Financial Framework of Urban Local Bodies in India

Every time a streetlight flickers on, a garbage truck rolls through a neighborhood, or a public park opens its gates, there is a financial engine humming quietly in the background. That engine belongs to urban local bodies (ULBs), the third tier of government that runs our cities and towns. Understanding how they raise and spend money is not just an academic exercise; it directly shapes the quality of life for the more than half a billion Indians who now call urban areas home.

The three pillars of urban municipal finance 🔗

The financial architecture of a municipal corporation rests on three broad pillars: revenues it generates on its own, transfers it receives from the state government, and grants that flow from both the state and central governments. When all three pillars are strong, a city can invest in good roads, clean water, and reliable sanitation. When one weakens, service delivery suffers, and the gap is usually visible in the form of potholes, overflowing drains, or unreliable water supply.

The 74th Constitutional Amendment Act of 1992 formally recognised ULBs as institutions of self-government and assigned them eighteen functions ranging from urban planning to public health. Yet, as research by Accountability Initiative notes, Indian ULBs remain among the weakest local governments globally in terms of fiscal autonomy, with a heavy dependence on grants from higher tiers of government.

Own revenue sources: the backbone of municipal autonomy 🔗

A ULB’s own revenue is the money it raises directly from residents and businesses within its jurisdiction. These sources give municipalities the autonomy to plan and spend based on local priorities rather than waiting for money to arrive from elsewhere. Broadly, own revenues are divided into tax and non-tax categories.

Tax revenues 🔗

Municipal Acts in most states allow ULBs to levy around twenty-five different taxes, though in practice only a handful are actually collected. Property tax is the single most important source, often contributing the largest share of own tax revenue. It is levied on land and buildings based on either an area-based method or a capital value method. Other taxes include advertisement tax, entertainment tax, tax on vacant land, and in some states, professional tax.

The Fifteenth Finance Commission’s study on metropolitan municipal corporations points out that the introduction of the Goods and Services Tax in 2017 eliminated critical local revenue streams such as octroi, local body tax, entry tax, and in some cases advertisement tax, without providing a full compensation mechanism. This structural shift narrowed the tax base of ULBs significantly and made them more dependent on transfers.

Non-tax revenues 🔗

Non-tax revenues come from fees and user charges. These include water supply charges, sewerage and sanitation fees, building permission fees, trade licence fees, parking charges, rent from municipal assets, and fines. The principle behind user charges is simple: those who directly use a service should contribute to its upkeep. However, recovery is often poor. A study cited by the Indian Institute for Human Settlements found that non-tax revenues rarely cover even the operation and maintenance costs of the services being provided, creating a perpetual shortfall.

State transfers and the role of State Finance Commissions 🔗

The second pillar of municipal finance comes from the state government. Article 243-Y of the Constitution requires every state to constitute a State Finance Commission (SFC) once every five years. These bodies are tasked with reviewing the financial position of ULBs and recommending how taxes, duties, tolls, and fees should be shared between the state and local governments.

State transfers come in two broad forms. Statutory devolutions are based on SFC recommendations and represent a share of the state’s own revenue. Grants-in-aid are discretionary and often tied to specific purposes or projects. Additionally, revenue from certain taxes like stamp duty or entertainment tax may be shared or assigned to ULBs based on state laws.

In practice, however, the SFC mechanism has been uneven. Many states delay constituting their SFCs, and even when reports are submitted, recommendations are often only partially accepted or implemented with significant delays. The Comptroller and Auditor General’s performance audit on the 74th Amendment has repeatedly flagged cases where municipalities remain heavily dependent on grants because own revenue generation is weak and SFC-recommended devolutions arrive late or in reduced amounts.

Central transfers and Finance Commission grants 🔗

The central government also supports ULBs. Under Article 280(3)(bb) and (c), the Central Finance Commission recommends measures to augment the consolidated fund of states so they can supplement the resources of panchayats and municipalities. The Fifteenth Finance Commission, for instance, recommended around Rs 1,21,055 crore for urban local bodies for the period 2021-26, split between basic and performance-linked grants.

On top of Finance Commission grants, central ministries run large mission-mode schemes that channel funds directly to qualifying cities. Programmes such as the Smart Cities Mission, the Atal Mission for Rejuvenation and Urban Transformation (AMRUT), the Swachh Bharat Mission (Urban), and the Pradhan Mantri Awas Yojana (Urban) have pumped substantial resources into urban infrastructure over the past decade.

Why ULBs continue to face a funding crunch 🔗

Despite multiple revenue sources, most Indian cities are financially stretched. Several interconnected factors explain this.

Weak own-source revenue generation 🔗

Own revenues remain far below potential. Research by the Centre for Social and Economic Progress estimates that cumulative property tax revenue across Indian ULBs stands at roughly 0.15 percent of GDP, compared with around 0.3 percent in low-income countries and close to 1.1 percent in OECD economies. Coverage gaps are striking; for example, analysis suggests that Bengaluru’s municipal body may have only about 20 lakh properties on its tax rolls against an estimated 42 lakh, a coverage ratio below 50 percent.

