Urban Fiscal Architecture in India

17.10.2025

1. Urban Fiscal Architecture in India

Context
India’s urban local bodies, which contribute nearly two-thirds of national GDP, receive less than 1% of total tax revenue. An analysis highlights that post-GST centralisation has weakened city-level fiscal independence.

About the News

Background:
India’s fiscal structure undervalues municipal contributions. Despite cities driving national growth, their tax powers remain severely limited and dependent on higher tiers of government.

Structural Flaws:

• Revenue–Responsibility Mismatch: Cities generate 66% of GDP but receive less than 1% of tax revenue, forcing high dependence on state and central grants.
• Tax Centralisation under GST: Traditional local levies like octroi and entry tax were merged into GST, eroding local fiscal autonomy.
• Dependence on Grants: ULBs rely on conditional transfers from AMRUT, Smart Cities Mission, and State Finance Commissions, leading to uncertain cash flows.
• Restricted Tax Autonomy: Local bodies cannot revise property or professional taxes without state approval.
• Inverted Federalism: While responsibilities are decentralised (waste management, housing), fiscal control remains centralised.

Loss of Revenue Autonomy

• Post-GST Impact: Nearly one-fifth of traditional municipal revenue sources were absorbed by GST, erasing city-specific income streams.
• Bypassed Compensation: GST compensation flows to states, not ULBs, preventing recovery of urban revenue loss.
• State Control: States decide property valuation and tax rates, delaying financial decision-making.
• Weak Enforcement of Fiscal Devolution: Implementation of the 74th Amendment remains limited, as many states fail to regularly constitute State Finance Commissions.
• Administrative Deficits: Low digitalisation and incomplete property databases restrict local tax collection efficiency.

Municipal Bonds and Fiscal Innovation

• Policy-Promise Gap: Despite government promotion, only about 40 cities have issued bonds due to weak municipal balance sheets.
• Credit Assessment Flaws: Rating agencies undervalue steady grants while overstating self-revenue dependency.
• Ideological Bias: Global lenders push user charges and property tax models, undermining fiscal justice.
• Need for Governance-Based Rating: City credit evaluation must consider transparency, citizen participation, and audit performance — not just income numbers.

Way Forward

• Recognise Shared Taxes as City Income: Include grants and GST compensation in urban balance sheets to reflect true fiscal capacity.
• Reform Credit Ratings: Introduce governance-linked performance measures.
• Establish Urban Fiscal Fund: Create a dedicated financing authority (like Sweden’s Kommuninvest) for pooled municipal lending.
• Guarantee Fiscal Transfers: Amend State Acts for predictable and untied grants under Article 280(3)(bb).
• Enable Borrowing Autonomy: Permit ULBs to use a share of tax transfers or GST compensation as bond collateral.

Conclusion
India’s urban future depends on genuine fiscal federalism. Strengthening municipal autonomy, ensuring predictable transfers, and linking creditworthiness to governance will empower cities as engines of inclusive national growth rather than dependent administrative units.