How is the third tier government faring in terms of finance?

Three decades have passed since the idea of Urban Local Bodies (ULB) as third level of government was crystallized into the Constitution, yet there seems a lot remaining to be done. Lack of autonomy, paucity of funds, and procedural hurdles, are some of the issues the ULBs are facing. Even now, financial issues of the ULBs are far from resolved.

Most of the ULBs in India need to learn to manage their finances for effectively managing their operations. The revenue sources are classified as follows:
Tax Revenue: Taxes are an important source of income for the ULBs. They include property tax, octroi, advertisement tax, water tax, sewerage tax, and professional tax. Amongst these, property tax is the biggest source of income for the municipalities. Octroi, once a large source has since been abolished in most ULBs. Non-tax revenue comprises fees levied such as fees on tehbazaari (imposed on hawkers etc.), license fees on cycle rickshaws, bicycles, etc.
Non tax revenue: Municipal fees, sale and hire charges, user charges,
lease amounts Other receipts: Sundry receipts, lapsed deposits, fees, fines and forfeitures, Law charges cost covered, rent on tools and plants, miscellaneous sales
Assigned (Shared) revenue: Assigned or shared revenue is that part of the State revenue, distributed to the urban local bodies from the divisible pool of taxes. Profession tax, surcharge on stamp duty, entertainment tax, motor vehicles tax, etc.
Grant in aid: Plan grants are budgetary allocations from the center/state governments for specific projects, programsor schemes. Non-plan grants are given as compensation for loss of income or some specific transfers
Borrowings: These form the smallest share of revenues. They include loans undertaken by the local authorities from Center or State government, banks, etc.

What is the issue?

The Finance Minister in this year’s budget speech acknowledged the growing boundaries of cities and the need to improve cities’ infrastructure. It is estimated that half of India’s population would be living in cities by the time India achieves 100 years of independence. According to 2011 census, 31.16 per cent population was living in cities. By 2050, more than 50 per cent of the country’s population will be urban, as per World Urbanization Prospects. The official data tends to be understated as they may not have included the population living in the urban areas which have not been declared as such, hidden urbanization in cities’ periphery. Planners are unanimous on the fact that cities will, therefore, be at the center of all development activities.
This underlines the growing significance of ULBs, granted constitutional status through the 74th Amendment Act, 1992. It granted them the status of third tier governments at the local level defining its scope, powers and functions. However, it did not include any specifics on the regulation of finances. The powers of financial regulation have been entirely devolved to the State Finance Commission (SFC). The problem is that the SFCs, along with the Finance Commission of India, are advisory bodies. In order to implement their recommendations strong political will is needed. States must voluntarily part with their powers in order to empower the local bodies.
The decision on which taxes can be levied by the ULBs has also been left to the discretion of the State. According to Dr Mukesh Mathur, former professor, National Institute of Urban Affairs, “there’s no change in the status of the finances of urban local bodies even after the 74th Amendment Act, because it hasn’t provided any local taxation list. That’s a major drawback. If the local taxation list is inserted in the Constitutional Act itself, the financial crisis of ULBs will be resolved.”
The municipal revenues/expenditures in India have been a meagre one percent of the total GDP for over a decade, according to a report submitted in 2019 to the 15th Finance Commission titled ‘State of Municipal Finances in India’ by Indian Council for Research on International Economic Relations. This is considerably inadequate for a municipal body which is considered as the third level of government. The growing cities of the country demand development of infrastructure at a pace that matches the pace of urbanization. The following table illustrates the stagnancy of municipal revenues over the years. It explains to a great extent the dismal state of ULB finances in India.

The way forward

As can be deduced from the present predicament of ULBs’ finances, the machinery of local governance needs to be overhauled. The 15th Finance Commission which submitted its report in October 2020 has given many recommendations in order to strengthen urban local bodies. One of the key recommendations of the Commission has been setting up of State Finance Commissions (SFC). Even though, this is a constitutional requirement, many states have still not shown the desired commitment even after three decades. The role of SFCs is to decide the mandate for devolution of funds to the local bodies, recommend to the state government regarding distribution of resources between state and local bodies, levying of taxes, duties, etc. and the distribution of their proceeds, suggesting ways to strengthen rural and local urban bodies. In order to strictly implement it, the Commission has made it a mandatory prerequisite for the states to have SFC, in order to get funds. After 2024, States which have still not made SFC will not be eligible to receive grants from the Centre. Another significant recommendation is that both provisional and audited accounting should be made compulsory for the ULBs. Every year’s audited accounts needs to be submitted, in order to receive next year’s grant. This will bring transparency in the system of funds devolution.
The grants-in-aid received by the ULBs are of two types- basic and performance-based grants. The Commission suggests that for Million-Plus cities (cities with population over a million) the grants should be performance-based, that is those grants which are reserved for special projects and programs. While, for cities having population less than a million, basic grants should be given, so that those ULBs have more autonomy to use it as per the needs of the city.
There is need for greater financial discipline and need for financial reforms in ULBs. Grant-in-aid should be made more effective better accounting procedures in place. Accounting system should be standardized across the states which can improve reporting system and transparency. Financial reforms alone will not be of much help unless accompanied by structural reforms. Before the 74th Amendment, local governance was subservient to the powers of the State as it was not yet encoded into the Constitution. But even now, Union or State governments are reluctant to devolve functions of the 12th Schedule and finances to the 3rd level of government thereby unable to achieve decentralisation. The need of the hour is to make urban local bodies strong units of governance in cities and not merely exist as nominal structures.
An important aspect of good governance is public engagement. Local bodies need to do much more in order to elicit active public participation which could improve their accountability to the public and therefore governance. People look to the state government for any inadequacy in the day-to-day functioning of the cities. The State governments need to pass on the responsibility and accountability to the local bodies to ensure robust cities with great infrastructure and excellent governance.