Fiscal Federalism and the Crisis of Municipal Finance in Urban India

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• Urban India contributes nearly two-thirds of the national GDP, yet its municipalities control less than 1% of the country’s tax revenue. 
• This mismatch highlights a fundamental flaw in India’s fiscal architecture, where centralisation of taxation powers has weakened municipal autonomy. 
• Understanding this issue is crucial, as it touches upon governance, decentralisation, urbanisation, and fiscal federalism.

The Fiscal Paradox of Urban India

• Urban contribution vs fiscal control:
  • Indian cities are economic powerhouses but remain fiscally handicapped.
  • Municipalities depend heavily on State and Central transfers, loans, and schemes.
  • This has created an inversion of democracy — power is centralised while responsibilities are decentralised.
• Post-GST revenue loss:
  • Introduction of GST (2017) led to the subsuming of octroi, entry tax, and local surcharges, resulting in an average 19% loss of municipal revenues.
  • Compensation mechanisms have not reached the municipal level effectively.
  • The result is the fiscal uncertainty and dependence on higher governments.

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Municipal Bonds – Promise and Pitfalls

• Policy push:
  • NITI Aayog and recent urban reforms promote municipal bonds as the next frontier of city finance.
  • However, credibility and uptake remain low due to systemic flaws.
• Challenges in creditworthiness:
  • Credit rating agencies assess cities narrowly on their “own revenue,” ignoring grants and transfers which form a legitimate and recurring income stream.
  • This misjudgment reflects an ideological bias, treating cities as dependent entities rather than equal tiers of governance envisaged under the 74th Constitutional Amendment.
• The property tax trap:
  • Property tax reforms, though vital, contribute only 20–25% of total revenue potential.
  • Over-reliance on the “user-pays” model shifts the burden of urban finance onto citizens, especially the urban poor, turning public goods into private commodities.
  • Services like water, sanitation, public lighting, and mobility are collective entitlements, not market goods.

The Constitutional and Ideological Dimensions

• 74th Amendment and fiscal equality:
  • The 74th Constitutional Amendment (1992) envisioned urban local bodies (ULBs) as institutions of self-government.
  • However, the absence of fiscal devolution has reduced them to dependent implementers of centrally designed schemes.
• Need for fiscal justice:
  • Recognising grants and shared taxes as rights, not favours, align with the spirit of cooperative federalism.
  • Urban fiscal empowerment is not a technical reform but a moral and political imperative.

The Way Forward

• Democratise the fiscal contract:
  • Adopt a Scandinavian model where cities have the right to levy and collect local taxes, including income taxes in some cases.
  • This promotes accountability, transparency, and a direct link between citizens and governance.
• Reimagine fiscal federalism: Ensure predictable, adequate, and untied transfers to cities. Recognise municipal grants as part of a shared fiscal ecosystem, not as discretionary handouts.
• Reform the municipal bond framework:
  • Recognise grants and shared taxes as part of city income.
  • Include governance indicators (transparency, audit compliance, citizen participation) in city credit ratings.
  • Allow cities to use GST compensation or State tax shares as collateral for borrowing.
• Strengthen local revenue mechanisms: Improve property tax coverage, digitise assessment systems. Diversify revenue sources — land value capture, service charges, and urban transport levies.
• Restructure urban fiscal framework: Tackling urban challenges — from waste management and housing to climate resilience and infrastructure, and grounded in cooperative federalism, predictability, and autonomy.

Conclusion

• India’s urban future depends on fiscal justice. Municipal finance is not merely a bookkeeping exercise, but a reflection of democratic and moral values.
• Cities should not be viewed as cost centres but as engines of national prosperity.
• For India to achieve sustainable urbanisation and inclusive growth, the fiscal relationship between the Centre, States, and cities must be rebalanced — restoring trust, autonomy, and resources to the grassroots.

Source: TH