1. Introduction

2.1 As brought out in Chapter I, analysis of the fiscal situation of local bodies is constrained by the non-availability of consolidated data. This chapter endeavours to redress this imbalance in respect of municipal corporations (MCs) across all States for the years 2017-18 (actuals), 2018-19 (revised estimates) and 2019-20 (budget estimates). The rest of this chapter is structured into three sections. Section 2 examines fiscal outcomes for the period of reference. Section 3 deals with financing of MCs. Section 4 summarises the findings. A historical overview of the evolution of municipal finances is given in the Annex.

2. The State of Municipal Finances

Municipal Receipts

2.2 Based on our sample¹, the revenue receipts of MCs - consisting of own tax revenue, own non-tax revenue and transfers - are estimated at 0.61 per cent of GDP in 2017-18 and were budgeted to increase to 0.72 per cent of GDP in 2019-20 (Table II.1).²

2.3 Own tax revenue, comprising property tax, water tax, toll tax and other local taxes, accounted for 31-34 per cent of total revenue during the period under study. Large variations are observed, with MCs in Delhi, Gujarat, Maharashtra, Chandigarh, and Chhattisgarh collecting higher taxes relative to others (Chart II.1).

2.4 Property tax has gained prominence among the own tax revenue sources as taxes such as octroi/local body tax were subsumed in the Goods and Services Tax (GST)³. There is, however, a wide variation in the collection of property tax across MCs (Chart II.2).

2.5 Despite its dominance over other municipal taxes, property tax collection in India is much lower compared to the OECD countries due to several factors, viz., property undervaluation, incomplete registers, policy inadequacy and ineffective administration (Awasthi and Nagarajan, 2020). Moreover, the collection system is marred by challenges of pending litigations and inadequate staffing pattern in MCs (Mankikar, 2018). Thus, there is a need for large-scale reform of property taxation practices in India (Box II.1).

2.6 Non-tax revenue, which accounted for around 30 per cent of total revenue receipts of MCs, is dominated by fees and user charges followed by income from investment, mainly in the form of interest earned and dividends, rental income from municipal properties, and sale and hire charges (Table II.2).

2.7 Transfers from Central and State governments also account for a sizeable portion of the revenue receipts of the MCs (Table II.3). Transfers from the State governments in the form of assigned revenues, compensation, State Finance Commission grants and other State government grants constitute the dominant component with a share of 30-35 per cent of revenue receipts. Transfers from the Central government, on the other hand, account for less than 5 per cent.

Box II.1: Scope and Opportunities for Property Taxes in India Property tax, which accounts for around half of the total tax collections of MCs, amounts to less than 0.5 per cent of GDP with significant inter-state variations (Chart 1a). Many of the larger cities, however, were able to increase property tax collections over 2017-20 (Chart 1b). Poor enforcement mechanisms, coupled with multiple outdated exemptions, dated property rolls and databases, sub-optimal tax rates, property undervaluation and weak tax administration have resulted in significant under-recoveries in the majority of the Indian cities (Awasthi and Nagarajan, 2020). While the level of urbanisation and the urban population density bear a positive correlation with the amount of property tax mobilised, there are several corporations which have been able to generate relatively higher revenue at much lower levels of urbanisation (Chart 1c). The potential of property tax needs to be fully leveraged by extending coverage, regular revision of tax rates, improving the assessment system and raising efficiency in tax administration. For the smaller MCs, lack of institutional capacity to undertake these reforms constitute the main challenge and assistance from the State governments in this regard may be helpful. For the larger corporations, it is vital that the expansion of tax base and increase in efficiency of tax collection are achieved through the use of technologies such as satellite photography and geo-coding of data. References: Awasthi, R. and Nagarajan, M. (2020). “Property Taxation in India: Issues Impacting Revenue Performance and Suggestions for Reform”. Governance Global Practice, Discussion Paper No. 5, World Bank Group.

Municipal Expenditure

2.8 Municipal expenditure declined between 2012-13 and 2017-18 while the share of revenue expenditure to total expenditure remained constant (Ahluwalia et. al., 2019). The share of revenue expenditure, however, declined steadily from 70 per cent of total expenditure in 2017-18 to 58 per cent in 2019-20 (BE) (Table II.4).

2.9 Establishment expense consisting of salaries, wages and pensions was the largest component of revenue expenditure, followed by operational and maintenance expenses, which are directed towards general services and maintenance of capital assets. Committed expenditure comprising establishment expenses, administrative expenses and interest and finance charges was estimated at 0.32 per cent of GDP during 2017-20.

2.10 Establishment and operational and maintenance expenses have been on the rise with wide variations, while interest and finance charges remained unchanged (Chart II.3).

2.11 The share of MCs’ capital expenditure increased sharply from around 30 per cent of total expenditure (0.20 per cent of GDP) in 2017-18 to 42 per cent in 2019-20 (0.44 per cent of GDP), with large inter-state variations (Chart II.4).

2.12 The ratio of revenue expenditure to capital expenditure of MCs was at 2.4 as against 7.1 for the Centre and 5.9 for the States in 2017-18 (Chart II.5). Various factors, viz., size of the MC, population density, transfer dependency and nature of expenditure of the parent State government have impacted the quality of expenditure of municipal corporations in India (Box II.2).

