Introduction

The 16th Finance Commission (FC) has commenced its pivotal work, operating under the mandate of Article 280 of the Indian Constitution. This article primarily focuses on the devolution of the consolidated fund. Since the enactment of the 73rd and 74th constitutional amendments, local bodies have gained significant recognition within the federal system. These amendments introduced sub-clauses 280(3)(bb) and (c), mandating the FC to recommend measures to augment State consolidated funds to support panchayats and municipalities. However, the fiscal health of urban local bodies remains a critical concern.

Cities as Engines of Growth

• The National Commission on Urbanisation in the mid-80s described cities as “engines of growth.”
• Although this view is somewhat narrow, it highlights the critical role cities play in India’s economy.
• Cities contribute around 66% of India’s GDP and about 90% of total government revenues.
• This makes urban areas crucial for the overall development of the country. However, the economic scale is insufficient to meet rising needs.
• The World Bank estimates that $840 billion is needed for basic urban infrastructure in the next decade.

Fiscal Devolution: A Continuing Struggle

• Despite the efforts of five commissions since the 11th Finance Commission, financial devolution to cities remains inadequate.
• The fiscal health of municipalities is poor, adversely affecting both city productivity and quality of life.
• Rapid urbanization without appropriate fiscal action has detrimental effects on development.
• Intergovernmental transfers (IGTs) to Urban Local Bodies (ULBs) in India are about 0.5% of GDP, significantly lower than the 2-5% typical of other developing nations.
• For instance, South Africa allocates 2.6%, Mexico 1.6%, the Philippines 2.5%, and Brazil 5.1% of their GDPs to their cities.
• Although IGTs make up about 40% of ULBs’ total revenue, issues persist regarding their predictability, earmarking for vulnerable groups, and horizontal equity.
• IGTs are crucial for ULBs, given their financial state and the need for stable support until their own revenues improve.

The Impact of GST on Local Taxation

• The introduction of the Goods and Services Tax (GST) has significantly reduced ULBs’ tax revenue (excluding property tax) from about 23% in 2012-13 to around 9% in 2017-18.
• IGTs from States to ULBs are very low, with State Finance Commissions recommending only about 7% of States’ own revenue in 2018-19.
• Increasing the quantum of IGTs as a percentage of GDP is necessary.
• Despite the 74th constitutional amendment’s aim to financially strengthen ULBs, progress over three decades has fallen short.
• The 13th Finance Commission observed that “parallel agencies and bodies are emasculating local governments both financially and operationally.”
• Local governments require support from Union and State governments through funds, functionaries, and technical aid.

The Importance of the Census

• In the absence of the 2021 Census, reliance on 2011 data is inadequate for evidence-based fiscal devolution.
• India has approximately 4,000 statutory towns and an equal number of Census towns, with an estimated 23,000 villages effectively urban.
• These figures must be captured by the 16th FC, including the significant migration to Tier-2 and Tier-3 cities.

Re-evaluating the 15th Finance Commission’s Guiding Principles

• The 15th FC’s nine guiding principles require a revisit.
• Not all of them, but references to the enhancement of property tax collection in tandem with the State’s GST; maintenance of accounts; resource allocation for mitigating pollution; and focus on primary health care, solid waste management, and drinking water deserve attention.
• The 16th FC must consider India’s urbanization dynamism and ensure IGTs to urban areas are at least doubled.

Conclusion

The fiscal health of India’s urban local bodies is a critical issue that demands urgent attention. The 16th Finance Commission has a significant role to play in addressing this challenge. By increasing intergovernmental transfers and providing stable support, the commission can help ensure that cities continue to be engines of growth for India’s economy. Failure to invest adequately in urban infrastructure will lead to severe shortages and deteriorating living conditions, hampering the country’s overall development.