Municipal corporations and the tyranny of backdoor governance

File photo of a taxi running on a street in Mumbai. All of Maharashtra’s 27 municipal corporations entered 2024 without even one being controlled by an elected body.  (istockphoto)
File photo of a taxi running on a street in Mumbai. All of Maharashtra’s 27 municipal corporations entered 2024 without even one being controlled by an elected body. (istockphoto)

Summary

  • From Mumbai to Bengaluru, municipal corporations are being temporarily run by states, and not elected bodies

New Delhi: Late last month, the government constituted the 16th Finance Commission to decide how taxes collected by the central government are to be shared with states. The Commission’s recommendations will be put into operation for a period of five years between 2026 and 2031. Arvind Panagariya, former vice-chairperson of NITI Aayog, will be the chairperson of the new commission.

Around the time that the government constituted the 16th Finance Commission, it was reported that all of Maharashtra’s 27 municipal corporations entered 2024 without a single one being controlled by an elected body. Instead, all were being run by state-appointed administrators. Tenures of elected municipal corporations in the state began to end during the covid pandemic, and no new elections were held. Changes of government at the state level, and legal challenges over reservations for other backward classes (OBC) in local body elections, were among the reasons cited for the delay in municipal elections. As a result, the combined budget of these 27 municipal corporations, amounting to about 1.10 trillion, was now controlled by the state.

How are these two events connected? Finance Commissions and their work might seem remote from the concerns of most citizens, but in fact they are highly contentious. Most of the controversy centres around how taxes are shared with states, and how certain types of taxes, such as surcharges and cesses, are kept out of the shareable tax pool.

But now, another problem the 16th Finance Commission will have to deal with is precisely the issue raised by the current situation in Maharashtra’s municipal corporations. Indian cities, and urban areas in general, generate a huge amount of wealth and income, but have little say—either politically or financially—on how to use it. Most of the money they generate goes back to the state they are part of, or the centre, and they are then dependent on handouts to survive and provide better amenities and services to their own residents.

Give and Take

Political and financial conflicts within India at a federal level are often framed as being between richer and poorer states. Richer states in the south and west claim they create most of the wealth, but they have little control over much of it—the centre takes a large part of that wealth in taxes, which are then distributed to poorer states in the north and east. So, richer states ‘lose out’ to poorer states.

This argument is of limited value. It ignores the fact that richer states rely heavily on poorer states for cheap labour and a large market. It is pretty much the same argument that Indian cities can make. A third of India’s population now live in cities and towns. A Niti Aayog report in May 2022 on cities as engines of growth pointed out that Indian cities occupy 3% of land, but contribute 60% of India’s GDP. A one percentage point increase in the urban population of a district was associated with a 2.7 percentage point increase in its GDP, it added.

Further, the report said, even after adjusting for factors like education, gender and work status, workers in cities with 1.5 million or more residents in 2011 had, on average, 16% higher monthly earnings than their counterparts in smaller cities. It was 36% higher than counterparts in rural areas. The report added: “By enabling firms and workers to interact closely, cities generate increases in productivity through several channels, collectively known as agglomeration economies. A key implication…is that firms in larger and/or denser cities should be more productive, [and] pay workers higher nominal wages and salaries…"

But very little of this economic dynamism is reflected in cities’ ability to govern themselves. The Reserve Bank of India (RBI) points out that municipal expenditures have ‘stagnated’ at 1% of GDP for over a decade. In contrast, municipal expenditures in countries like South Africa and Brazil are around 6-7.4% of GDP. Cities, both in India and elsewhere, have a wide range of responsibilities, like sanitation, health and infrastructure, but they tend to be heavily dependent on the upper tiers of government, at either the state or the centre, for funds to carry out those functions.

According to a paper by Meera Mehta and others, published in the Economic and Political Weekly in February 2023, city governments in India account for only 2.6% of total government revenue across all tiers of government (central, state and local), as compared with 4.2% in Mexico, and a whopping 27.2% in Denmark.

In 1992, a constitutional amendment (74th amendment) gave clear legal recognition to local elected bodies in rural and urban areas, and entrusted successive finance commissions with the job of determining the proportion of taxes to which local bodies were entitled, or a mechanism by which individual states could assign certain types of revenue (for example, tolls) to urban local bodies. The 15th Finance Commission recommended a fixed amount— 4.36 trillion—to be given to local governments, with urban local governments entitled to 33-35% of that amount (the rest going to rural local governments).

Even here, though, there has been a shortfall of about 15%, according to the RBI study, as many city governments were unable to meet the conditionalities required to receive funds. In comparison, a World Bank study in 2022 on urban infrastructure projects stated that Indian cities will need $840 billion over 15 years ($55 billion a year) to meet the needs of their citizens.

