Financial Management in Urban Local Governments: Sources and Challenges

Every time your city cleans a drain, repairs a streetlight, or collects garbage from your doorstep, money quietly flows through a system that most of us never see. Urban Local Bodies (ULBs) – the municipalities and municipal corporations that run our cities – operate on budgets that are stretched thin, pulled between ballooning service demands and a revenue base that has barely kept pace with urbanisation. Understanding how these bodies earn, spend, and borrow money is key to understanding why some cities thrive while others struggle to keep the lights on.

Why ULB finances matter more than ever 🔗

Cities are the economic engines of the country. Urban areas contribute close to 67% of GDP and generate roughly 90% of government revenue, yet the municipal bodies that serve them remain financially anaemic. Total ULB revenues hover around just 1% of GDP, a figure dwarfed by the 5-8% that municipalities in developed economies command. This mismatch between responsibility and resources is the single most important story in urban local finance today.

The 74th Constitutional Amendment of 1992 assigned 18 functions to ULBs through the Twelfth Schedule – covering everything from water supply and solid waste management to urban planning and slum upgradation. But the amendment did not guarantee commensurate financial powers, leaving cities with expanding duties and shrinking fiscal independence.

The three pillars of ULB revenue 🔗

Municipal finances rest on three main legs: own tax revenue, own non-tax revenue, and intergovernmental transfers. A fourth, increasingly important leg – market-based borrowing – is slowly emerging but remains underused.

Own tax revenue 🔗

Property tax is the undisputed heavyweight here. It is levied on residential, commercial, industrial, and institutional properties within municipal limits, and for most corporations it is the single largest internally generated revenue stream. Other own taxes include profession tax, advertisement tax (where still permitted), and entertainment-related levies.

The problem is that property tax in India is severely underperforming. Revenue realised from property taxation is estimated at around 0.2% of GDP in India, compared to a developing-country average of about 0.7%. The Economic Survey 2018 also flagged that Indian ULBs raise only 10-11% of their finance from property taxes, while Chinese ULBs raise 20-22%. Outdated valuation rolls, sweeping exemptions, weak collection machinery, and political reluctance to revise rates all combine to suppress this crucial revenue source.

Own non-tax revenue 🔗

Non-tax revenues include user charges for water and sewerage, building plan approval fees, trade licence fees, parking fees, advertisement permissions, and rental income from municipal properties. These sources are tied directly to services delivered, which in theory makes them both fair and elastic.

In practice, however, cost recovery remains poor. Cost recovery by Indian urban utilities on average is below that of comparator countries like Brazil and Mexico. User charges for water, for instance, rarely cover the cost of production and distribution, leaving municipalities to subsidise services through other revenues or simply let infrastructure deteriorate.

Intergovernmental transfers 🔗

Grants from the Centre and the state form the third – and increasingly dominant – pillar. These come through two channels. The first is statutory devolution recommended by Central Finance Commissions (CFCs) and State Finance Commissions (SFCs). The second is scheme-based grants tied to programmes like the Smart Cities Mission, AMRUT, and Swachh Bharat Mission.

A Comptroller and Auditor General report found a 42% gap between the resources and expenditure of urban local bodies across 18 states, with ULBs generating only 32% of their revenue independently. The remaining two-thirds arrives from higher levels of government, often with conditions attached.

Evolution of thinking: from the Taxation Enquiry Commission to the 16th Finance Commission 🔗

The question of how to fund India’s cities is almost as old as the Republic itself. The Local Finance Enquiry Committee (1951), the Taxation Enquiry Commission (1955), the Rural Urban Relationship Committee (1963), and the Committee on Augmentation of Financial Resources of Urban Local Bodies (1963) were among the earliest bodies to examine urban public finances after Independence.

The Taxation Enquiry Commission, in particular, laid the intellectual foundations for modern municipal finance thinking. It recommended that property tax be levied on the rateable value of property, that user charges be adequate to recover costs, and that finance commissions be set up periodically by state governments to determine principles of devolution to local bodies. It also called for dedicated development finance institutions to fund urban capital projects – an idea that continues to echo in today’s debates on municipal bonds and infrastructure funds.

Successive Central Finance Commissions have gradually increased allocations to local bodies. The 15th Finance Commission recommended grants of ₹4.36 lakh crore to local bodies for 2021-22 to 2025-26, the largest-ever share assigned to the third tier, though roughly 60% of this flows to rural bodies and only about 40% to urban ones. The 16th Finance Commission has recommended ₹3.56 lakh crore for ULBs, more than double the previous urban allocation, with the urban share rising from 19% in the 10th Finance Commission to 45% in the 16th.

