Urban India stands at a crossroads. Despite its cities generating nearly two-thirds of the nation’s gross domestic product, India’s municipalities control less than 1% of the country’s tax revenue—a contradiction that has become a central flaw in the country’s fiscal architecture. According to recent analysis by The Hindu, this mismatch has left Indian cities as economic powerhouses, yet fiscally handicapped, unable to fully realize their potential as engines of national prosperity.
At the heart of this paradox is a system that centralizes taxation powers while decentralizing service delivery responsibilities. Municipalities now depend heavily on state and central transfers, loans, and centrally designed schemes for more than 75% of their annual budgets, as highlighted by the Comptroller and Auditor General in 2024. This dependency is not just a technical flaw; it’s a democratic inversion. Cities are tasked with critical functions—housing, waste management, climate adaptation—without the financial autonomy to fund them, leading to fiscal uncertainty and limited local discretion.
The introduction of the Goods and Services Tax (GST) in 2017 marked a turning point. GST subsumed major local taxes such as octroi, entry tax, and surcharges, which previously served as vital revenue streams for municipalities. For instance, the loss of octroi in Maharashtra slashed Mumbai’s municipal income by approximately ₹7,000 crore annually, according to The Hindu. On average, the GST led to a 19% loss in municipal revenues nationwide. Compensation mechanisms, intended to offset these losses, have not reached the municipal level directly. Instead, compensation flows to states, leaving urban local bodies (ULBs) with a widening fiscal gap and eroding their tax flexibility.
This over-centralisation has also meant that property and professional taxes—among the few remaining local tax instruments—cannot be revised without state approval. In Gujarat and Kerala, for example, municipal bodies require state clearance to alter tax slabs, which delays vital fiscal decisions and stymies dynamic revenue mobilisation. The result? Weak fiscal autonomy and a chronic mismatch between the responsibilities assigned to cities and the resources available to fulfill them. Bengaluru, as cited by NITI Aayog in 2023, faces an annual gap of ₹3,000 crore between its mandated duties and municipal resources.
Municipalities’ reliance on grants and schemes like AMRUT and the Smart Cities Mission further compounds their vulnerability. Over 70% of Smart City funds remain centrally monitored, offering little city-level discretion. Only 10–12 states have established State Finance Commissions regularly, as per The Hindu, leading to uneven fiscal decentralisation and a lack of enforcement of fiscal federalism envisioned under the 74th Constitutional Amendment.
The 74th Amendment, passed in 1992, was supposed to empower urban local bodies as institutions of self-government. In practice, however, the absence of fiscal devolution has reduced them to dependent implementers. Cities are left to carry out centrally designed schemes without the resources or autonomy to tailor solutions to local needs. As one analysis from The Hindu puts it, “Urban fiscal empowerment is not a technical reform but a moral and political imperative.”
In recent years, NITI Aayog and the Union Ministry of Housing have promoted municipal bonds as the next frontier of city finance. The idea is simple: cities raise capital from the market to fund infrastructure and development. However, the reality has not lived up to the hype. Only about 40 cities have issued municipal bonds to date, with limited success. Pune’s ₹200 crore bond in 2017 was pioneering, but similar initiatives have stagnated due to weak municipal balance sheets and the narrow way creditworthiness is assessed.
Credit rating agencies typically judge cities on their “own revenue,” ignoring the recurring nature of grants and shared taxes. This approach, according to The Hindu, reinforces the false narrative that cities are dependent entities rather than equal tiers of governance. It overlooks the constitutional entitlement of municipalities to a share of national resources, as intended by the 74th Amendment. Global institutions like the World Bank and Asian Development Bank have also pushed for self-reliance through property taxes and user charges, but these measures alone are insufficient and, at times, regressive.
Property tax reforms, while important, currently contribute only 20–25% of total revenue potential. Over-reliance on the “user-pays” model shifts the burden of urban finance onto citizens, especially the urban poor, effectively turning public goods into private commodities. Services like water, sanitation, public lighting, and mobility are collective entitlements, not market goods, and should not be treated as such.
So, what’s the way forward? Experts and analysts point to a series of reforms that could help India’s cities reclaim their fiscal autonomy. First, there’s a call to democratise the fiscal contract by adopting a Scandinavian model, where cities have the right to levy and collect local taxes—including, in some cases, income taxes. This would create a direct link between citizens and governance, promoting accountability and transparency.
Second, the current system of grants and shared taxes must be reimagined. Predictable, adequate, and untied transfers to cities are essential. Municipal grants should be recognised as part of a shared fiscal ecosystem, not as discretionary handouts. The 16th Finance Commission, some suggest, could institutionalise formula-based transfers to ULBs, ensuring stability and equity.
Third, the municipal bond framework needs to be overhauled. Grants and shared taxes should be recognised as legitimate city income, and governance indicators—such as transparency, audit compliance, and citizen participation—should be incorporated into city credit ratings. Cities should also be allowed to use GST compensation or state tax shares as collateral for borrowing, enabling even Tier-II cities to attract private and multilateral financing.
There’s also a push for a dedicated urban fiscal fund, modeled on the Swedish Kommuninvest, which pools capital for low-cost loans to local projects. Tamil Nadu has already begun releasing devolution funds directly to ULBs through a transparent digital dashboard, setting an example for other states to follow.
Strengthening local revenue mechanisms is equally important. Improving property tax coverage, digitising assessment systems, and diversifying revenue sources—through land value capture, service charges, and urban transport levies—can help cities build more robust and independent fiscal bases. Administrative weaknesses, such as low digitalisation and outdated records, must also be addressed to improve tax collection efficiency. In Tier-II cities, property tax coverage averages only 60–65% of potential properties, according to the Ministry of Housing and Urban Affairs in 2024.
Ultimately, India’s urban future depends on fiscal justice and decentralisation. Empowering municipalities with predictable, independent, and equitable revenues will not only restore the true spirit of the 74th Amendment but also ensure that cities are recognised as vital economic engines, not mere cost centres. As The Hindu succinctly puts it, “Municipal finance is not merely a bookkeeping exercise, but a reflection of democratic and moral values.” For India to achieve sustainable urbanisation and inclusive growth, the fiscal relationship between the Centre, states, and cities must be rebalanced, restoring trust, autonomy, and resources to the grassroots.
With these reforms, Indian cities could finally gain the fiscal muscle they need to match their economic might, paving the way for a more equitable and prosperous urban future.