Cesses, Surcharges, and Fiscal Federalism: Article 270 & PAC Audit

Overview

The rapid expansion of non-divisible cesses and surcharges creates severe friction in Indian fiscal federalism. These levies allow the Union Government to collect substantial revenues that legally bypass the Article 270 tax-sharing pool. At the same time, central ministries often fail to transfer earmarked receipts into dedicated reserve accounts.

According to Comptroller and Auditor General (CAG) Report No. 6 of 2026, the Union Government retained ₹9,222 crore of earmarked cesses within the Consolidated Fund of India during financial year 2024–25 rather than transferring them to statutory reserve accounts.

This accounting practice reduces the untied revenue transferred to States. It also temporarily masks central deficit numbers, putting pressure on the framework established under the Constitution (Eightieth Amendment) Act, 2000.

Parliament's Public Accounts Committee (PAC) scrutinised the Union Ministry of Finance in September 2026 over the non-transfer of ₹9,222 crore in statutory cess collections. As of September 2026, legislative oversight intensified after audit findings showed that collected levies remained inside general revenues instead of moving into designated Public Accounts.

Key dimensions of the parliamentary scrutiny include:

• Audit Disclosure: The CAG revealed that collected cess proceeds stayed inside the Consolidated Fund of India (CFI) rather than moving to designated reserve accounts.
• Constitutional Bypass: Ordinary central taxes must be shared through the divisible pool under Article 270, but statutory cesses legally bypass this requirement.
• Federal Impact: Retaining these proceeds in general revenues weakens fiscal federalism and undermines parliamentary financial control.

The Constitution of India establishes distinct legal categories for Union revenues. Taxpayers often see them as interchangeable deductions on a salary slip. Under public finance law, their statutory design and fund destinations differ substantially.

Indian fiscal law classifies these levies across three distinct instruments:

• Ordinary Tax: An un-earmarked compulsory financial charge on income, commodities, or transactions under Article 266. Tax proceeds enter the Consolidated Fund of India and fund general expenditure through an Appropriation Act.
• Cess: A dedicated statutory levy imposed as a tax-on-tax for an explicit, pre-determined socio-economic objective. Collections enter the CFI initially, but Parliament must appropriate these exact sums into a non-lapsable Reserve Fund in the Public Account.
• Surcharge: An additional percentage charge levied directly on an existing base tax rate. Surcharges carry no mandated legislative purpose and accrue directly to the CFI for unrestricted central spending.

Indian public finance law distinguishes taxes, cesses, and surcharges across their constitutional source, revenue divisibility, fund management, and expenditure restrictions.

The distribution of tax revenues between the Union and States rests primarily on Article 270 and Article 271 of the Constitution. This constitutional mechanism governs which central collections must be distributed to regional governments and which streams remain exclusive to New Delhi.

Article 270(1) mandates that all taxes and duties levied and collected by the Union Government form a unified pool shared with the States. The Constitution explicitly excludes specific categories from this pool:

• Duties and taxes covered under Articles 268, 269, and 269A;
• Surcharges levied for Union purposes under Article 271;
• Any cess levied for specific purposes under legislation enacted by Parliament.

The Constitution (Eightieth Amendment) Act, 2000 fundamentally restructured central-state financial arrangements. Implementing the alternative devolution scheme framed by the Tenth Finance Commission, the 80th Amendment brought all Central taxes into a single divisible pool while expressly retaining the exclusion for cesses and surcharges.

Article 271 grants Parliament sovereign authority to increase any tax or duty under Articles 269 and 270 by imposing an exclusive Union surcharge. The entire proceeds form an unshared part of the Consolidated Fund of India. While the Constituent Assembly conceived Article 271 as a temporary instrument for emergencies, successive budgets have turned surcharges into permanent revenue pillars.

Comptroller and Auditor General Report No. 6 of 2026 detailed major accounting lapses in transferring statutory levies during financial year 2024–25. The audit revealed that ₹9,222 crore collected under specific legislative enactments was never transferred to its designated accounts.

Paragraph 3.3.1 of the CAG audit confirmed that the Union Government collected these revenues from taxpayers but retained them directly inside the Consolidated Fund of India. Total collections across all Union cesses, surcharges, and statutory levies reached ₹3,89,220 crore during financial year 2024–25.

The short-transfers spanned vital developmental sectors:

• The Pradhan Mantri Swasthya Suraksha Nidhi (PMSSN) received ₹6,646 crore less than the ₹21,085 crore collected under the health cess;
• The Prarambhik Shiksha Kosh (PSK) experienced a short-transfer of ₹1,270 crore against its dedicated education cess collection;
• Two additional statutory reserve funds suffered corresponding shortfalls, bringing the total un-transferred balance to ₹9,222 crore for the single fiscal year.

This failure of statutory compliance undermines legislative intent. When Parliament levies a cess, citizens pay a targeted premium on the condition that the funds serve that specific objective. Retaining these balances inside the Consolidated Fund creates an un-earmarked cash cushion that can artificially compress the fiscal deficit on paper.