The Second ARC and HPEC perspectives 🔗

The Second Administrative Reforms Commission in 2007 and the Thirteenth Finance Commission in 2009 both recommended switching to the capital value method of property tax assessment, moving away from the outdated annual rental value system. The High-Powered Expert Committee on Urban Infrastructure (2011) went further, estimating an investment need of over ₹39,000 billion for urban infrastructure over two decades and calling for time-bound property tax reforms across all states.

The squeeze on expenditure: why there’s never enough 🔗

Even where revenue comes in, a disproportionate share is consumed by establishment costs. Typically 60-80% of ULB budgets go toward revenue expenditure – salaries and pensions – leaving negligible funds for capital expenditure on new infrastructure. This structural imbalance means that even when fiscal transfers rise, the additional money often plugs existing holes rather than building anything new.

The post-GST era has added another layer of complexity. With the introduction of GST, ULBs lost buoyant revenue sources like octroi, entry tax, local body tax, and advertisement tax, which were subsumed into the new regime. Compensation from the state or Centre has partially replaced these flows, but often with delays and political frictions.

Municipal bonds and the promise of market finance 🔗

To escape this dependency trap, cities are being nudged toward the capital market. Municipal bonds allow ULBs to raise long-term funds from investors to finance specific infrastructure projects, with repayment secured by project revenues or general municipal income.

The Indian municipal bond market is growing but remains tiny. Ten cities across six states – including Pune, Ghaziabad, Lucknow, Hyderabad, Visakhapatnam, Indore, Bhopal, Surat, Ahmedabad, and Vadodara – have municipal bonds listed on the National Stock Exchange, and in February 2023 the NSE launched India’s first municipal bond index. The Indore Municipal Corporation issued tax-free municipal bonds in 2023, attracting strong retail investor interest.

But the market faces structural headwinds. Borrowing by ULBs often requires case-by-case approval from the state government, a process that is opaque and slow. Most smaller ULBs also lack the audited accounts, credit ratings, and project-preparation capacity that the Securities and Exchange Board of India requires for bond issuance. Pooled financing – where several smaller ULBs issue a common bond – has been promoted as a solution, but uptake remains limited.

The deeper challenges behind the numbers 🔗

Behind every revenue figure lies a governance problem. Several recurring issues stand out.

Fiscal dependency and unfunded mandates 🔗

State Finance Commissions have not met the standards set by Central Finance Commissions, and urban local governments continue to operate with lack of funds and unfunded mandates. When SFC recommendations are delayed, diluted, or ignored by state governments, ULBs are left planning their budgets on quicksand.

Weak property tax administration 🔗

Outdated property rolls are a chronic problem. Urban local bodies historically made little attempt to update property cadasters regularly to identify properties and their owners, which means new constructions slip through the net while older entries remain frozen at decades-old valuations. GIS-based mapping, digital assessment, and area-based valuation systems are slowly changing this, but progress is uneven.

Capacity deficits 🔗

ULBs face an average vacancy rate of 35-37% in sanctioned posts, and in 16 states municipalities lack independent recruitment powers. Without trained finance professionals, urban planners, and project managers, even well-intentioned reforms stall at implementation.

Tied grants and reduced autonomy 🔗

Tied grants restrict expenditure to specific sectors like water, sanitation, and wastewater, reducing fiscal autonomy by compelling cities to follow state or central priorities rather than local needs. Performance-linked conditions under the 16th Finance Commission – where a share of funds depends on meeting revenue targets and publishing accounts – try to incentivise discipline, but they also add compliance burdens that smaller municipalities struggle to bear.

The road ahead: reforms that could change the equation 🔗

There is no shortage of reform ideas, and many of them are already on the table. The priorities cluster around a few themes.

First, property tax deserves urgent attention. Expanding the tax base through GIS mapping, shifting to capital-value-based assessment, and limiting exemptions could multiply revenues without raising rates. Second, user charges need to move closer to cost recovery, with safeguards for low-income households through lifeline rates rather than blanket subsidies. Third, accounting reforms – particularly a shift to double-entry accrual accounting – are a prerequisite for accessing bond markets and credit-enhancement schemes. Fourth, predictable and formula-based intergovernmental transfers would allow cities to leverage future flows for borrowing. Finally, capacity-building, through dedicated municipal cadres and training partnerships, is indispensable if any of the above reforms are to actually work on the ground.

Urban India is projected to cross 600 million people in the coming decade. The cities that figure out how to fund themselves sustainably will shape the country’s economic future; those that don’t will become bottlenecks for growth and quality of life alike.

What do you think? Should ULBs be granted direct constitutional taxing powers rather than depending on state-delegated authority, and would greater financial autonomy actually translate into better service delivery, or would it simply expose the deeper governance weaknesses that already plague our cities?

References

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