India’s cities drive economic growth but are short on resources. How can the gap be bridged?

A July 17 Press Information Bureau release titled “Finance Commission holds meeting with MoHUA” states that the Ministry of Housing and Urban Affairs requested a substantial increase in grants for municipal resources, with an increase of devolution to municipalities by at least 400%.

It is hoped that the Union Finance Commission, in its final report due in October, will pay heed to this request and increase grants to urban local bodies substantially.

Indian cities, despite their significant contribution to the national gross domestic product at nearly 70%, remain poor without adequate resources to meet their mandates. Recently, Indian cities have been affected the most by the Covid-19 pandemic. City officials, especially health and sanitation workers, are at the forefront of fighting the battle against Covid-19.

A prolonged lockdown has also affected municipal own revenues significantly. For cities to remain at the forefront of the battle against Covid-19, it is critical to ensure that they have access to adequate and predictable financial resources. Adequate financing is also essential to enable municipal governments to fulfil their mandate of various services and functions assigned to them.

India lags behind

A key source of revenues for local governments globally is the transfers from national governments, as well as transfers from state governments in federal countries. Such transfers, referred to as inter-governmental transfers, are significant as they account for over half of the resources of urban local governments.

Unlike other countries, the Indian Constitution does not specify distinct fiscal resources for local governments. Their resources are dependent on the inter-governmental transfers made by both the national and state governments and their own sources assigned to them by the state governments.

When compared to the global experience, municipal corporations in India lag far behind in, both, the extent of inter-governmental transfers that they receive as well as in their own revenues.

In India, the share of such transfers to municipal governments is estimated to be 0.45% of the GDP. In Brazil, Indonesia, the Philippines and Mexico, such transfers accounted for 5.1%, 5.4%, 2.5% and 1.6% of their GDPs respectively. In some European counties, it was as high 6 to 10% of GDP.

It would also be useful to explore the possibilities of emulating the successful experience of federal countries such as Brazil, where municipalities receive significant transfers called municipalities’ participation fund, which are 23.5% of the income taxes and industrialised products taxes.

In the Philippines, the Local Government Code of 1991 mandates that 40% of internal revenue collections of the preceding fiscal year be transferred to local government units. This experience of other countries with a substantially higher level of transfers suggests that there is considerable increase needed in the level of transfers to India’s municipalities.

Strengthening the fiscal base of our cities is possible only if the transfers are increased significantly. This will mean resources from the central and state finance commissions, as well as the central and state governments through their programmatic support.

Impact of GST

The need to increase inter-governmental transfers is even more important now, in view of the adverse impact of the Goods and Services Tax on municipal corporations’ own revenues. Cities are considered as “engines of economic growth”. However, cities do not benefit from their economic vibrancy as all the buoyant local taxes – such as the octroi, entry tax and local body tax – have been subsumed under the GST.

It has been suggested by leading economists and urban practitioners that “in order to maintain fiscal balance across the three levels of government, the combined revenues from GST ought to have been shared among all the three levels of government”.

Instead, the sharing has been half and half between the Centre and states and in the process, the independent power of local governments to raise their own sources of revenue have been appropriated by the Centre and the states.

The impact of GST on local finances is well illustrated for Mumbai. It is estimated that, “In compliance with the new GST regime, the Municipal Corporation of Greater Mumbai has had to abolish octroi, which on average had contributed almost 35% of its annual total revenue”.

Experts have suggested that Constitution be amended again to provide sharing of the revenues from GST among all three levels of government. Vijay Kelkar, the former chairman of the 13th Finance Commission, highlighted the vertical imbalance in India’s federalist structure and advocated for a greater share of GST resources for the third tier (municipal corporations) by allocating “a sixth of this with the third tier”.

Many scholars have argued for including a separate list of revenue sources for local governments in the Constitution. While the 74th Constitutional Amendment Act suggested a list of functions for urban local governments in the 12th Schedule, it did not provide a municipal resources list to match these functions.

They are dependent on state governments to allocate them such resources from the state list. For this, strong and well- functioning state finance commissions with adequate support are essential to ensure good quality of fiscal decentralisation envisaged in the 74th amendment. Unfortunately, the state finance commissions, who were charged with this, have also not been very successful.

Only 13 states have constituted their fifth state finance commissions and of these, many have not accepted the reports. A recent study shows that state finance commissions have been hampered by inadequate data as well as lack of staff and even places to operate.

Thus, most state finance commission reports have seen significant delays. It is often suggested that an appropriate amendment of the Constitution or other measures to insert a “Local Bodies Finance List” along the lines of the Union and state lists. While this has been discussed often, now it needs to receive priority.

These efforts will help to alter the adage: “Rich cities and poor city governments” and make India’s municipal bodies financially strong to serve their population. The cities will have the strength to attract good talent and to improve and sustain city services to higher standards.

This column is based on a paper prepared as input to a White paper on “Municipal Strengthening for Improved Urban Services” being developed by a Task Force of the National NFSSM Alliance, India.

Meera Mehta and Dinesh Mehta are Executive Directors and Professor Emeritus at the Center for Water and Sanitation at the CEPT Research and Development Foundation of CEPT University, Ahmedabad.

Dhruv Bhavsar is Senior Programme Lead at the Center for Water and Sanitation.