The statutory process follows three distinct steps, alongside the identified accounting diversion:

1. Tax Collection: Taxpayer pays cess into the Consolidated Fund of India.
2. Statutory Transfer: Parliament passes an appropriation to transfer sums to a dedicated Public Account.
3. Identified Audit Gap: ₹9,222 crore was retained in the CFI rather than transferred, temporarily masking central deficit figures.

The Public Accounts Committee, a parliamentary panel of 22 members (15 from the Lok Sabha and 7 from the Rajya Sabha) led traditionally by an Opposition chairperson, exercises post-facto scrutiny over Union accounts pursuant to Article 151 and Rule 308 of Lok Sabha procedure. The PAC had issued clear directions in its 69th Report in August 2023, demanding that all cess receipts be moved to non-lapsable funds without delay. The recurring short-transfers in 2024–25 demonstrate persistent administrative friction in central accounting.

State governments have raised sharp objections because the expanding proportion of cesses and surcharges steadily erodes their unconditional revenue transfers. By structuring tax hikes as cesses rather than basic rate increases, the Centre captures 100% of the incremental yield.

The structural composition of Union tax receipts has transformed over the past decade:

• The share of cesses and surcharges in the Union's Gross Tax Revenue (GTR) rose from 8.16% in FY 2011–12 to over 28% in FY 2021–22;
• The divisible pool as a proportion of total central collections has narrowed concurrently;
• As a direct consequence, actual devolution to States as a percentage of Gross Tax Revenue stands between 29% and 32%.

This divergence creates a misleading headline picture. While the Fifteenth Finance Commission prescribed a 41% vertical devolution share, the exclusion of non-divisible cesses means States receive nearly ten percentage points less of total central tax collections. States argue this trend severely limits their fiscal autonomy, forcing greater dependence on tied Centrally Sponsored Schemes.

Successive Finance Commissions and constitutional review committees have proposed institutional safeguards to curb the unchecked reliance on non-divisible levies.

The Sarkaria Commission on Centre-State Relations (1988) examined Article 271 in detail. The Commission recommended that surcharges should remain strictly temporary devices to meet sudden, unforeseen emergencies. The panel advised amending the Constitution to ensure that surcharges maintained beyond short durations become part of the divisible tax pool.

Subsequent Finance Commissions adjusted their awards to counteract this structural erosion:

• The Fourteenth Finance Commission increased the States' devolution share from 32% to 42% explicitly to offset the proliferation of central cesses;
• The Fifteenth Finance Commission maintained vertical devolution at 41% (adjusted for Jammu & Kashmir) and formally highlighted how high non-divisible levies constrict state finances;
• A research study by the Vidhi Centre for Legal Policy submitted to the 15th Finance Commission noted that over 42 separate cesses have been introduced since 1944, demonstrating how temporary levies become entrenched revenue instruments.

Reforming India's fiscal architecture requires statutory caps on cesses, strict accounting timelines, and a constitutional recalibration of the divisible tax pool. To safeguard federal balance and maintain transparent accounting, the Union and States must pursue coordinated systemic reforms.

1. Constitutional Cap on Non-Divisible Collections: Parliament should consider placing a constitutional ceiling on the proportion of Gross Tax Revenue that can be raised through cesses and surcharges. Capping this component at 10% of GTR would protect the integrity of the Article 270 divisible pool.
2. Mandatory Sunset Clauses on Cesses: Every newly enacted cess should carry a rigid statutory sunset clause of three to five years. If a socio-economic programme requires sustained long-term financing, the Union should integrate the levy into standard tax rates rather than extending temporary cesses indefinitely.
3. Automated Transfer to Reserve Funds: The Ministry of Finance should establish automated accounting mechanisms within the Public Account. Earmarked cess receipts should transfer automatically to their corresponding non-lapsable funds within the same financial year to eliminate arbitrary retention in the Consolidated Fund of India.
4. Independent Audit of Public Accounts: The Comptroller and Auditor General should present a standalone annual compliance report on the accrual, transfer, and end-use utilisation of all statutory reserve funds to ensure continuous oversight by the Public Accounts Committee.

• Article 270(1) governs the divisible pool of Union taxes shared with States, but Article 271 and statutory cesses remain explicitly excluded from this revenue sharing.
• The Comptroller and Auditor General found that ₹9,222 crore of earmarked cesses collected during FY 2024–25 was retained in the Consolidated Fund of India instead of being transferred to designated reserve funds.
• Cesses and surcharges grew from 8.16% of Gross Tax Revenue in FY 2011–12 to over 28% in FY 2021–22, shrinking actual tax devolution to 29%–32% of central receipts despite the 15th Finance Commission's 41% recommendation.
• The Sarkaria Commission recommended that Article 271 surcharges be temporary emergency measures and subject to sharing if prolonged.
• The Public Accounts Committee (22 members under Rule 308) exercises constitutional oversight pursuant to Article 151 to enforce accounting compliance and ensure that earmarked public revenues reach their statutory funds.