India is poised for massive urban transformation, necessitating a sustained increase in investment to build urban infrastructure. The present NDA government in its maiden budget has allocated INR 82576.57 crores to the Ministry of Housing and Urban Affairs - equaling almost 19 per cent increase over the revised estimates of INR 69270.72 crores in 2023-24.
This budgetary support needs to be complemented by private and market-based instruments for financing the urban infrastructure. Accordingly, the budget proposes to formulate a framework for enabling policies, bankable projects and market-based mechanisms. The Economic Survey 2023-24 has explicitly acknowledged the import of strengthening the city government (CG) in the proposed framework. Financial empowerment of the CGs can make them attractive before the private investors and help them to explore the innovative sources of financing.
Frailty of city finance
However, infirm financial health of the cities remains a serious policy concern. Municipal own revenue constituted only 2.6 per cent of the combined revenue of central, state and cities in India. This is significantly low compared to the corresponding ratio of 4.2 per cent in Mexico and 27.2 per cent in Denmark.
Moreover, problem of poor finance is severe among the smaller cities. Municipal finance in India suffers from two basic problems. First, the cities do not have access to broad basket of ‘own’ taxes commensurate with their mandated responsibilities. The 74th Constitutional Amendment Act stipulates the functional domain of the cities but it does not spell out clearly the revenue-generating sources for them.
State Governments specify the taxes and fees that cities can use and collect. Second, available tax sources are not properly utilized. So, there is gross mismatch between the ‘functions’ and ‘finances’ of the cities.
Untapped Property Tax
Property Tax (PT) is the most important urban local tax in India and it’s importance has increased in the post GST period. However, in contrast to the 1 per cent (in OECD countries) and 3 to 4% (in developed countries, like Canada and US) contribution to GDP, PT in India roughly contributes 0.15% of the GDP. The PT is specified in the State List (‘Entry 49’) of Seventh Schedule of the Constitution.
So, the state governments lay down the framework for determining the tax bases, procedure for valuation, rebate and exemption policies, rate setting, tax liability, and measures for dealing with delays and tax evasion. This effectively takes the PT away from the control of the cities. Manual, paper-based systems for creation and maintenance of property undermine the completeness and accuracy of property records.
Apart from five states (Gujarat, Karnataka (only in Municipal Corporation Act), Tamil Nadu (only in Municipal Councils), Uttar Pradesh and Uttarakhand), there is no provision for periodic enumeration of properties in State Acts.
Lack of credible database on market rental values or capital value of properties; prevalence of rent control act and high discretionary powers exercised by the revenue officials in assessment cloud the true market value of the properties. Inefficient collection, widespread exemptions and absence of penal provisions as well as dispute resolution mechanisms have further undermined revenue potential of the PT.
Shrunken tax baskets
Cities have also not been able to exploit the full potential of motor vehicle tax and advertisement tax in spite of growing economic and commercial activities. After introduction of GST, several taxes (e.g., entertainment tax, octroi, local body tax) have been subsumed under the GST.
Local body tax and octroi were major sources of revenue for cities in Maharashtra and Gujarat. Discontinuation of these taxes have resulted in loss of buoyant sources of revenue, weakening of the revenue generation capacity of the cities from own sources. However, the CGs have not been compensated on account of revenue losses from discontinuation of these taxes. This is in complete contrast to the Ministry of Urban Development and experts’ recommendations of sharing a certain percentage of GST revenue with the cities.
Underutilized non-tax instruments
Few cities in India utilize the non-tax sources (e.g., user charges, betterment fees) to cover even operation and maintenance costs of basic services. The water and sewerage utilities in Indian cities, on average, recovered only 55% of their operating costs. This is below the O&M cost recovery rates of countries like Brazil, Mexico South Africa, and Bangladesh, implying financial unsustainability of such services.
Some cities piggyback the user charges on property tax that suffers from the problems of improper valuation and exemptions. Such low utilization of non-tax sources can be attributed to narrow political compulsions (e.g., fear of losing votes) and citizens’ dissatisfactions with the urban services.
Essentially, the absence of any revenue model jeopardizes the scope of preparing bankable projects, as envisaged in this budget, for urban services. Thus, overt expectation of the Budget 2024 about leveraging limited budgetary support with substantial market-based financing for urban infrastructure investment is unlikely to be materialized.
The Way Forward
So, strengthening fiscal health of CGs in India becomes a necessity rather than a matter of choice. This can be achieved by improving the revenue generation capacity of the CGs. Reforms should be made to fully utilize the revenue potential of property tax through digitization of property tax base with provision of periodic updating, simplification of PT valuation, introduction of newer modes of tax paymemts, and improving tax compliance. All measurable basic services should be provided on the basis of costs.
Cities should be provided with the authority to set the tax rate and determine the tax base, making the CGs accountable for their tax decisions. Peoples’ resentment with urban services can be palliated by strengthening the linkages between municipal taxes and expenditures on those services. This can help cities in their endeavor to build ‘future ready urban infrastructure’.