Box II.2: Determinants of Expenditure Quality of Municipal Corporations India has the second largest urban population in the world after China, and it is projected to add another 416 million urban dwellers between 2018 and 2050 (UN, 2018). By the Government of India’s Municipal Performance Index, Indore emerged as the highest-ranked municipal corporation in 2020, followed by Surat and Bhopal (GoI, 2021). The New Delhi Municipal Council has emerged as the leader in the less than million population category, followed by Tirupati and Gandhinagar. Efficiency and quality of expenditure were important performance parameters. Three key indicators of expenditure quality - ratios of capital outlay4 to total expenditure (COTE); revenue expenditure to total expenditure (RETE); and revenue expenditure to capital outlay (RECO) - have been used for analysing the determinants of expenditure quality of the MCs. Lower RECO and RETE and higher COTE imply improvement of expenditure quality and vice versa. MC level fixed effect regressions with State-level clustering, controlling for relative MC size (total expenditure of MC as a per cent of total expenditure of the respective State), transfer dependency (share of transfers in total revenue receipt of MC), State expenditure quality (respective State’s COTE, RETE, and RECO), and district population density, were estimated using the following model: In equation (1), i stands for individual MC, d stands for corresponding district, s stands for corresponding State and t stands for year. The estimation results suggest that quality of expenditure improves with higher transfer dependency (Model 1 and Model 2) (Table 1). In addition, municipal expenditure quality also improves with the increase in relative financial size of the MC and the State’s expenditure quality (Model 3). On the other hand, high population density of district has an adverse impact on expenditure quality in all the three models. Table 1: Fixed-Effect Results   Model 1 Model 2 Model 3 Dependent Variable COTE RETE RECO MC Size 1.34 (1.10) -1.36 (-1.05) -2.81** (-2.39) Transfer Dependency 1.06** (2.44) -0.79* (-1.72) -0.49 (-1.15) State COTE -0.28 (-0.93)     State RETE   -0.09 (-0.49)   State RECO     0.61** (2.25) District Population Density -0.06* (-1.73) 0.08** (2.08) 0.08** (2.50) Constant 36.64*** (8.54) 65.69*** (4.40) 3.23 (1.42) MC Fixed Effect Yes Yes Yes State-level Clustering Yes Yes Yes Observations 609 609 589 Adjusted R-squared 0.31 0.34 0.26 Note: t statistics in parentheses; * p<0.05, ** p<0.01, *** p<0.001. References: GoI (2021). “Municipal Performance Index: Assessment Framework, 2019”. Ministry of Housing and Urban Affairs. UN (2018). “World Urbanization Prospects 2018”.

3. Borrowings

2.13 The level of gross municipal borrowings in India is minuscule and constitutes less than 0.05 per cent of GDP cumulatively for all MCs. There is, however, perceptible inter-State variation in municipal borrowings (Chart II.6a). As a proportion to total receipts of MCs, borrowings account for only around 6 per cent, though MCs in Telangana, Bihar and Kerala report relatively higher shares (Chart II.6b). The bulk of the borrowings are raised by a few large metropolitan corporations. For example, Greater Hyderabad Municipal Corporation alone accounts for more than 90 per cent of the total municipal borrowings in the State of Telangana. Per capita gross borrowing is the highest for Telangana, followed by Bihar and Maharashtra (Chart II.6c).

2.14 Composition-wise, borrowings from banks and financial institutions, and loans from Centre/State governments account for more than half of the total loans raised by MCs (Chart II.6d). Funds raised from capital markets through bond issuances at less than a tenth of the total borrowings remain an underutilised source of financing.

4. Conclusion

2.15 The analysis of municipal finances for the period 2017-18 to 2019-20 reveals certain noteworthy features. To start with, the combined budget size of the MCs in India is found to be much smaller than that of the Central and State governments. Second, despite getting constitutional recognition in 1992, there was no distinct rise in overall municipal revenue in India which remained broadly unchanged from 1946-47. Third, the composition of municipal revenue in India has changed considerably over time, with increased reliance on transfers. Fourth, despite lesser financial autonomy, the ratio of revenue expenditure to capital expenditure is lower than the Centre and the States. The higher share of capital expenditure of the MCs is largely on account of Central and State grants. Fifth, the overall borrowing by the MCs is miniscule and their market borrowings through bond issuances is negligible, dominated by a few large MCs. Going forward, property tax reform and development of a vibrant municipal bond market may provide a boost to the municipal finances in India.

¹ While the budgetary data of 221 municipal corporations was obtained, information received from 20 municipal corporations was incomplete and hence, they were dropped from the final analysis. Thus, our sample consists of 201 municipal corporations.

² Many MCs did not provide data on transfers and amongst those that provided, many corporations did not report the respective shares of Central and State transfers. Hence, the data reported here may be an underestimation.

³ The year 2017 was marked by the implementation of GST, which subsumed many taxes of the Centre, States and local bodies. The States’ value-added tax/sales tax, entertainment tax, purchase tax, luxury tax and taxes on lottery, betting, and gambling were subsumed under GST, some of which were shared with the MCs. The inclusion of octroi/entry tax (i.e., tax imposed by local civic bodies on the entry of goods into a state/local area for consumption, use or sale therein) in GST has financial implications for the MCs in Maharashtra, which were levying this tax. All other States, however, had abolished it at different points in time. To protect the interests of the MCs in Maharashtra, after several rounds of negotiations, the government passed the Maharashtra Goods and Services (Compensation to Local Bodies) Act, 2017, which guarantees compensation for the loss of revenue following the abolition of octroi (Mankikar, 2018).

⁴ As loans and advances data of MCs are not separately available, capital outlay here actually represents the capital expenditure of MCs.

⁵ This report studied 1,508 out of 2,023 ULBs in India: 20 out of 20 municipal corporations; 1,238 out of 1,471 municipalities; and 250 out of 532 notified/town area committees.