Daily RC and Vocabulary 30th January 2026

Cesses and surcharges levied by Centre must be in divisible pool

While the Union Budget is keenly tracked by States to assess their share in overall Central tax devolution, it is becoming increasingly clear that this revenue stream no longer plays the stabilising role it once did in State finances. The evidence lies in the rapid expansion of State Development Loans (SDLs), which have emerged as a key financing instrument for States’ day-to-day spending needs. In 2024-25 (Revised Estimates), SDLs amounted to about 35% of Tamil Nadu’s total revenue receipts and nearly 26% of Maharashtra’s — levels that would have been considered fiscally exceptional a decade ago. This shift gathered pace after 2020-21, when the COVID-19 pandemic delivered a severe economic shock and Central devolution proved inadequate. This dependence on borrowing has not reversed since. Instead, States are increasingly relying on SDLs; borrowings by profit-making State PSUs and Special Purpose Vehicles are done to finance even routine revenue expenditure. This has happened despite the 15th Finance Commission fixing States’ share at 41% of the divisible pool, as the effective flow of resources has been eroded by the growing use of cesses and surcharges, which lie outside the divisible pool. The problem is acute for industrialised States with a large indirect tax base. Since the introduction of GST in 2017, a substantial share of these revenues is collected by the Centre and redistributed through a formula that often weakens the fiscal link between tax effort and reward. Consequently, welfare commitments — pensions for the elderly and retired employees and mass health insurance schemes for the poor — are increasingly being funded through domestic borrowing. This limits the availability of funds for public capital expenditure and private investment, which is essential to sustain growth.

A comparison of borrowing patterns over the past five years across Punjab, Uttar Pradesh, Tamil Nadu, Maharashtra and West Bengal underlines this trend. West Bengal, which is structurally dependent on Central devolution — averaging about 47.7% of its revenue receipts over the last five years — continued to borrow heavily from the domestic market. SDLs constituted roughly 35% of the State’s revenues on average during this period, even as nominal tax devolution rose. This points to a steady erosion of States’ fiscal autonomy, with potentially serious macroeconomic consequences as debt-to-GSDP ratios rise while assured revenue streams weaken. If debt, rather than devolution, becomes the primary shock absorber in India’s federal system, fiscal sustainability itself comes under strain. India needs higher effective devolution, and a reworking of horizontal devolution criteria to give greater weight to tax effort and efficiency. Cesses and surcharges must be brought into the divisible pool.

 

1. Devolution

Meaning: Transfer of powers, responsibilities, or revenues from a higher level of government to a lower one.

Example:

Inadequate fiscal devolution weakens the autonomy of States in India’s federal structure.

2. Divisible Pool

Meaning: Portion of the Centre’s gross tax revenue that is shared with States as per constitutional provisions.

Example:

Cesses and surcharges remain outside the divisible pool, reducing States’ effective share.

3. Fiscal Autonomy

Meaning: The ability of a government unit to independently raise and spend financial resources.

Example:

Rising dependence on borrowing has eroded the fiscal autonomy of States.

4. Erosion

Meaning: Gradual weakening or reduction of strength, value, or authority.

Example:

The increasing use of cesses has led to an erosion of cooperative federalism.

5. Shock Absorber

Meaning: A mechanism that cushions the impact of economic or fiscal disturbances.

Example:

Tax devolution, rather than debt, should function as the primary shock absorber for States.

6. Macroeconomic Consequences

Meaning: Economy-wide effects influencing growth, debt, stability, or investment.

Example:

Unchecked State borrowing may have serious macroeconomic consequences.

7. Crowding Out

Meaning: A situation where increased public borrowing reduces private investment.

Example:

Excessive State debt can crowd out private capital formation.

8. Fiscal Sustainability

Meaning: The capacity of a government to maintain finances without excessive borrowing over time.

Example:

Financing routine expenditure through debt threatens fiscal sustainability.

9. Redistributive Formula

Meaning: A rule-based mechanism for reallocating resources among different units.

Example:

GST relies on a redistributive formula that weakens the link between tax effort and reward.

10. Intergenerational Burden

Meaning: Financial obligations passed on to future generations due to present borrowing.

Example:

Borrowing for consumption creates an intergenerational burden without asset creation.

 

Q1.

The primary concern expressed by the author regarding the increasing use of State Development Loans (SDLs) is that it:

A. Reflects inefficiency in State-level tax administration

B. Signals a temporary fiscal imbalance caused by the pandemic

C. Indicates a structural weakening of assured revenue mechanisms

D. Violates constitutional borrowing limits imposed on States

Q2.

The author’s reference to States borrowing even for routine revenue expenditure most strongly implies that:

A. Welfare schemes are inherently fiscally unsustainable

B. Capital expenditure has become fiscally irrelevant

C. The nature of State borrowing has undergone a qualitative shift

D. States prefer debt over grants for political reasons

Q3.

Which one of the following best captures the author’s criticism of the Centre’s increasing reliance on cesses and surcharges?

A. It increases inflationary pressures in the economy

B. It undermines the constitutional logic of shared taxation

C. It discourages States from expanding their tax base

D. It disproportionately benefits poorer States

Q4.

According to the passage, why are industrialised States particularly disadvantaged under the post-GST fiscal arrangement?

A. Their direct tax bases have declined sharply

B. Their expenditure commitments are higher than poorer States

C. The link between tax effort and fiscal reward has weakened

D. They are excluded from Finance Commission grants

Q5.

The discussion on West Bengal’s borrowing pattern primarily serves to:

A. Highlight inefficiencies in State-level expenditure management

B. Demonstrate that high Central transfers do not guarantee fiscal stability

C. Argue for differential borrowing limits across States

D. Show the failure of GST compensation mechanisms

Q6.

Which of the following assumptions is most central to the author’s argument?

A. States will eventually default on their debt obligations

B. Borrowing is inherently inferior to taxation

C. Fiscal federalism requires predictable and shareable revenue streams

D. Welfare expenditure should be reduced to control debt

Q7.

The phrase “debt, rather than devolution, becomes the primary shock absorber” suggests that:

A. States are deliberately avoiding fiscal discipline

B. Market borrowing is replacing institutional fiscal support

C. The Centre is unwilling to support States during crises

D. State finances are insulated from economic shocks

Q8.

Which of the following policy responses is most consistent with the author’s recommended way forward?

A. Increasing States’ borrowing limits during economic downturns

B. Expanding discretionary grants from the Centre

C. Including cesses and surcharges within the divisible pool

D. Replacing GST with State-level indirect taxes

Q9.

The tone of the editorial can best be described as:

A. Alarmist and adversarial

B. Normative but evidence-driven

C. Descriptive and neutral

D. Ideological and polemical

Q10.

Which one of the following best summarises the central argument of the passage?

A. Rising State debt is inevitable in a developing economy

B. GST has failed to deliver fiscal stability to States

C. Effective devolution, not borrowing, should anchor fiscal federalism

D. Welfare expenditure must be curtailed to restore fiscal balance

 

1. C – The concern is structural erosion of assured devolution, not temporary stress

2. C – Borrowing has shifted from capital creation to routine expenditure

3. B – Cesses bypass constitutionally mandated sharing

4. C – Tax effort no longer translates into proportional revenue gains

5. B – Even high devolution does not prevent fiscal stress

6. C – Predictable, shareable revenues are core to fiscal federalism

7. B – Debt substitutes institutional fiscal transfers

8. C – This directly restores effective devolution

9. B – Normative argument supported by data and examples

10. C – This is the editorial’s core thesis