Is the fiscal architecture of municipalities flawed?
The fiscal architecture of municipalities in India is flawed primarily due to excessive dependence on state government transfers and weak own-source revenues such as property tax. Despite the 74th Constitutional Amendment (1992) that aimed to empower urban local bodies (ULBs), municipalities have limited financial autonomy because most major taxes like GST are centralized at the state and central government levels. This centralization restricts municipalities’ capacity to independently raise adequate revenue and finance infrastructure projects. Many municipalities also suffer from poor tax assessment and collection systems, further limiting their revenue base.
Issues
Erosion of Municipal Revenue Post-GST
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- Pre-GST: Cities collected octroi, entry tax, and local surcharges.
- Post-GST: These were subsumed, leading to a 19% drop in municipal own-source revenue.
- Result: Cities became heavily dependent on state and central transfers.
Centralization vs. Decentralization
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- Paradox: Power is centralized (taxation), but responsibility is decentralized (service delivery).
- Implication: Cities are expected to deliver on solid waste, housing, climate resilience, etc., without adequate funds.
Municipal Bonds – A Flawed Solution?
- Policy Push: NITI Aayog and others promote municipal bonds.
- Challenges:
- Creditworthiness judged narrowly by “own revenue” (property tax, user fees).
- Grants and transfers are wrongly treated as “non-recurring” or “charity.”
- Constitutional View: Grants are entitlements under the 74th Amendment, not favors.
Critique of “User Pays” Model
- Problem: Over-reliance on property tax and user fees.
- Equity Concern: Burdens low-income residents; commodifies public goods like water and sanitation.
- Revenue Reality: Property tax forms only 20–25% of potential revenue and is politically constrained.
Scandinavian Model
- Example: Denmark, Sweden, Norway allow municipalities to levy income tax.
- Benefits:
- Transparent citizen-government fiscal relationship.
- Long-term planning and accountability.
- Grants treated as part of a shared fiscal ecosystem.
Reimagining Fiscal Federalism
- Recognize Grants as Legitimate Income: Include them in creditworthiness assessments.
- Reform Rating Systems: Factor in governance capacity (transparency, audits, citizen participation).
- Leverage GST Compensation: Allow cities to use it as collateral for borrowing.
- Ensure Predictable, Adequate, Untied Transfers: Both own-source and constitutional transfers.
Reforming the fiscal federal structure to devolve more stable and untied revenue sources to municipalities is crucial for them to fulfill their expanded urban development roles effectively.
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