“Effective devolution and transfer of revenue sources under these [finance commission] provisions has, however, been limited," says the RBI report. It adds that: “Indian cities are emaciated financially and are far from being able to generate the resources required for providing good quality infrastructure and services to their citizens."

Currently, municipalities depend on transfers from their respective state governments, or the centre, for around 35% of their revenue. Thus, while the constitution did recognise the existence of urban governments, it did not back that up with the clear financial powers those governments needed to do their job. Globally, transfers of funds from upper tiers of governments to municipalities are a much higher share of GDP than in India (see chart).

State Gaps

 Experts have called for a constitutional amendment to ensure that GST revenue is shared across all three levels of government.
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Experts have called for a constitutional amendment to ensure that GST revenue is shared across all three levels of government. (Mint)

Finance commissions at the state level, which are supposed to decide a framework within which to transfer state resources to local governments, have not been constituted in many states. “The central finance commissions, whose task is to only suggest ‘measures to augment local government resources’ end up allocating ad hoc amounts to local governments with a string of conditions," point out Mehta and co-authors.

A study paper for the 15th Finance Commission, prepared by Isher Ahluwalia and others, called for a constitutional amendment to ensure that GST revenue is shared across all three levels of government.

Of the sources of revenue which a municipal corporation can control directly, property tax, comprising 10-11% of total revenue, remains the most important. This is half as much as China’s local governments earn in property taxes, according to the Peterson Institute of International Economics. Beside this, a much larger component (30% in 2021) of that country’s local government revenue comes from selling land use rights. In countries such as the US, as the paper by Mehta and others points out, city governments can impose a wide range of taxes, including local income taxes. “In Denmark, local personal income tax is the major source of municipal tax revenue," the authors point out.

Post-GST financing

The introduction of the goods and services tax (GST) in 2017 made the problem worse, since it subsumed taxes such as sales tax, octroi (in states like Maharashtra) and local entertainment taxes, among others, within it. Revenue from some of these taxes had earlier been assigned to local governments. With GST, municipalities (which govern smaller towns) and municipal corporations (which govern larger cities) became more reliant, not less, on the upper tiers of government for funds.

Possibly the most extreme example of this was the Municipal Corporation of Greater Mumbai (MCGM). Before the advent of GST, it earned around 7,000 crore, or 35% of its total revenue, from octroi—a tax on the entry of goods. MCGM’s annual budget exceeds that of some of the smaller states in India. With GST, octroi as a source of revenue vanished overnight, to the extent that the MCGM asked for special compensation to make up for that loss.

But the problem started well before GST (see chart). In 1960-61, municipal corporations were able to earn almost 90% of their revenue from their own sources, relying on central and state governments for around 10% of the remaining funds. By 2007-08, the proportion of ‘own’ revenue to the total pool of money available had fallen to 67%, and had dipped further to 65% by 2012-13, a level at which it more or less remains today.

Political Problem

 Arvind Panagariya, who will take over as the chairperson of the 16th Finance Commission. The Commission could go further than its predecessors in recommending greater fiscal autonomy to city governments.
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Arvind Panagariya, who will take over as the chairperson of the 16th Finance Commission. The Commission could go further than its predecessors in recommending greater fiscal autonomy to city governments. (Madhu Kapparath)

In recent years, the central government has raised a substantial sum of revenue through the imposition of cesses and surcharges on income taxes. Constitutionally, it does not have to share such funds with states, as opposed to revenue from raising base income tax rates. States have charged the centre with acting in bad faith, and of wanting to have its cake and eat it too.

However, states have been as unwilling to cede financial and political independence to municipal corporations. In Maharashtra, for political reasons, there will likely be no new municipal elections till the state assembly elections are over in October 2024. Direct control over the budget of municipal corporations in the state (of which MCGM alone has a budget of over 52,000 crore) gives the state government huge additional firepower to dispense favours and patronage in a year when not one, but two crucial elections are due to take place.

In fact, putting off municipal corporation elections for political or other reasons is hardly limited to Maharashtra. As Alok Prasanna Kumar, in an article for Economic and Political Weekly, pointed out, the Bruhat Bengaluru Mahanagara Palike (BBMP), the municipal corporation of Bangalore, has been without an elected body since late 2020. Again, elections to the body are unlikely to take place before the general elections in May 2024. Before this, the BBMP was without an elected government between 2006 and 2010. Chennai’s municipal corporation did not have an elected body between 2016 and 2022. And while constitutional provisions exist to regulate the period of time for which an individual state can go without an elected government, no such provisions exist for urban local governments.

The 16th Finance Commission could go further than its predecessors in recommending greater fiscal autonomy to city governments. If it does, it will face strenuous opposition from both state and central governments who are unwilling to give up economic control of some of the fastest growing regions in the country.

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