Towards Fiscal Empowerment of Municipal Bodies

• 24 Oct 2025

For Prelims: Municipal corporation, Property tax,  Seventh Schedule, Article 243G,  73rd Constitutional Amendment , Balwantrai Mehta’s 1957 Report, Central Finance Commission, 15th Finance Commission.  

For Mains:  Role of Local Bodies Play in Strengthening Development, Major Challenges Confronting Local Bodies 

 Source: TH 

Why in News?  

Urban India contributes nearly two-thirds of India’s GDP, yet its municipalities control less than 1% of national tax revenue. This stark fiscal imbalance has reignited debate over flawed fiscal architecture of Indian urban governance and the need for empowering cities through structural reforms. 

 What are the Structural Issues that Undermine the Fiscal Effectiveness of Municipal Bodies? 

• Over-reliance on Grants and Schemes: Urban finance now depends heavily on State and Central government grants, many of which are tied or discretionary. 
  • Intergovernmental transfers and grants often bypass municipal accounts or are delayed, disrupting planning and execution of projects. 
• GST Impact: The introduction of Goods and Services Tax (2017) has undermined municipal fiscal autonomy by subsuming key local taxes such as octroi, entry tax, and local surcharges, leading to nearly 19% revenue loss. 
• Unequal Contract: While cities are tasked with critical services-solid waste management, climate resilience, urban housing, they lack the financial tools to deliver. This has led to what experts term an "inversion of democracy”. 
  • Weak fiscal capacity limits municipalities’ ability to invest in infrastructure or meet sustainability goals. 
• Creditworthiness Issues: Credit rating mechanisms focus narrowly on "own revenue" performance (e.g., property tax), ignoring the regularity of state/central transfers. 
• Political Hesitation: Local representatives are reluctant to impose new taxes for fear of losing voter support. 
• Weak Institutional Capacity: Lack of trained staff, poor data systems, and fragmented governance hinder fiscal reforms. 

Urban Local Bodies (ULBs)  

• The 74^th Constitutional Amendment Act, 1992, was enacted to strengthen democratic governance in urban areas. 
• It introduced Part IXA (Articles 243P–243ZG) in the Constitution, providing a constitutional status to ULBs. 
• The Act created three types of urban bodies – Nagar Panchayats, Municipal Councils, and municipal Corporations. 
• The 12^th Schedule lists key municipal functions such as urban planning, water supply, sanitation, and waste management. 
• It mandated regular elections every five years, reservation for weaker sections, and a State Election Commission to oversee polls. 

Sources of Funds for Municipalities 

• Own Revenue Sources: Property tax, user charges, advertisement tax, trade licenses, parking fees, and development charges. 
• Transfers from Higher Governments: State Finance Commission and Central Finance Commission grants, revenue-sharing arrangements, and special-purpose transfers under schemes like AMRUT and Smart Cities Mission. 
• Borrowings and Bonds: Municipal bonds allow cities to raise funds from investors for long-term projects. Cities like Ahmedabad, Pune, Surat, Hyderabad, and Lucknow have used this route. 
• Public-Private Partnerships (PPP): Monetising underutilised assets or developing infrastructure through private participation. 

Why is the Need to Reform Urban Local Bodies’(ULBs) Fiscal Architecture? 

• First Layer of Democracy: Urban Local Bodies (ULBs) are the closest level of government to citizens, ensuring participatory democracy and effective delivery of essential urban services. 
• Mismatch Between Functions and Funds: The devolution of responsibilities under the 74th Constitutional Amendment has not been matched with adequate fiscal powers, creating a gap between duties and available resources. 
• Rising Population and Urbanisation: Rapid urban growth and migration have increased pressure on ULBs to provide infrastructure, housing, and public services, demanding stronger fiscal capacity. 
• Limited Access to Innovative Financing: Municipalities often lack frameworks for leveraging alternative financing tools like municipal bonds, PPP models, and land-based instruments to fund large-scale projects. 

What Steps Have Been Taken to Strengthen Urban Fiscal Governance in India? 

