Municipal Finance Transformation Post-74th Amendment in India

When the Constitution (74th Amendment) Act came into force on 1 June 1993, it promised a quiet revolution in how Indian cities would be run and, crucially, how they would pay for themselves. More than three decades later, the story of municipal finance reads like a tale of ambition meeting inertia. Constitutional recognition arrived, State Finance Commissions were set up, and the Twelfth Schedule handed 18 functional responsibilities to urban local bodies. Yet cities still struggle to collect taxes efficiently, depend heavily on state transfers, and often find themselves financially cornered. Understanding this transformation, and where it has stalled, is essential to grasp how urban governance actually works today.

The financial architecture created by the 74th Amendment
The role of the State Finance Commission
Taxation powers and revenue sources of urban local bodies
Own-source revenue
Transfers and grants
Where implementation has fallen short
Weak functioning of State Finance Commissions
The blame game between municipalities and states
Limited people’s participation and resistance to reform
The push for professionalising municipal governance
Rebalancing autonomy and accountability

The financial architecture created by the 74th Amendment

Before 1992, municipalities operated at the mercy of state governments. Elections were irregular, funds were uncertain, and local bodies had no constitutional footing. The 74th Amendment changed the legal landscape by inserting a new Part IX-A containing Articles 243-P to 243-ZG into the Constitution, along with a Twelfth Schedule that listed 18 functional items meant for urban local bodies. For the first time, municipalities became a justiciable part of the constitutional framework, which meant states could no longer dissolve or ignore them at will.

The financial backbone of this new system rests on Article 243-X, which authorises the state legislature to empower municipalities in four specific ways. Municipalities can be allowed to levy, collect, and appropriate taxes, duties, tolls, and fees. States can also assign to them a share of state-collected taxes, such as entertainment tax or stamp duty. Grants-in-aid can flow from the Consolidated Fund of the state. And municipal funds can be formally constituted to credit and withdraw money. The idea was simple but powerful: urban local bodies should not depend entirely on the goodwill of the state government.

The role of the State Finance Commission

Perhaps the most significant institutional innovation was the State Finance Commission (SFC). Under Article 243-Y, every state governor must constitute an SFC every five years to review the financial position of municipalities and recommend a framework for fiscal devolution. The SFC’s mandate covers the distribution of net tax proceeds between the state and municipalities, the allocation of shares among municipalities at different levels, the determination of taxes and fees assigned to municipalities, and grants-in-aid from the Consolidated Fund of the state.

The scope of the SFC is broader than people realise. As the Haryana State Finance Commission notes, the SFC’s inquiry is much wider than that of the Union Finance Commission because it must also suggest measures to improve the financial position of local bodies so that they become viable units of local governance. In theory, the SFC was meant to be the institutional agency that turned the golden rule of cooperative federalism into practice, ensuring every citizen access to minimum public goods regardless of where they live.

Taxation powers and revenue sources of urban local bodies

The 74th Amendment left the actual design of municipal taxation to state legislatures, which was both a strength and a weakness. It allowed flexibility across states, but it also meant that real fiscal empowerment varied dramatically depending on political will. Today, urban local bodies draw revenue from a mix of own sources and external transfers.

Own-source revenue

Property tax remains the workhorse of municipal finance. It is levied on built-up properties within municipal limits and is calculated using either the Annual Rental Value system or the Capital Value system. Beyond property tax, municipalities collect taxes on professions and vehicles, along with non-tax revenue from fees for services like building permits, trade licences, and user charges for water, sewerage, and waste management.

The problem is that property tax performance in India is weak by any international standard. Cumulative property tax revenue across urban local bodies is about 0.15 per cent of GDP, compared with 0.3 per cent in low-income countries and 0.6 per cent in middle-income countries. Collection efficiency rarely crosses 70 per cent, and smaller municipalities often recover less than half of what is due. Outdated property registers, rampant undervaluation, and generous exemptions eat into potential revenue. The Second Administration Reforms Commission had estimated that only about 60 to 70 per cent of urban properties are actually assessed.

Transfers and grants

The other half of municipal finance comes from above. State governments make statutory transfers based on SFC recommendations, and central as well as state authorities give purpose-specific grants-in-aid. The Union Finance Commission, mandated by Article 280, also recommends measures to augment the Consolidated Fund of the state to supplement municipal resources. The 15th Finance Commission allocated approximately ₹1.2 to 1.3 lakh crore to urban local bodies over five years, which works out to only about 0.12 per cent of GDP. The 16th Finance Commission has proposed a larger absolute amount for 2026-31, but the share as a fraction of GDP has barely moved.

