The discourse on fiscal devolution in India predominantly centres on transfers from the Centre to the States, often neglecting the equally crucial devolution from State governments to local bodies. Despite the constitutional mandate under the 73rd and 74th Amendments, local governments remain fiscally constrained, with their share of total government expenditure at less than 7 per cent. This lack of financial autonomy severely limits their ability to address pressing urban challenges. As a result, Indian cities, expected to drive the nation’s economic growth, struggle with inadequate infrastructure, unreliable basic services, and environmental degradation.
Decentralisation is often touted as a means to foster intergovernmental competition and maximise social utility. However, in India, this principle is undermined as urban local bodies (ULBs) remain financially constrained. Over the last three decades, little progress has been made in empowering ULBs, which are almost entirely reliant on grants from State Finance Commissions (SFCs) and the Union Finance Commission (UFC).
The shortcomings of SFCs compound the problem. Many States fail to constitute SFCs as mandated by Article 243I of the Constitution, delaying the distribution of taxes and grants to local bodies. Even when constituted, SFCs struggle with resource constraints, such as inadequate infrastructure and lack of updated fiscal data, leading to delays and ad-hoc recommendations. Furthermore, States often ignore SFC reports, delay their presentation to legislatures, or reject their recommendations outright. In some cases, States even fail to implement recommendations which they themselves have accepted, as seen in Bihar’s failure to release funds for FY 2015-16. This neglect of SFCs undermines the constitutional obligation of States to ensure resource devolution to ULBs, leaving them perpetually underfunded and incapable of meeting their responsibilities.
To address the persistent fiscal constraints faced by ULBs, the solution lies not only in better implementation of intergovernmental transfers but also in empowering ULBs to mobilise their own revenues effectively. Over-reliance on grants from SFCs and the UFC has stifled their autonomy and created a cycle of dependency, leaving cities ill-equipped to tackle urbanisation challenges. Mobilising their own source revenue is therefore, essential for ensuring financial self-reliance and enabling cities to invest in sustainable urban development. Although the proportion of municipal corporations’ OSR (own-source revenue) to their total revenue expenditure has improved nationwide, the progress remains insufficient. One should read RBI’s report on Municipal Finances which was released on November 13. The median ratio is still below 0.5, indicating that over half of all municipal corporations rely on external sources to fund more than 50 per cent of their revenue expenditures.
MCs in India struggle to finance their revenue expenditures through OSR, except in States like Andhra Pradesh, Telangana and Goa. In Jammu and Kashmir, Arunachal Pradesh, Uttarakhand, Bihar, Uttar Pradesh, Rajasthan, and Odisha, OSR accounts for less than one-third of revenue expenditures, creating a structural imbalance in municipal finances. From 2020-21 to 2022-23, OSR constituted an average of 59 per cent of total revenue receipts for MCs, with tax revenues forming the largest component (47.1 per cent). Property tax, the dominant source, made up 59.1 per cent of tax revenues on average during this period. However, the growth in property tax collections has failed to keep pace with the rapid rise in urban property values, exacerbating fiscal constraints and limiting the financial autonomy of MCs. Further, this over-dependence on property tax reveals a glaring lack of innovation and diversification in revenue-generation strategies. Political compulsions often exacerbate this stagnation, as local bodies hesitate to levy or raise taxes like vehicle tax, advertisement tax, or cess for fear of public backlash.
Property taxes
Several avenues exist for ULBs to enhance OSR generation. Property taxes, a major revenue source for municipal bodies globally, need to be more utilised in India due to outdated valuation systems, poor collection mechanisms, and weak enforcement. Modernising property tax systems — through GIS mapping, automated valuation tools, and transparent collection methods — can significantly augment local revenues. Similarly, user charges for municipal services like water supply, waste management, and public transport are either absent or grossly underpriced, leading to inefficiencies and revenue leakage. Rationalising and appropriately pricing these services based on usage and income considerations can improve service delivery and ensure cost recovery.
Previous UFCs have recommended incentivising revenue efforts, with FC-XI and FC-XII assigning weights of 10 per cent and 20 per cent, respectively, to these efforts while distributing grants. They emphasised revising user charge structures and granting local bodies the autonomy to set rates. FC-XIII proposed sharing mining royalties with local bodies in jurisdictions generating such revenues. FC-XIV linked performance grants to audited accounts and improved OSR, advocating property tax reforms, including adjustments in rates and base and sharing land conversion charges. Exploring municipal bonds and creating intermediaries for smaller municipalities were also suggested. FC-XV highlighted revising the professional tax ceiling and tying property tax growth to State GSDP as a condition for urban grants.
Unfortunately, little progress has been made on this front. States must take decisive action to enhance OSR and ensure that taxes collected by municipal bodies are primarily utilised within their jurisdictions. The continued neglect of this issue undermines local governance and perpetuates fiscal dependence, leaving municipalities ill-equipped to address the growing challenges of urbanisation.
The writer is an economist and author