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Introduction

Urban India generates nearly two-thirds of the GDP but holds under one per cent of tax revenue. Despite driving growth, municipalities remain fiscally weak due to centralised taxation, and GST has further reduced their autonomy, revealing flaws in India’s fiscal federalism.

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Key Fiscal Challenges Hindering Financial Autonomy of Municipalities

• Centralisation of Taxation Powers: Cities lack direct control over major revenue sources as most taxes are collected at the Union or State level.
  Eg: After GST, local bodies lost Octroi, entry tax, and surcharges about 19% of their revenue sources.
• Dependence on Grants and Transfers: Municipalities rely heavily on discretionary State and Central transfers, leading to uncertainty in funding.
• Narrow Revenue Base: Property tax and user fees contribute only a small share of municipal revenue, limiting fiscal flexibility.
  Eg: Property tax accounts for only 20–25% of a city’s total potential revenue and is politically constrained.
• Flawed Credit Assessment System: Credit ratings ignore regular grants and focus narrowly on “own revenue,” distorting fiscal credibility.
  Eg: RBI and credit agencies treat grants as “non-recurring income,” undermining legitimate revenue streams.

Municipal Bonds as a Solution

• Potential for Infrastructure Financing: Bonds can mobilise long-term capital for urban projects like water, waste management, and transport.
  Eg: NITI Aayog and 15th Finance Commission encourage municipal bond use for urban development.
• Enhancing Financial Discipline: The bond framework pushes municipalities to improve record-keeping, audits, and governance transparency.
• Market-Based Resource Generation: Bonds help diversify funding beyond government transfers, aligning with global best practices.
• Limitations in Practice: Weak municipal credibility and low investor confidence restrict the potential of bonds as a standalone solution.
  Eg: Indian municipal bonds remain low-rated due to lack of predictable revenue and governance capacity.

Deeper Reforms Based on Fiscal Justice

• Reimagined Fiscal Federalism: Cities should receive predictable, constitutionally mandated tax shares, not ad hoc grants.
  Eg: The 74th Amendment envisaged cities as equal tiers of governance, not dependent entities.
• Recognition of Grants as Legitimate Income: Rating systems must include grants and shared taxes as part of municipal revenues.
• Decentralisation of Tax Powers: Empower municipalities to levy and collect certain taxes directly, as seen in Scandinavian models.
  Eg: Denmark and Sweden allow cities to collect income tax, ensuring fiscal autonomy and accountability.
• Reform of Credit Rating and Borrowing Rules: Include governance indicators citizen participation, transparency, audit compliance in city credit evaluations.

Conclusion

Municipal bonds alone cannot fix India’s urban fiscal crisis. Lasting reform needs a decentralised, equitable fiscal system with predictable, constitutionally protected city revenues. Strengthening fiscal autonomy under true cooperative federalism is vital for resilient and self-reliant cities.

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