Municipal fiscal reforms crucial for addressing urban governance challenges

Over 50 per cent of municipal corporations generate less than half their revenue independently, while government transfers rose by over 20 per cent in 2022–23, according to the Reserve Bank of India’s (RBI’s) recent report on municipal finances.

 

Decentralising local governance is crucial to empowering municipal bodies with greater administrative autonomy and financial independence. Strengthening municipal revenue streams is not merely a financial necessity but a fundamental requirement for effective urban governance. Municipalities can develop more responsive and sustainable urban management strategies by diversifying income sources and enhancing fiscal capabilities.

 

Effective municipal finance management involves a dual approach that necessitates financial transfers from higher levels of government and the proficient generation, use, and allocation of local revenue streams. In India, urban local bodies (ULBs) face significant challenges in achieving financial autonomy, primarily due to the limited devolution of authority and resources.

 

Financial transfers to municipal governments account for only 0.45 per cent of India’s gross domestic product (GDP), a stark contrast to countries like Brazil, Indonesia, the Philippines, and Mexico, where the figures range from 1.6 per cent to 5.4 per cent. In European nations, such transfers can even reach 6 per cent to 10 per cent of GDP, exemplifying the critical role of robust intergovernmental fiscal frameworks in supporting local governance. These international benchmarks highlight the pressing need to enhance financial transfers to Indian municipalities. Equally important is the ability of municipal bodies to generate their own revenue, an area where they lag significantly.

 

In this second aspect, municipal finance in India faces a triad of challenges, including low revenue collection, heavy reliance on transfers from the state and the Centre, and an increase in municipal borrowings. The 2024 RBI report titled “Own Sources of Revenue Generation in Municipal Corporations: Opportunities and Challenges” sheds light on these challenges.

 

Municipal corporations generated only 0.6 per cent of GDP in revenue, compared to 14.6 per cent by state governments and 9.2 per cent by the central government. This has resulted in a heavy reliance on transfers, which increased by 24.9 per cent and 20.4 per cent from the Centre and state governments, respectively, in 2022–23. Municipal borrowings have surged by a staggering 363.06 per cent, rising from Rs 2,886 crore in 2019–20 to Rs 13,364 crore in 2023–24.

 

To meet the growing demand for high-quality public services in urban areas, the report recommends adopting geographic information system (GIS) mapping, a digital payment system, and improved property tax mechanisms that better reflect appreciating property valuations, as property tax remains the most significant source of tax revenue.

 

For improving non-tax revenue, which is all the more critical considering the restriction on earning tax revenue, the report cites the examples of Maharashtra, Gujarat, Rajasthan, and Tripura to make a case for introducing “user charges” for essential services such as water supply, sanitation, and waste management.

 

A recent study titled “Municipal Performance of Indian Cities: An Evaluation Based on UOF Data” highlights the pressing challenges faced by ULBs in India. Using data collected by the Ministry of Housing and Urban Affairs through the Urban Outcome Framework on the AMPLIFI platform, the study evaluates the performance of 134 municipalities. It examines five critical verticals — governance, services, technology, planning, and finance — across 20 sectors and 100 indicators, offering a granular view of urban municipal performance.

 

The finance pillar, a cornerstone of this evaluation, provides particularly valuable insights. It assesses municipalities across four crucial areas: Revenue management, expenditure management, fiscal responsibility, and fiscal decentralisation. In the revenue management sector, approximately 50 per cent of municipalities generate less than 23 per cent of their total revenue independently, relying heavily on tax revenue.

 

Along with this, 22 municipalities derive 80 per cent of their total revenue from taxes alone. Perhaps most concerning is that nearly half the municipalities struggle to develop alternative financing sources, excluding state and central government grants.

 

The Expenditure Management sector analysis provides further nuanced insights into municipal financial efficiency. Municipalities demonstrate an average central grant efficiency rate of 59 per cent, with state grant efficiency averaging 67 per cent across 79 municipalities. Most municipalities primarily allocate their own tax revenue to salary expenditures, consequently limiting capital expenditure per capita.

 

Insights from the Fiscal Responsibility sector are a silver lining. Municipalities have consistently maintained a budget surplus exceeding 10 per cent over the past three years, indicating a commendable level of financial prudence and stability. However, the findings of the Fiscal Decentralisation sector highlight significant structural challenges. An overwhelming majority of 109 municipalities (approximately 81 per cent) lack independent borrowing and investment powers, requiring state approval for financial decisions. This constraint severely limits local governance autonomy and the ability to address region-specific priorities effectively. 

 

These assessments align closely with the findings of the RBI report on municipal finances. The insights from these reports call for a new institutional architecture in which municipalities must be at the core of developmental strategies and equipped with enhanced administrative and financial autonomy.

 

The path forward requires two key strategies. First, the devolution of finances should be improved by increasing financial allocations from central and state governments. Second, municipalities must diversify revenue streams and be empowered to make autonomous financial decisions. This can be achieved through public-private partnerships, digital solutions for cost optimisation, and financial instruments such as municipal and green bonds. These measures, particularly for smaller municipal corporations, can strengthen municipal fiscal foundations and support critical urban infrastructure, sustainable development, and climate resilience efforts, as highlighted in the RBI report.

 

By reimagining municipal governance through enhanced accountability, financial flexibility, and strategic resource management, Indian municipal corporations can transform their developmental potential and address complex urban challenges more effectively.

 

The author is chair, Institute for Competitiveness. Nabha Joshi contributed to this column