Why in the news?

  • Urban India contributes nearly two-thirds of the nation’s GDP, yet its municipalities manage less than one per cent of total tax revenue.

Fiscal Challenges of Urban Local Bodies

  • Context:
    • The 74th Constitutional Amendment Act, 1992 empowered Urban Local Bodies (ULBs) to perform 18 functions listed in the 12th Schedule, including water supply, waste management, and public health.
    • However, fiscal devolution has not kept pace with functional devolution.
    • Urban India contributes nearly two-thirds of the national GDP, but municipalities control less than 1% of the country’s tax revenue.
  • Major Fiscal Challenges:
    • Weak Own Revenue Base:
      • Property tax, user fees, and local cesses form only 20–25% of potential municipal income.​
      • Low collection efficiency, outdated valuation, and political reluctance to hike rates further weaken revenue.
    • Dependence on Higher Level Transfers:
      • ULBs depend on tied grants from State and Central governments through schemes like AMRUT, Smart Cities Mission, etc., reducing fiscal autonomy and flexibility.
      • Intergovernmental transfers often lack predictability and are scheme-based, limiting local innovation.
    • Impact of GST:
      • Introduction of GST abolished key local taxes like octroi, entry tax, and advertisement tax, leading to a loss of around 19% of municipal revenue sources.​
      • Promised compensation mechanisms do not reach ULBs directly.
    • Limited Access to Credit Markets:
      • Poor creditworthiness and unclear accounting frameworks restrict ULBs’ ability to borrow.
      • Only 13 ULBs have issued municipal bonds totaling about ₹2,833 crore (2017–2025), indicating minimal penetration.​
      • Credit rating agencies undervalue cities by ignoring regular grants, calling them “non-recurring income,” leading to skewed credit ratings.
    • Over Centralisation of Taxation Powers:
      • ULBs lack independent taxation authority beyond minor taxes.
      • Most buoyant taxes — income tax, GST, excise — are controlled by the Union and States.​
    • Weak Administrative and Institutional Capacity:
      • CAG audit (2024) revealed a 42% mismatch between ULB financial requirements and their actual income; 37% staff vacancies across ULBs limit fiscal efficiency.
  • Underlying Structural Issues:
    • Fragmented fiscal federalism: Decentralisation without financial empowerment.
    • Inadequate intergovernmental coordination: Poor linkage between planning and funding.
    • Low credit culture and transparency: Weak financial reporting systems in ULBs.
  • Reforms Needed:
    • Strengthening Own Revenue Generation:
      • Implement GIS-based property valuation and digital payment systems for better tax compliance.​
      • Regularly revise property tax rates linked to market valuation.
    • Rational Fiscal Transfers: States should operationalize the State Finance Commissions (SFCs) regularly to provide predictable, untied grants.
    • Reforming Municipal Bond Market:
      • Include regular grants and shared tax revenues as part of income metrics for credit ratings.
      • Develop pooled financing models and allow ULBs to use part of GST share or state allocations as collateral.
    • Enhancing Institutional and Human Resource Capacity:
      • Fill staffing gaps and train local officials in financial management.
      • Integrate Urban Outcome Framework (UOF) data for performance-based funding.