• AMRUT 2.0 Incentives: Under AMRUT 2.0, incentives have been continued for issuance of Municipal Bonds to ULBs.  
• SASCI Scheme: Incentives are also given to States for property tax reforms under Scheme for Special Assistance to States for Capital Investment(SASCI) 2023-24 - Part-IV (Financing reforms in ULBs to make them credit worthy for Municipal Bonds and for issue of Municipal Bonds) under which an amount of ₹3,298.23 crore has been released to the States by Department of Expenditure. 
• Finance Commission (FC) Recommendations: 12th Finance Commission– Use of GIS and digital mapping to improve property tax administration. 
  • 14th Finance Commission, empower municipalities to levy vacant land tax. 
• Smart Cities Mission and Swachh Bharat Mission: Encourage revenue generation through user charges and service improvements. 
• Digital Reforms: Promotion of online tax payment systems, e-filing, and transparent accounting practices for efficient collection and reduced leakages. 

What Reforms can Strengthen the Fiscal Architecture of Urban Local Bodies (ULBs)? 

• Recognising Grants and Shared Taxes: Grants and shared taxes should be treated as legitimate and stable sources of municipal income to ensure reliable funding for urban services. 
• Revising Credit Rating Norms: Credit rating frameworks should include governance quality and fiscal management as key indicators to reflect municipal financial health accurately. 
• Using GST Compensation as Collateral: GST compensation or State revenue shares can be allowed to serve as collateral for municipal borrowing, improving access to finance. 
• Strengthening Property Tax Reforms: Property tax efficiency should be enhanced through GIS mapping, regular revaluation, and improved collection mechanisms to boost municipal revenues. 
• Promoting Cooperative Federalism: Cities should receive predictable, united, and formula-based transfers to encourage fiscal autonomy and accountable urban governance. 
• Exploring Innovative Financing Tools: Urban infrastructure funding can leverage Social Stock Exchanges and Value Capture Financing to mobilise additional resources sustainably. 

Conclusion 

A robust and equitable municipal finance framework is essential to realise Sustainable Development Goal 11 (Sustainable Cities and Communities) and ensure that India’s cities become financially self-reliant, accountable, and resilient. 

Drishti Mains Question 

Q. What are the key reasons for India’s urban fiscal crisis, and what steps has the government taken to address it?

 

Frequently Asked Questions 

 Q1. Why is India facing an urban fiscal crisis? 

Urban bodies contribute two-thirds of GDP but control less than 1% of tax revenue, causing severe fiscal imbalance and dependence on higher government transfers. 

 Q3. What are municipal bonds, and why are they important? 

Municipal bonds are debt instruments issued by cities to fund infrastructure, reduce state dependence, enhance creditworthiness, and attract private and green investments. 

 Q4. What key reforms can improve municipal finances? 

Reforms include recognising grants as income, improving property tax systems, revising credit ratings, enabling fiscal autonomy, and ensuring predictable, untied transfers to municipalities. 

UPSC Civil Services Examination, Previous Year Question (PYQ) 

Prelims 

Q. Consider the following: (2023)

1. Demographic performance 
2. Forest and ecology 
3. Governance reforms 
4. Stable government 
5. Tax and fiscal efforts 

For the horizontal tax devolution, the Fifteenth Finance Commission used how many of the above as criteria other than population area and income distance? 

 (a) Only two 

 (b) Only three 

 (c) Only four 

 (d) All five 

 Ans: (b) 

 Q. According to the Constitution of India, it is the duty of the President of India to cause to be laid before the Parliament which of the following? (2012)

1. The Recommendations of the Union Finance Commission 
2. The Report of the Public Accounts Committee 
3. The Report of the Comptroller and Auditor General 
4. The Report of the National Commission for Scheduled Castes 

Select the correct answer using the codes given below: 

 (a) 1 only 

 (b) 2 and 4 only 

 (c) 1, 3 and 4 only 

 (d) 1, 2, 3 and 4 

 Ans: (c) 

 Q. With reference to the Finance Commission of India, which of the following statements is correct? (2011)

 (a) It encourages the inflow of foreign capital for infrastructure development 

 (b) It facilitates the proper distribution of finances among the Public Sector Undertakings 

 (c) It ensures transparency in financial administration 

 (d) None of the statements (a), (b) and (c) given above are correct in this context 

 Ans: (d) 

 Mains 

 Q. Do government’s schemes for up-lifting vulnerable and backward communities by protecting required social resources for them, lead to their exclusion in establishing businesses in urban economies? (2014)

 Q. Discuss the recommendations of the 13th Finance Commission which have been a departure from the previous commissions for strengthening the local government finances. (2013)