Fiscal Architecture of Municipalities in India

16.10.2025

Fiscal Architecture of Municipalities in India

Context
 India’s governance operates through three tiers: Union, State, and Local. Municipalities, as urban local bodies, oversee planning, sanitation, health, and infrastructure. Despite urban areas contributing over 65% of GDP, municipalities control less than 1% of tax revenues, making them heavily reliant on State and Central transfers. This fiscal imbalance limits autonomy and hampers effective service delivery.

Impact of GST on Municipal Finances
 Before GST (2017), municipalities raised revenue via Octroi, local cesses, and surcharges. GST unified indirect taxes but eliminated many local revenue streams, reducing municipal income by 19%. Compensation promised by the Central government flows through States rather than directly to municipalities, deepening fiscal dependence and restricting local decision-making and infrastructure investment.

Solution
 Municipal bonds offer a market-based financing mechanism for urban bodies. Initiatives like NITI Aayog guidelines, the Smart Cities Mission, and the Finance Commission encourage bond issuance.

Challenges:

• Weak creditworthiness due to limited own-source revenue.
   
• Heavy reliance on State and Central grants.
   
• Low investor confidence leading to limited uptake.
   

Potential:
 By strengthening finances, improving credit ratings, and treating grants as regular income, municipal bonds can fund infrastructure and enhance urban development.

Constitutional and Policy Framework

• 74th Constitutional Amendment (1992): Institutionalized Urban Local Bodies, granting powers to levy taxes and perform governance functions.
   
• Articles 243W–243Y: Empower municipalities to collect taxes, manage finances, and receive devolution from State Finance Commissions.
   
• 15th Finance Commission (2021–2026): Recommended ₹4.36 lakh crore allocation to local bodies, emphasizing fiscal decentralization.
   

International Experience
 Countries like Denmark, Norway, and Sweden provide relevant models:

• Local governments raise substantial revenue through direct taxes, reducing dependence on central transfers.
   
• Fiscal autonomy ensures predictable budgets, efficient service delivery, and sustainable infrastructure investment.
   

Way Forward

• Legal recognition of grants: Treat State and Central grants as regular municipal revenue to improve predictability and creditworthiness.
   
• Expand own-source revenues: Reintroduce or redesign local taxes compatible with GST to enhance autonomy.
   
• Encourage municipal bonds: Strengthen financial management, transparency, and accounting standards to attract investors.
   
• Capacity building: Train municipal officials in financial planning, debt management, and revenue mobilization.
   
• Fiscal justice mindset: Recognize municipalities as drivers of national prosperity, ensuring equitable fiscal architecture.
   

Conclusion
 Despite their economic contribution, India’s municipalities remain underfunded, limiting urban service delivery and development. Reforms in fiscal autonomy, municipal bonds, and grant recognition are critical to creating empowered local governance. Aligning with global best practices can enhance efficiency, infrastructure development, and citizen welfare, fostering inclusive and sustainable urban growth.