Can Enhanced State Borrowing Be the Catalyst for Overdue Municipal Revenue Reforms? 

The history of trying to enact revenue reform at the urban local body level isn't pretty. It may require a constitutional amendment process to make ULBs truly the third tier of government.

The fifth tranche of India’s economic stimulus package included a conditional increase in the state borrowing limit from 3% to 5% of GSDP (gross state domestic product) for 2020-21 amounting to Rs 4.3 lakh crore. 

One of these conditions relates to Urban Local Bodies’ (ULBs) revenue reforms. Namely, states have to notify property tax floor rates in accordance with circle property rates; and notify water and sewerage charges, to at least recover operation and maintenance (O&M) costs. 

While this conditional borrowing have been in equal measures lauded and criticised, what is important to remember is that similar reforms in fact have been suggested umpteen times over the past three decades. Some limitations of these reforms based on numerous empirical studies need to be highlighted at the outset. 

First, linking property tax rates to circle rate – as against Annual Rateable Value (ARV), Capital Value or Unit Area Assessment usually practiced in India – could be effective provided circles rates were updated more regularly, which happens only in a few large cities such as Mumbai and Bengaluru. On the other hand, there is a risk of circle rates being inflated at a time of dropping property values. Also, low property tax collection is not just a matter of right indexation of the rates, but also of regular revisions, improving billing and collection, removal of exemptions and expanding coverage. 

Second, the key challenge of determining water supply and sewerage user charges linked to O&M cost is that most ULBs, which use a general budget to fund various municipal services, do not even know what the actual cost of providing each service is. Only a few ULBs like Municipal Corporation of Greater Mumbai have a separate budget for water supply and allied services. In addition, there is the vicious cycle of poor quality of service and low willingness to pay as well as huge ill-targeted subsidies given to the undeserving users.

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Another question that should be raised is whether these long overdue reforms can take place in the current economic crisis when incomes are low all around and a number of cities are already reporting lower property tax and service charge collection? Or, conversely, is this a good time to seriously rethink ways of truly empowering ULBs with due functional and fiscal decentralisation? 

The 74th Constitutional Amendment Act (CAA), 1992, initially spurred extensive debates on urban local governance and finance with a new energy and great deal of expectation. A decade later, not much progress was made by way of actual execution of the suggested reforms.

 In order to give it greater thrust, some of these reforms were incorporated as conditions for funding urban infrastructure development under the Jawaharlal Nehru Urban Renewal Mission (JNNURM), 2005-2013, though with limited success. These reforms were taken forward in the Atal Mission for Rejuvenation and Urban Transformation (AMRUT), 2015-2022. Simultaneously, the 10th to 12th Finance Commissions (FCs) made ad hoc grant allocations for ULBs due to challenges encountered with the establishment and reporting of the State Finance Commissions (SFCs).

Only since the 13th FC (2010-2015), specific recommendations were made for improving the financial position of ULBs.  The following noteworthy observations on ULBs’ revenue reforms emerge from a review of the above mentioned initiatives:

Recommendations to increase property tax – a major source of ULBs’ own revenue – and user charges for water supply and sewerage have been made by all the SFCs and FCs since the 13th FC.

13th FC was the first to recommend transfer of a part of profits of the Development Authorities as another means of ULBs’ revenue enhancement. 

V. Srinivas Chary and D. Ravindra Prasad, 2014, in Municipal Finances and Service Delivery in India, A Study Sponsored by the 14th FC, Administrative Staff College of India (ASCI), Hyderabad, suggested inclusion of a municipal finance list through a Constitutional amendment to make Centre-State fiscal transfer to ULBs more effective. It was mentioned in the 14th FC report, but it did not translate into a recommendation.

In a study prepared for the 15th FC, an ICRIER team proposed compensating ULBs for the loss of revenue from taxes subsumed in GST after its implementation in July 2017. 

15th FC Report for 2020-21 (November 2019) did not consider the ICRIER Team’s proposal. Hopefully, it would be included in their final report for 2020-25.

The history of ULB revenue reforms in India is dismal. Even incentivised funding schemes like JNNURM and AMRUT have not been able to push these reforms. In fact, ironically while the population of Indian cities is growing, ULB revenue is decreasing. The ICRIER report quoted above, which is based on data from 37 municipal corporations, shows that the total municipal revenue has declined from 0.49% of GDP in 2012-13 to 0.45% in 2017-18. These corporations’ own source revenue has also dropped from 0.33% of GDP in 2012-13 to 0.23% in 2017-18. This does ring an alarm bell, which calls for tough policy decisions, not a little enhanced state borrowing proposed by the FM to drive extremely rigid ULB revenue reforms.  

It is imperative to ask why it has taken almost three decades to enhance ULB revenues without much success. The two oft cited reasons are: a lack of ULBs’ management capacity; and that state governments are not willing to give more authority and autonomy to create another power centre in empowered ULBs. This is not only a critical opinion of scholars and experts, but is also a common narrative within the government circle. In the Economic Survey 2016-17, Arvind Subramanian aptly quoted Professor Raja Chelliah: ‘Everyone wants decentralisation, but only until his level.’ 

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If the state governments are not willing to let go a bit of their power and control over major urban vote banks, we have to make more concerted efforts to convince them to build, and feel proud of, well-functioning, productive and liveable cities for all.

In addition, the Centre should initiate a constitutional amendment process to make ULBs truly the third tier of the government for: 

  1. Providing compensation to ULBs for the loss of revenue on account of GST, or the keeping the devolved ULB taxes out of the GST purview.
  2. Adding a Municipal List in the 7th Schedule of the Constitution, with full functional and fiscal decentralisation and autonomy to determine local tax rates and user charges.
  3. Addressing comprehensively a range of urban local governance challenges in the current context as well as lessons drawn from the limited success of the 74th CAA implementation.

Finally, now that we have a prime minister who is a champion of being ‘vocal for local’, there is no better time to just do it.  

Pushpa Pathak is a Senior Visiting Fellow at the Centre for Policy Research, New Delhi. Views expressed are personal.