For local governments in India, 25 February was a red-letter day, and we can thank Vijay Kelkar for this. It was the day when the 13th Finance Commission’s report—with recommendations for how India’s taxes will be shared across our federal system—was placed before Parliament.

By way of background, the Finance Commission’s mandate is to determine how the divisible pool of tax collections is to be shared, primarily between Union and state governments. The past three commissions have been making small ad hoc grants to local bodies (panchayats and cities), recognizing their increasing importance in India’s federal set-up.

Unfortunately, the Constitution of India doesn’t allow for the national finance commission to make substantive recommendations on local government finances—this is the job of state finance commissions, which have been around since the seminal 73rd and 74th constitutional amendments in 1992-93—making local governments an independent third tier of our federal system. However, state finance commissions—while being constitutional bodies—are hobbled by a number of weaknesses: poor leadership, abysmal data, minimal support from state governments and so on.

We have, therefore, been in a peculiar bind with regard to the finances of our panchayats and cities: too many responsibilities, not enough funds. The only “buoyant" (growing as the economy grows) source of revenues for cites is property taxes, but this is: a) not enough; and b) fraught with weak collection systems, resulting in estimated property tax collections of only around 0.2% of the gross domestic product, a figure that ought to be at least five times larger.

Experts and policy advocates on decentralization—including V. Ramachandran, possibly the doyen of decentralization in India, and Govind Rao, one of India’s pre-eminent fiscal federal advocates—have long argued that this fundamental fiscal imbalance needs to be corrected. But we have been caught in a constitutional vice.

Until Kelkar. With great finesse, he has navigated the turbulent waters of India’s fiscal federal system, and produced an outcome that works at many levels: creating a substantial, buoyant, predictable source of funds for local governments; building in rigorous performance incentives; and setting out a clear architecture as a foundation for future commissions.

The numbers first. The 13th Finance Commission has recommended that a total of Rs87,519 crore be transferred to local bodies between 2010 and 2015. This is a fourfold increase from the previous commission’s Rs22,500 crore. Of this, the urban share has grown at least 500%— accounting now for 27% of the total transfers, based on the 2001 census urban population share.

Importantly, this isn’t an ad hoc transfer, but driven by a formula—allocating just under 2% of the total divisible pool of taxes in 2010-15—an excellent signal that a share of total taxes should go to local governments.

In doing this, Kelkar and his colleagues on the commission have side-stepped the tricky constitutional issue. Read this: “Taking into account the demand of local bodies that they be allowed to benefit from the buoyancy of Central taxes and the constitutional design of supplementing the resources of panchayats and municipalities through grants-in-aid, we recommend that local bodies be transferred a percentage of the divisible pool of taxes (over and above the share of the states), as stipulated by us, after converting this share to grant-in-aid under Article 275 (italics mine)." The last phrase is key—the Finance Commission is treating this as a grant for local bodies (as has been the tradition with previous commissions), but has moved away from an ad hoc sum to a share of the divisible pool.

In addition, the commission has also put in place very strong performance incentives. A full 40% of the total grant will be based on state governments fulfilling a set of nine conditions. These include rigorous audit by the Comptroller and Auditor General of India, establishment of an independent ombudsman, electronic funds transfer by states to local bodies within five days, qualifying criteria for state finance commission appointments, systemic changes in property tax regimes, service-level benchmarks for urban services and the creation of fire hazard plans for India’s million-plus cities (the last being especially timely, given the recent tragedies in Bangalore and Kolkata).

There’s more. For those with even a passing interest in such issues, I would strongly recommend a thorough read of the chapter. Having been part of a small band of urban groupies advocating policy changes for urban issues for over a decade now, I have often been dismayed by the general paucity of intellectually rigorous policy positions on a variety of urban challenges that India faces.

Chapter 10 of the 13th Finance Commission report is a huge reason to celebrate. Kudos, Mr Kelkar, for rearranging India’s fiscal federal architecture, with this sublime piece of policymaking.

Ramesh Ramanathan is co-founder, Janaagraha. Möbius Strip, much like its mathematical origins, blurs boundaries. It is about the continuum between the state, market and our society. We welcome your comments at