The Centre may consider introducing one or two new cesses  this Budget, one to fund part of Covid-related expenses and another to meet defence  expenditure. A final decision on the number of new cesses will be taken at the highest level and closer to the Budget day, according to multiple sources.

But introducing cesses amid rising demand by States to subsume cess and surcharge into basic tax rates may not go down well with them.

The health allocation is bound to go up due to Covid, necessitating a new cess. While normally the cess would have been applicable  for all taxpayers,  it may not be appropriate at this moment, considering how much the lower-income groups have been impacted by the pandemic.  This leaves open the option of levying a surcharge on the high-income group.

Alternatively, a cess on specific expenditure can be imposed. This again is a  difficult choice as the GST system discourages any new cess on expenditure related  to services.

Defence expenses

A second possible cess is for defence.

DK Srivastava, Chief Policy Advisor with EY India, said such a cess  may be considered once a recommendation for setting up an earmarked fund for defence purposes is received from the Finance Commission.

Cess and surcharge are levied for specific purposes. While every direct taxpayer is required to pay cess, only specified categories of taxpayers with high incomes are required to pay surcharge.  The Centre is not required to share the earnings from cess and surcharge with the States.

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No share for States

The principle of not sharing is causing  great concern for the States, whose finances have been battered by the pandemic. Thus, at  a pre-Budget consultation with Finance Minister Nirmala Sitharaman on Monday, at least two States — Tamil Nadu and Telangana — urged the merging of cess and surcharge with basic tax rates.

Tamil Nadu Deputy Chief Minister and Finance Minister O Paneerselvam said  the levy of cesses and surcharges  deprives the States of their legitimate share of the Centre's tax revenue. “All such cesses and surcharges should be merged into the basic rate of tax, so that the States also receive their due share from the additional revenue,” he said.

For similar reasons, Telangana Finance Minister T Harish Rao asked the Centre to do away with the practice. His suggestion was that the Centre should increase the rates of taxes where the States can get a better share.

The share of cesses and surcharges in the revenue mix has been increasing,  particularly after the recommendations of the  14th Finance Commission, which raised the States’ share in the  divisible pool of taxes to 42 per cent from the earlier 32 per cent, observed EY’s Srivastava.

Cesses and surcharges, excluding the GST compensation cess, relative to the Centre’s gross tax revenues, have increased 6.3 percentage points, from 8.9 per cent in FY13 to 15.2 per cent in FY19. Revised estimates show a further increase to 15.6 per cent in FY20.

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