massive increase from the 32% share before FY16.

However, the consistent rise in the share of cesses and surcharges has meant that the Finance Commissions’ recommendations have been rendered less effective, as the divisible pool itself is shrinking. Many experts have previously pointed out that despite a formula in place, in practice the actual devolution to the States falls short of the agreed recommendations. In fact, many non-BJP ruling States now want this share to increase to 50% from 41%.

GST compensation cess was not included in the list of cesses considered, as it was collected to compensate the States for revenue loss due to implementation of GST.

Usage of cess

While the rise in cesses and surcharges is one part of the problem, they are often not used for the specific purposes for which they were collected.

Many Comptroller and Auditor General of India (CAG) audit reports have pointed out that these cesses are not being completely transferred to the reserve funds or adequately utilised for the intended purposes. For instance, the crude oil cess is meant to be transferred to the oil industry development body, which is not followed. In the latest three such reports, the CAG pointed out that about ₹2.19 lakh crore in cesses meant for transfer to the designated Reserve Funds between FY20 to FY22 did not happen.

While all the States put together get 41% of the divisible pool, the share of each State in that is calculated based on a formula, which is decided by the Finance Commission. Predominantly, it is decided by income distance, which measures how far a State is from the State with the highest per capita income. Other factors such as population, demographic performance (population control), forest cover, area and efficiency in tax collection are also given weightage.

Certain States have also raised an issue with the way their share in the divisible pool is being calculated as they feel that the formula is subject to political bias and they are losing out on account of economic and social progress.

Share of States in divisible pool

The share of various States in the divisible pool has undergone significant changes since FY02, as shown in Table 2. 

The share of all the southern States has fallen. Kerala’s share fell from 3.08% in FY02 to 2.5% in FY17 and is estimated to fall even further to 1.9% in FY26 (BE). Tamil Nadu’s share shrunk from 5.46% in FY02 to 4.02% in FY17 and is expected to remain at the same level in FY26. Karnataka’s has come down from 4.98% in FY02 to 3.6% in FY26 BE. The share of Andhra Pradesh and Telangana together declined from 7.7% in FY02 to 6.75% in FY17 and is expected to drop to 6.1% in FY26. West Bengal and Odisha’s shares have also come down consistently in the period. In contrast, the shares of Madhya Pradesh, Maharashtra, Rajasthan, and Gujarat have increased in this period.

States such as Uttar Pradesh and Bihar continue to receive the bulk of the share. Bihar is expected to get 10.1% in FY26, slightly lower than 11.49% in FY02; and Uttar Pradesh is expected to get 17.9% in FY26, slightly lower than 19.15% in FY02.

As the data show, not only is the divisible pool shrinking, but the share allocated to certain States — most of which are in south India and parts of the east — is also dwindling. This imbalance explains why many of these States now feel short changed.

Source: The data for the charts were sourced from Union Budget documents and CMIE. It also includes The Hindu’s calculations.

samreen.wani@thehindu.co.in

Also Read:How States’ share in Centre’s taxes declined due to cesses, explained in 5 charts