Strengthen the Urban Local Bodies: Solution to India’s Problems

While huge responsibilities were laid out for the local bodies, no efficient financing mechanism has been developed for their proper functioning.
Keywords: Urban, Rural, Development, Village, Economy, Taxes, Solutions, Urbanisation, Population, Civic, Infrastructure, Geographical, Amenities, Management, System
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The twenty-first century is witnessing an urban revolution and India is at the forefront of this transformation. Although according to 2011 Census data, the urban population in India was little over 31 percent, a world bank report in 2016 claims the Indian population living in areas with ‘urban-like’ features to be more than 55.3 percent in 2010. The urban population in India is expected to double between 2018 and 2050, from 461 to 877 million.

The rise in urban population is due to some rural areas ‘mutating’ into urban, migration from rural areas in search of a better livelihood and general population increment. This rise in the human density and geographical expansion of cities has posed enormous challenges for all levels of the government, especially the local bodies. The rapid urbanization has put extreme pressure on the latter to provide for the required infrastructure and to deliver basic civic amenities. The civic facilities in India are among the poorest in the world owing to the weak financial and governance structure of the municipalities. The local bodies have failed to maintain a regular supply of water; ensure public health, sanitation, and an efficient management system for solid waste; provide urban facilities like parks, gardens, etc; provide public amenities including street lighting, parking lots etc; deliver the required infrastructure like roads and bridges; and/or plan for slum upgradation and poverty alleviation in cities.

Many major and minor factors are responsible for the current state of local bodies and urban infrastructure in India. Since the country attained independence, urban development has never been an agenda for governments and policymakers. Starting from Mahatma Gandhi who believed that the future of India lies in its villages and saw it emerging as a nation of autonomous villages, the focus of the politicians has always been rural development and poverty alleviation since more than two-thirds of the population still live in the rural areas.

Gandhi regarded the growth of cities to be evil and unfortunate for mankind. His thoughts paved the path for his followers and decision-makers of India for decades, starting with Nehru who believed that cities could take care of themselves and it was the villages that required the government’s attention. Owing to such views, none of the five-year plans post-independence have focussed on urban development, and no reforms or policies were taken up to strengthen the cities until 2004 when Dr. Manmohan Singh highlighted the role of urbanisation in the Indian economy. Due to the inattention by the politicians and decision-makers, cities in India fail poorly on the liveability index.

All the major cities in India are facing unplanned and haphazard expansion of boundaries, proliferation of slums, unhygienic living conditions, indiscriminate conversion of land use, deteriorating quality of life, environmental challenges etc. A pandemic like Covid-19 raises further doubts about the viability of cities due to the higher human density that is being blamed for the spread. The local bodies are not prepared for handling the challenges brought along by this agglomeration process. There is a dire need to develop cities with proper infrastructure facilities like roads, bridges, hospitals, schools etc. and civic amenities like basic sanitation, sewage, and water facilities on the lines of equity, affordability and inclusivity.

The importance of developing cities as engines of growth can be understood by the fact that around 80 percent of India’s tax revenue is generated from cities. Major cities in India contribute more than 65 percent of India’s GDP and have the potential to contribute more. There is a strong positive correlation between urbanisation and GDP growth. Various studies in the last decade have indicated that Indian cities have the ability and capacity to generate resources not only to sustain themselves but to also fund the rural development and poverty alleviation programs in India. The cities require the initial push required for them to come out of the ‘poor service-poor revenue’ trap.

At present, the local bodies are not in a condition to even pay the salaries to employees and cover the operation charges. They are facing a tremendous fund crunch. Their ‘own revenue’ sources have been declining due to the taxes being merged with various other state and central level taxes. With the advent of GST, major taxes like octroi, advertisement tax, entry tax, etc. got abolished which has further worsened the situation. While states were compensated for the loss in revenues, the local bodies have not been given their due share. The local bodies are completely dependent on the transfers and grants-in-aid which they receive from the state and the central government even for their basic services. Property tax remains the only major tax source post-GST with the municipalities which is grossly underexploited due to various economic-political reasons.

The mapping technology and field area are not updated due to which the tax base is not clear and the excessive interference of the state governments has left the local bodies helpless. According to the Economic Survey (2017), major cities in India collected 10-20 percent of their property tax potential. In 2017-18, revenue from property tax as a share of GDP in India was 0.15 percent as compared to an estimate of 1 percent for taxes on immovables in OECD countries. In developed countries like the US and Canada, property tax accounts for 3 to 4 percent of GDP (OECD 2010). The total municipal revenue has come down to 1 percent of GDP in 2017-18 while the share of “own revenues” in total revenues has dipped from 63.48 percent in 2002-03 to 42.7 percent in 2017-18. With this declining revenue trend, the local bodies cannot meet the rising capital expenditure requirements for infrastructure investments.

