05-July-2024-Editorial

FINANCIAL SUSTAINABILITY ISSUES IN URBAN AREAS AND THE ROLE OF THE 16TH FINANCE COMMISSION 

Urban areas in India are vital economic hubs, contributing significantly to the country’s GDP and government revenues. 

The 16th Finance Commission’s recent developments have brought attention to critical issues regarding fiscal decentralisation and the financial sustainability of urban areas. 

The World Bank estimates that USD 840 billion is needed for basic urban infrastructure over the next decade. 

Financial Sustainability Issues with Urban Areas 

Urbanisation Challenges 

• Economic Contribution: Urban areas contribute 66% of India’s GDP and about 90% of total government revenues. 

• Inadequate Fiscal Support: Despite their importance, cities receive insufficient fiscal support, with intergovernmental transfers (IGTs) constituting only 0.5% of GDP. 

• Service and Infrastructure Challenges: This inadequate support hampers their ability to provide essential services and maintain infrastructure. 

Financial Devolution Issues 

• Comparison with Other Nations: The devolution of funds to Urban Local Bodies (ULBs) in India is significantly lower than in other developing nations. 

• South Africa: 2.6% of GDP 

• Mexico: 1.6% of GDP 

• The Philippines: 2.5% of GDP 

• Brazil: 5.1% of GDP 

• Impact of GST: The introduction of the Goods and Service Tax (GST) has reduced ULBs’ own tax revenues, affecting urban productivity and quality of life. 

Draining Resources 

• RBI Survey: An RBI survey of 221 municipal corporations (2020-21) revealed a decline in revenues for over 70% of these corporations, while their expenditure rose by almost 71.2%. 

• Property Tax Issues: The limited coverage of property tax and its inefficiency in generating revenues is a major issue. 

• OECD Report: India has the world’s lowest property tax collection rate (property tax to GDP ratio). 

Decline in Grants 

• Impact of GST: GST has not only ended octroi but also negatively impacted small businesses, leading to a significant decline in tax revenue for urban local bodies. 

• Previously, urban centers relied heavily on octroi, which used to cover nearly 55% of their total revenue expenditure, but its contribution has significantly decreased now. 

Other Issues 

• Census Data Concerns: The absence of updated census data (since 2011) hinders accurate assessment of urban population needs. 

• Policy Distortions: Parallel agencies and schemes, such as MP/MLA Local Area Development Funds, undermine the financial autonomy of local governments. 

• Lesser Functional Autonomy: During the pandemic, the heads of municipal corporations were not included in decision-making groups, highlighting their lack of autonomy. 

• Structural Issues: Some urban local governments lack basic infrastructure and human resources, and in some states, regular elections are not conducted for local bodies. 

Principal Areas of Focus for the 16th Finance Commission 

About 

• Constitutional entity: Formed in accordance with Article 280 of the Indian Constitution. 

• Primary Function: Recommends the distribution of financial resources between the central government and the state governments. 

Terms of Reference 

• Division of tax revenues: Making recommendations on how taxes should be allocated between the Union Government and the States. 

• Includes allocation of shares among the States. 

• Principles for Grants-in-Aid: Establishing principles for grants-in-aid to the States from the Consolidated Fund of India. 

• Determines amounts for grants-in-aid under Article 275 of the Constitution. 

• Enhancing State Funds for Local Bodies: Identifying measures to enhance the Consolidated Fund of a State to supplement resources for Panchayats and Municipalities. 

• Evaluation of Disaster Management Financing: Reviewing current financing structures for Disaster Management and recommending improvements. 

State Finance Commissions 

• Assam Example: The Seventh Assam State Finance Commission was constituted to streamline fiscal relations at the state and sub-state levels. 

• Regulated by Article 243-I and 243-Y of the Indian Constitution. 

Steps Needed for Better Urban Finance 

Strengthening Municipal Revenue 

• Property Tax Revenue: All Finance Commissions have emphasized augmenting property tax revenue. 

• 12th Finance Commission: Promoted the adoption of Geographic Information System (GIS) technology and digital tools to enhance property tax administration. 

• 14th Finance Commission: Suggested that municipalities should be granted the authority to impose taxes on vacant land. 

Modernising Tax Administration 

• Digital Platforms: Implementing digital platforms for property tax assessment, e-filing, and online payments to improve transparency and boost collection rates. 

User Charges for Specific Services 

• Fair Fees: Implementing user charges for specific services like parking and waste collection to reflect the cost of providing the service. 

Strategic Property Management 

• Public-Private Partnerships (PPPs): Monetising underutilised properties through PPPs for developing commercial spaces, markets, or parking lots. 

• Generates rental income and economic activity. 

Promoting Local Businesses and Economic Development 

• Supportive Environment: Initiatives to support local businesses can include streamlining business licenses and offering tax breaks for startups. 

Exploring Social Stock Exchange (SSE) 

• Raising Capital: Social enterprises can raise capital through SSEs, attracting investment towards initiatives that address local social needs. 

Implementing Value Capture Mechanisms 

• Capturing Property Value: Capturing a portion of the increased value of private properties resulting from public infrastructure projects. 

Conclusion 

• The 16th Finance Commission’s work is pivotal in addressing the fiscal challenges faced by urban areas. 

• Revisiting fiscal devolution principles, updating methodologies based on current urbanisation dynamics, and recommending substantial increases in IGTs to urban areas are crucial. 
• Effective implementation will require concerted efforts from Union and State governments to align policies and ensure sustainable urban development in India.