16th Finance Commission and the financial position of urban local bodies

The 16th Finance Commission was constituted in December 2023. The 16th Finance Commission, established under Article 280 of the Indian Constitution, has started its work.

The primary function of the Finance Commission is

• The Central Finance Commission focuses primarily on transfers to the Consolidated Fund. However, since the 73rd and 74th Constitutional Amendments, local bodies have received significant recognition within the federal system.
• Through these amendments, sub-sections 280(3)(BB) and (C) empower the Finance Commission to recommend measures for augmenting the Consolidated Fund of the State for supporting panchayats and municipalities.
• According to Article 280(1) of the Constitution, a Finance Commission shall be established to determine the distribution of the net proceeds of taxes between the Union and the States, grants-in-aid and to take measures for supplementing the resources of the revenues of the States and the Panchayats during a specified period and to make recommendations regarding the allocation among the States of their respective share of revenues.

Terms of Reference for the 16th Finance Commission

• The 16th Finance Commission is to make recommendations on the following matters:
• The distribution between the Union and the States of the net proceeds of taxes which are to be, or may be, divided between them under Chapter I, Part XII of the Constitution and the allocation between the States of the respective shares of such proceeds
• The principles which govern the sums payable to the States by way of grants-in-aid and grants-in-aid of their revenues out of the Consolidated Fund of India under article 275 of the Constitution for purposes other than those specified in the provisions of clause (1) of that article and
• Measures necessary to augment the Consolidated Fund of the State to supplement the resources of the Panchayats and Municipalities in the State based on the recommendations made by the State Finance Commission.
• The Commission may review the current arrangements on funding of disaster management initiatives in respect of the funds constituted under the Disaster Management Act, 2005 and make appropriate recommendations thereon.

Key issues related to urban bodies before the 16th Finance Commission

Financial condition of urban bodies

• Urban bodies as engines of economic growth
  • In the mid-80s, the National Urbanisation Commission described cities as ‘engines of growth’.
  • Cities contribute to about 66% of India's GDP and about 90% of total government revenue. Thus, cities are a critical spatial sector for the overall development of the country.
  • The World Bank estimates that $840 billion is needed for basic urban infrastructure over the next decade.
• Financial challenges faced by urban bodies
  • Despite the efforts of five commissions, including the 11th Finance Commission, financial transfers to cities remain inadequate.
  • The fiscal situation of municipalities is poor, which affects both the productivity and quality of life of the city.
  • Rapid urbanisation without appropriate fiscal action adversely impacts growth.
  • Intergovernmental transfers (IGT) to urban local bodies (ULBs) in India are about 0.5% of GDP, which is much lower than other developing countries (2-5%).
• India's investment in urban infrastructure at current rates is inadequate and will undermine urban infrastructure, according to a McKinsey Global Institute report.
• • This will create problems of water supply and untreated sewage.

Taxation System

• With the introduction of the Goods and Services Tax (GST) system, the tax revenue (excluding property tax) of urban local bodies has declined from about 23% in 2012–13 to about 9% in 2017–18.
• The IGT that urban bodies receive from the states is very little.
  • The State Finance Commissions have recommended only 7% of the states' own revenues in the year 2018-19.
• There is a need to increase the amount of IGT as a percentage of GDP. Despite the aim of the 74th Constitutional Amendment to strengthen urban bodies financially, progress has been minimal in three decades.
• According to the 13th Finance Commission, parallel agencies and bodies are weakening local governments both financially and operationally.
• Local governments need support from the federal and state governments in the form of money as well as officials and technical assistance.

Importance of Census

• In the absence of the 2021 Census, evidence-based fiscal transfers will require relying on 2011 data, which may not reflect the real situation.
• India has about 4,000 statutory towns and an equal number of census towns, with an estimated 23,000 villages, all of which are effectively urban.
  • These figures should be incorporated by the 16th Finance Commission, which also includes significant migration to tier-II and III cities.

The way forward

• Some of the nine guiding principles of the 15th Finance Commission that need to be revisited are as follows:
  • Increase in the state's GST as well as property tax collection
  • Maintenance of accounts
  • Resource allocation to reduce pollution
  • Primary health care
  • Solid waste management
  • Drinking water
• The 16th Finance Commission should consider India's urbanisation dynamics and ensure at least doubling of IGT in urban areas.