Financing ULBs to Strengthen our Future Cities

Against the backdrop of the 73rd and 74th Amendments, in 1992, India institutionalised the structure of local governance with the devolution of functions and finances to the third tier of government. The Urban Local Bodies (ULB) include municipal corporations, municipal councils and Nagar panchayats, which are created for providing civic and community services like health care, education, housing, and transport in cities. However, given the asymmetry in the functions and finances, “unfunded mandates” became a critical issue in the financing of cities.
Urban Local Bodies (ULBs) in India are amongst the weakest globally in terms of fiscal autonomy. In South Africa, the local governments have attractive tax handles with no major taxes at the State level other than casino taxes and horse races, which gives an ‘hourglass model of finances’. In Scandinavian countries, local governments have substantial access to dynamic tax bases including income tax. However, in India, there are no major buoyant and dynamic taxes at the third tier.
In India, the financing of cities depends on two sources of revenue – intergovernmental fiscal transfers from the Centre (including Finance Commissions) and State governments; and their own tax handles. The recent RBI (2022) report on municipal finance shows that municipal revenues and expenditures in India have stagnated at around 1 per cent of GDP for over a decade. In contrast, municipal revenues/ expenditures account for 7.4 per cent of GDP in Brazil and 6 per cent of GDP in South Africa. Property tax, the significant source of revenue for ULBs, amounts to less than 0.5 per cent of GDP. Vijay Kelkar and Ajay Shah (2019) in their book argued that the Centre and the States may share one-sixth of their GST revenue with the third tier to improve the buoyancy of municipal revenue.
The gross municipal borrowing constitutes less than 0.05 per cent of GDP cumulatively for all municipal corporations, with significant variations across States (RBI, 2022). The hard budget constraints at the local level thwart the flexibility of funds at the local level, with no captive sub-sovereign debt market. As pointed out by Abhay Pethe (2013), the inability to autonomously access capital markets has weakened the ability of ULBs to fulfil their mandated functions. Only nine municipal corporations have municipal bond issuances in India, raising around Rs 3,840 crore during the period between 2017 and 2021 (RBI, 2022). A dynamic municipal debt market for municipal bonds can provide fiscal space for financing city infrastructure projects.
The “principle of subsidiarity” which states that the decision should be taken at the level closest to people – is crucial for minimum government, and maximum governance. The 15th Finance Commission (FC-XV) report under the Chairmanship of Dr N K Singh has recommended Rs 4.36 lakh crore as grants to Local governments for the period 2021-22 to 2025-26. This is a game changer, as this is the largest share of grants to be assigned to local bodies by Finance Commissions. The 15th FC’s preference for a fixed amount rather than a proportion of a divisible pool adds predictability to the quantum and timing of fund flow, thus reducing revenue uncertainty, as reported by RBI MF Report 2022. However, fiscal marksmanship is affected due to a huge deviation between the allotted share and the actuals. The actual release to the local bodies has been lower than the recommended amount by about 15 per cent, primarily due to their failure to meet different conditionality (RBI, 2022). The inter se distribution of Finance Commission transfers among States is based on a weight of 90 per cent for the population and 10 per cent for the area of States. The 15th FC recommendation to make audited municipal finance accounts (digital access) is laudable to attain general government data. Digital infrastructure is crucial for sustainable urbanisation.
State Finance Commissions (SFCs) are also crucial in the financing of cities. The SFC reports are mandated for fiscal devolution, arriving at a formula for the devolution of funds with due consideration to (i) distribution of tax proceeds between State governments and municipalities; (ii) allocation of revenue across all levels of municipal governments; (iii) taxes, duties and tolls to be assigned or appropriated by municipalities; and (iv) measures to improve the financial position of municipalities. Pinaki Chakraborty and Manish Gupta (2019) in their analysis highlighted that in most States, SFCs have not been effective in reducing Adhoc-ism and arbitrariness in rules-based devolution of funds to local governments because the SFCs on average take around 32 months to submit their reports, resulting in an average delay of about 16 months. Thus affecting the flow of funds. They also estimated that the average time taken by State governments to table the Action Taken Report (ATR) in the State legislature is around 11 months.
Yet another major constraint in analysing the financing of cities is the lack of uniform data across all States in India. The lack of consolidated data on third-tier finances in India constrains the evaluation of the quality of local-level public expenditure for determining the magnitude of intergovernmental fiscal transfers (IGFT). RBI reported that in only nine of the fourteen States, a “municipal accounts manual” has been approved by the respective State government. There is no uniform accounting code for ULBs to date, which makes the comparison and consolidation difficult. IMF has consistently published the cross-country general government data as “Government Finance Statistics” (GFS). The RBI (2022) data collation of municipal finances would bring India on par with international standards for GFS, as underscored in the progress reports of the G20 Data Gaps Initiative. The Sustainable Development Goal (SDG 11) which refers to Sustainable Cities and Communities mandates that effective governance of cities is critical to sustainable development, to make cities inclusive, safe, resilient and sustainable.