Where implementation has fallen short

The constitutional vision and the ground reality have rarely aligned. Many of the problems stem from how states have chosen to interpret and implement their constitutional obligations.

Weak functioning of State Finance Commissions

By the current calendar, fifth-generation SFCs should have already submitted their reports across the country. In reality, only a handful of states like Assam, Himachal Pradesh, Tamil Nadu, and Kerala have submitted their fifth SFC reports, while many others are still stuck at the third SFC stage. This delay, as the analysis notes, amounts to a large-scale violation of a constitutional mandate.

Even when SFCs do submit reports, their effectiveness is limited. According to analyses of SFC performance, there is widespread political reluctance to devolve real power and resources, commissions often lack domain experts, data collection is chaotic, and Action Taken Reports are rarely tabled in legislatures. States also have a habit of quietly ignoring SFC recommendations, which erodes the credibility of the entire process.

The blame game between municipalities and states

A familiar pattern has emerged in urban governance. Municipalities complain that state governments strangle them financially while retaining control over the most productive taxes. States retort that local bodies fail to collect even the taxes already assigned to them. Both are partly right. Financial transfers to municipal governments account for only about 0.45 per cent of GDP, compared with 1.6 to 5.4 per cent in countries like Brazil, Indonesia, the Philippines, and Mexico. European nations push transfers as high as 6 to 10 per cent of GDP. By any comparative benchmark, Indian cities are starved.

At the same time, municipal corporations themselves generated only about 0.6 per cent of GDP in own revenue, while states and the Union government collect 14.6 and 9.2 per cent respectively. Dependence on transfers has been climbing, and municipal borrowings jumped by over 360 per cent between 2019-20 and 2023-24, which signals rising stress rather than genuine financial health.

Limited people’s participation and resistance to reform

The 74th Amendment envisaged ward committees and active citizen engagement in urban planning. In practice, ward committees are either not constituted or exist on paper, and public participation in municipal budgeting remains rare. Citizens rarely know how property tax rates are set, which contractors are hired, or how capital spending is decided. This lack of transparency feeds a vicious cycle: weak accountability leads to weak trust, which leads to lower voluntary tax compliance.

Public-private partnerships, often pitched as a way to plug the resource gap, have faced resistance in many cities. Political unease about privatising essential services, combined with past experiences of failed or opaque PPP contracts, has made municipalities cautious. The result is that innovative financing, whether through municipal bonds, land value capture, or user charges that reflect real cost, remains underused.

The push for professionalising municipal governance

If municipal finance is to move beyond the current cycle of dependence and complaint, professionalisation is unavoidable. Three shifts matter most. The first is technology. Digitisation is already transforming municipal finance through online tax payment systems, GIS-based property mapping, and data analytics. When Pune issued India’s first municipal bond in 2017, it showed that disciplined cities could tap capital markets directly. More cities are following, though slowly.

The second shift is administrative. Many urban local bodies lack specialised financial management capacity, with gaps in budgeting, accounting, project finance, and financial reporting. Smaller municipalities feel this most acutely. Without trained staff, even well-designed reforms cannot translate into results on the ground.

The third shift is about incentives. The 15th and now the 16th Finance Commission have tied significant portions of their grants to performance conditions, including regular elections, publication of audited accounts, constitution of SFCs, and own-source revenue targets of ₹1,200 per household. These performance-based grants push cities to improve fiscal discipline, though critics argue that tied grants and rigid conditionalities end up reducing the fiscal autonomy that the 74th Amendment had tried to build in the first place.

Rebalancing autonomy and accountability

The deeper question is philosophical. Should cities be empowered to plan and manage their finances independently, with higher tiers of government acting as facilitators, or should they remain tightly supervised because of weak capacity and governance concerns? The 74th Amendment took a clear stance in favour of empowerment. Implementation has drifted toward supervision. Bridging that gap requires political will at the state level, stronger institutional design at the municipal level, and a citizenry that demands better performance in exchange for paying taxes.

What do you think? Three decades after the 74th Amendment, why do Indian cities still struggle to generate even a fraction of the municipal revenue collected in comparable developing countries? And what would genuinely professional, autonomous urban local bodies look like in practice, beyond the language of constitutional provisions?

References

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Table of Contents

The financial architecture created by the 74th Amendment 🔗

The role of the State Finance Commission 🔗

Taxation powers and revenue sources of urban local bodies 🔗

Own-source revenue 🔗

Transfers and grants 🔗

Where implementation has fallen short 🔗

Weak functioning of State Finance Commissions 🔗

The blame game between municipalities and states 🔗

Limited people’s participation and resistance to reform 🔗

The push for professionalising municipal governance 🔗

Rebalancing autonomy and accountability 🔗