Daily Gist of the Hindu/Indian Express : 16 Oct 2025

Article – Why is the fiscal architecture of municipalities flawed?

Published: The Hindu 16 Oct , 2025

Very Important Topic for UPSC/PCS  Mains : GS 2 ( Local Governance/Devolution of fiscal resources.)

Why in News? Urban India contributes nearly two-thirds of India’s GDP, yet municipalities control less than 1% of the country’s tax revenue. Recent discussions on municipal fiscal stress, low creditworthiness of urban local bodies (ULBs), and the inefficacy of municipal bonds have brought attention to the broken architecture of urban finance in India.

Main Challenges:

1. Centralisation of Taxation Powers:

• After the implementation of Goods and Services Tax (GST), cities lost key local taxes like octroi, entry tax, and local surcharges.
• Municipalities lost nearly 19% of their own revenue sources, increasing dependence on state and central transfers.

2. Dependence on Intergovernmental Transfers:

• Unpredictable and tied grants limit autonomy.
• Even constitutionally mandated transfers are treated as discretionary favours.

3. Weak Municipal Bond Market:

• Promoted as a major financing tool, but credibility is low.
• Bond ratings often ignore grants and transfers and only consider “own revenues”.

4. Inadequate Property Tax Reforms:

• Property tax contributes only 20-25% of total city revenue.
• Politically sensitive and hard to revise or expand due to valuation and enforcement challenges.

5. Inequitable Burden on Citizens:

• Excessive focus on “user pays” logic disproportionately affects the urban poor.
• Converts public goods into private commodities (e.g., water, sanitation, mobility).

Comparative Examples: What Other Countries Do?

Scandinavian Countries (Denmark, Sweden, Norway)

• Municipalities have power to levy income tax
• Strong link between citizens’ tax payments and public service delivery.
• Transfers are institutionalised, not viewed as charity.
• Promotes efficiency, equity, and local planning capacity.

Way Forward:

1. Reimagine Fiscal Federalism:

• Recognise municipalities as equal tiers of government (as envisioned in 74th Constitutional Amendment).
• Ensure predictable, adequate, and untied revenues.

2. Redesign Creditworthiness Metrics:

• Recognise grants and shared taxes as part of a city’s legitimate income.
• Improve municipal bond ratings by including governance indicators: audit compliance, transparency, citizen participation.

3. GST Compensation as Collateral:

• Allow cities to use a portion of GST compensation or State share as collateral for municipal borrowing.

4. Property Tax Reforms with Equity:

• Improve collection efficiency but avoid over-reliance on property tax.
• Explore innovative taxation models (e.g., land value capture, betterment levies).

5. Capacity Building of Urban Local Bodies:

• Strengthen human resources, financial management systems, and technical skills.
• Encourage citizen participation and social audits.

Conclusion:

India’s urban future hinges on fiscal justice and genuine cooperative federalism. Municipal finances should not be seen merely as accounting exercises but as instruments of democratic empowerment. Cities are not cost centres; they are the engines of national growth. Real reform begins by recognising the rights of cities to adequate and untied fiscal resources, ensuring they are not beggars, but partners in governance.

Article Based Mains Questions : UPSC/PCS/250/200 words

 Qn.1 “Urban India contributes significantly to the national economy, yet municipalities lack fiscal autonomy.”Critically examine the challenges of municipal finance in India and suggest reforms to empower Urban Local Bodies (ULBs).

Qn.2“Municipal finance in India is not just a technical issue but a moral and political one.” Discuss in the context of fiscal federalism and the role of grants, municipal bonds, and taxation powers.