Weak valuation practices compound the problem. Most cities use an area-based method where a base rate is set per square foot and rarely revised, meaning tax demand does not grow with market values. Political reluctance to revise rates, widespread exemptions, and limited staff strength for physical inspection further depress collections.

Fiscal mismatch and heavy dependence on transfers 🔗

Municipalities are responsible for a long list of functions under the 74th Amendment, but their share of total public expenditure remains very small. Policy briefs on the Sixteenth Finance Commission highlight that only around 32 percent of municipal revenue is generated internally, while property tax realisation is stuck at about 56 percent of assessed demand. Intergovernmental transfers to ULBs in India remain around 0.5 percent of GDP, far lower than the international benchmark of 2 to 5 percent.

Delayed and inconsistent SFC implementation 🔗

The effectiveness of State Finance Commissions is uneven. Some states have skipped cycles, some have accepted only a fraction of the recommendations, and in many cases the actual release of funds lags far behind the formal acceptance. This unpredictability makes it difficult for ULBs to plan long-term investments or commit to infrastructure projects that require steady cash flows.

Capacity deficits and governance gaps 🔗

A financial framework is only as good as the institutions that run it. ULBs face chronic staff shortages, with some estimates pointing to average vacancy rates of 35 to 37 percent in sanctioned posts. Many municipalities have not yet fully adopted accrual-based double-entry accounting, making it hard to assess their true financial position or borrow on commercial terms.

Exploring new frontiers: borrowing, bonds, and partnerships 🔗

As traditional revenues fall short of mounting infrastructure needs, ULBs are beginning to explore alternative financing avenues.

Municipal bonds 🔗

Municipal bonds allow cities to raise long-term capital directly from investors for specific infrastructure projects. The Bangalore Municipal Corporation issued India’s first municipal bond back in 1997, and Ahmedabad followed soon after. More recently, Pune Municipal Corporation’s 2017 bond issue of Rs 200 crore revived investor interest. Cities like Indore, Ghaziabad, Hyderabad, and Lucknow have since tapped the bond market, including green bonds tied to environmental projects. SEBI has put in place a regulatory framework for municipal debt issuance, yet the total volume remains modest compared with the infrastructure gap.

Public-private partnerships 🔗

Public-private partnerships (PPPs) bring in private capital and operational expertise for projects such as solid waste management, water treatment, urban transport, and affordable housing. When designed well, they allow ULBs to deliver services without bearing the full upfront cost. However, PPPs require strong contract management capacity and credible dispute resolution mechanisms, both of which remain works in progress in many Indian cities.

Land-based financing and asset monetisation 🔗

Cities sit on significant real estate assets that can generate revenue through leases, development charges, betterment levies, and premium for additional floor space index. Some municipalities are also leasing air rights above bus terminals or converting underused buildings into commercial spaces. Land value capture, done transparently, can unlock substantial resources for urban infrastructure.

The road to financial sustainability 🔗

Fixing municipal finance is not about a single magic bullet. It requires simultaneous progress on several fronts. Property tax reform must focus on updating valuation methods, improving coverage through GIS and door-to-door surveys, and transparently reporting demand and collection data. User charges need to be rationalised so that basic services at least recover their operating costs, while protecting affordability for the poor. Timely SFC cycles and consistent implementation of their recommendations can bring predictability to transfers. Finally, capacity building – in accounting, project management, and financial analysis – is essential so that ULBs can credibly access capital markets and manage complex partnerships.

The Sixteenth Finance Commission has signalled a significant push in this direction by raising the urban share of local body grants and recommending a much larger overall allocation than before. Whether this translates into stronger, self-reliant cities will depend on how state governments, municipalities, and citizens engage with the reforms that accompany the money.

What do you think? How much of a city’s financial autonomy should depend on the willingness of its residents to pay higher property tax and user charges? And should citizens have a formal role – through participatory budgeting or social audits – in deciding how municipal money is raised and spent?

References

1. https://www.mohua.gov.in/
2. https://accountabilityindia.in/blog/urbanisation-in-india-urban-local-bodies/
3. https://fincomindia.nic.in/asset/doc/commission-reports/15th-FC/reports/studies/Finances%20of%20Municipal%20Corporations%20in%20Metropolitan%20cities%20of%20India.pdf
4. https://www.shankariasparliament.com/current-affairs/municipal-finances
5. https://cag.gov.in/uploads/download_audit_report/2022/10-Chapter-6-064199054cbade3.14694339.pdf
6. https://india.mongabay.com/2023/02/are-cities-smart-enough-to-leverage-municipal-bonds/
7. https://smartcities.gov.in/
8. https://csep.org/working-paper/enhancing-property-tax/
9. https://thedailybrief.zerodha.com/p/behind-indias-poor-property-tax-collection
10. https://laex.in/daily-mains-question/16th-finance-commission-urban-local-bodies/