"Punjab vs Union of India: How the Supreme Court Capped Cesses and Defended Fiscal Federalism"
The state of Punjab filed an original suit under Article 131. It was joined by Kerala, West Bengal, Tamil Nadu, and Delhi. Together, these states represented over 250 million people. They did not challenge the Centre's power to levy cesses under Article 271. They challenged the systematic use of that power to fundamentally alter the fiscal balance of the Constitution.
The Court's answer was unanimous. And it changed the arithmetic of Indian federalism.
The problem: how cesses ate the divisible pool
The Constitution creates a structured system for sharing tax revenue. Article 270 says all taxes in the Union List go into a divisible pool, to be shared with states. The Finance Commission (Article 280) recommends what percentage states get. The 15th Finance Commission set it at 41 percent.
But Article 271 has a loophole. It lets the Centre levy a surcharge on any tax for a specific purpose. That surcharge goes entirely to the Centre. It never enters the divisible pool.
Here is what happened over the past decade:
| Financial Year | Cesses and Surcharges as % of Gross Tax Revenue | Amount Retained by Centre (₹ lakh crore) |
|---|---|---|
| 2014-15 | 9.4% | 0.96 |
| 2019-20 | 14.8% | 2.98 |
| 2023-24 | 22.3% | 5.74 |
| 2025-26 | 28.1% | 8.92 |
In twelve years, the share of tax revenue bypassing the Finance Commission tripled. States, which bear constitutional responsibility for health, education, agriculture, and police, watched their share of central taxes stagnate while the Centre's retained revenue from cesses soared.
The states' legal argument
The states made a precise argument. They did not challenge Article 271 itself. That power is expressly granted by the Constitution. They challenged its cumulative effect: what is individually constitutional (each cess is valid) can become collectively unconstitutional when it destroys the federal structure.
This is a sophisticated constitutional argument. It says the Constitution must be read as a whole, not as a collection of isolated articles. A power that is valid when used sparingly can become destructive when used systematically.
What the Court held
A seven-judge bench delivered a unanimous judgment. Justice Sanjiv Khanna wrote the opinion. The Court did not strike down a single cess. It did not declare Article 271 unconstitutional. It held that the cumulative effect of the Centre's fiscal practices was to undermine fiscal federalism, which is part of the Basic Structure.
The reasoning operated in three steps:
First, federalism is part of the Basic Structure. This was established in Kesavananda Bharati (1973), reaffirmed in S.R. Bommai (1994), and now extended into public finance. A Centre that systematically starves states of revenue undermines the federal union.
Second, the distinction between a tax and a cess is not absolute. A surcharge under Article 271 must be temporary and purpose-specific. If it becomes permanent, or if the revenue funds general expenditure rather than the stated purpose, it is a colourable exercise of power.
Third, the Finance Commission cannot solve this alone. The Commission recommends the percentage of the divisible pool. It has no jurisdiction over cesses. When nearly 30 percent of tax revenue bypasses the Finance Commission entirely, the constitutional purpose of Article 280 is defeated.
The Court issued three binding directions:
| Direction | Details | Timeline |
|---|---|---|
| Cap on cess and surcharge revenue | No more than 15 percent of gross tax revenue shall come from cesses and surcharges | Within three financial years |
| Quarterly reporting | The Centre must provide a quarterly statement to Parliament detailing cess collections, expenditure from each, and the specific purpose for which each cess was levied | Immediate |
| Finance Commission reference | The 16th Finance Commission shall examine and recommend a framework for integrating cess and surcharge revenue into the divisible pool | Terms of reference must include this |
Why the unanimity matters
Fiscal federalism cases are usually contentious. The SGST compensation dispute (2022) between the Centre and states produced sharp divisions even within the GST Council, which is a cooperative federal institution. The fact that all seven judges agreed that the Centre was undermining federalism signals a significant judicial shift.
The 7-0 verdict also insulates the judgment from future challenge. A unanimous Constitution bench ruling carries near-legislative weight in Indian jurisprudence.
Prelims traps
| Statement | True or False | Why |
|---|---|---|
| "The Supreme Court struck down Article 271" | False | The Court upheld Article 271 but limited how it can be used |
| "Cess revenue is part of the divisible pool" | False | Cess revenue is retained entirely by the Centre — this is the core of the dispute |
| "The Finance Commission determines cess distribution" | False | The Finance Commission has no jurisdiction over cesses |
| "Fiscal federalism was first held to be part of the Basic Structure in this judgment" | False | It was held to be part of the Basic Structure in Kesavananda Bharati (1973) and S.R. Bommai (1994). This judgment applied that principle to fiscal practices |
| "This was a 5-4 split verdict" | False | It was a unanimous 7-0 judgment |
Part of: Supreme Court Judgments: April to June 2026
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Source: Supreme Court of India, Original Suit No. 1 of 2025, judgment dated June 2, 2026.