According to the McKinsey (2010) and High-Powered Expert Committee (HPEC) report on the investment requirements for urban infrastructure services, India would need to spend 3 to 5 percent of the GDP every year to support the demands of the rising urban population. The Budget 2021-22 has taken much-needed steps in this direction. A National Infrastructure Pipeline (NIP) has been created with a target of more than 7,000 projects. 217 projects worth Rs. 1.1 lakh crores have already been completed during the Covid period itself which explains the commitment of the government towards the NIP. For financing the infrastructure, the government has decided to set up a Development Financial Institution (DFI) which will provide funds for infrastructure and act as a catalyst to attract more investments from foreign and private investors. DFI was a long pending demand of many urban planners and public finance specialists as it will ease out the situation for bodies working under acute fiscal stress.

The government has also announced a scheme for monetizing the assets of the government which are lying idle with different ministries and government authorities. This will help the government in raising funds either by selling the land as done by various countries, especially China, or by using it as collateral to borrow money. India should now move on from short-term borrowing to long-term borrowing for 30-35 years at lower interest rates. In the current market scenarios, a lot of foreign funds are lying idle with various international funding institutions. Also, the central and state governments should help in reviving the municipal bond market which has almost collapsed due to inefficiency of the local bodies, lack of transparency in accounts, and  excessive reliance on higher levels of government for funds.

While borrowing is one part of the solution, the other major part is to find a method for repayment of the debt. India needs to adopt the Tax Increment Financing (TIF) method which has been practiced widely in the US, Canada, Australia, and many European countries. TIF is a payment mechanism based on the escrowing principle. According to the TIF mechanism, when infrastructure is developed, it leads to an increment in the tax base and increases the value of the existing properties around the development. For example, the property values of an area will rise after the construction of a metro line in that area. This incremental property tax value should be escrowed in a separate account and used for the repayment of the debt.

The pre-development tax revenue will still go to the original taxing authority but the incremental value will be put in a separate escrowed account, usually set up by a Special Purpose Vehicle (SPV). Post completion of the repayment of the debt, the entire tax revenue will go to the original taxing authority. Thus, following the TIF principle helps in repayment of the debt and also leads to an enhanced tax revenue post completion of repayment which can then be used either for maintenance of the infrastructure or new developments. Apart from the already existing taxes, the SPV can make use of various Value Capture Financing (VCF) tools for repayment of the debt either as a one-time charge or by introducing a tax for a fixed tenure. Some of the common VCF tools that can be used are User charges, Betterment levy, Sale of Land, Sale of Floor Space Index (FSI), Impact Fees, Vacant Land Tax, Land Use Conversion Charge, Transfer of Development Rights, etc. These are some of the most common VCF tools that have been used across the globe and also for funding some projects in Indian states. These VCF tools capture the value that has been created due to the development in that area. These must be paid directly in the account of the SPV set up for managing the particular infrastructure development. These measures, if used efficiently, can solve the problem of Indian municipal finance and strengthen the local bodies to carry out their responsibilities effectively as laid out by the 74th amendment of the constitution.


Cities are the hubs of economic activity for a country and the urban local bodies are supposed to be the most efficient tier as they work directly for the needs of a common man and are responsible for providing all basic necessities from affordable housing, water, sanitation to constructing roads, bridges, educational institutes, and healthcare facilities. The development of cities is also crucial as it can generate and mobilize resources for all levels of the government and help in funding rural development. The inattention from the governments since independence has brought ULBs to a state where they are questioned for being exclusively reserved for the rich as they fail to provide housing to all. Also, the lack of basic amenities and facilities has made them unhygienic, crowded, unsafe, and environmentally unfriendly. Starting from global warming to a pandemic like Covid-19, cities are being blamed as posing  a risk to human beings.

However, while huge responsibilities were laid out for the local bodies, no efficient financing mechanism has been developed for their proper functioning. Recent governments have taken some steps to ease out the situation but the pace of work is very slow. Immediate steps are needed to cover the fiscal and infrastructure gap to develop inclusive and efficient cities.

First, the higher-level governments need to compensate the local bodies for their revenue loss by making them  shareholders of the GST collections in order to maintain the vertical balance. Second, the central and state governments should help in the revival of the municipal bond market and help the local bodies in raising resources using different municipal, green, and infrastructure bonds. Third, the governments need to help the local bodies in clearing their financial records and develop a structure to maintain accountable and transparent financial accounts. Fourth, long-term borrowing from foreign investors and institutions needs to be encouraged for infrastructure development. Fifth, the repayment mechanism of TIF and VCF tools must be made legally solid for easy implementation. Sixth, the latter must be free from state government interference. Seventh, the state finance commission (SFC) reports must be made mandatory for every state before they claim any grants and transfers from the centre. SFCs have not been taken up seriously by the state governments, which has made the local bodies suffer. Once these measures are taken up to strengthen the local bodies and make them financially strong, most of the problems of the common man would be solved at the local level itself and India would find the solution to its urban  and rural development problems.


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  • Very nice article 🙂 First time i have saw an article mentioning about repayment of debt. Kudos to you Abhishek.

    Infact, all municipal corporation should be net zero debt institutions and self-reliant / sustainable institution taking on development works head on.

    I suggest public listed sovereign wealth fund for 500+ municipal corporations in India. To be enabled by hybrid SPAC model & listed on GIFT city in Ahmadabad.

    And then deploying it through fund of fund structure.


    1) net zero debt corporation in 2021;
    2) funds for development;
    3) wealth creation & distribution;
    4) job creation;
    5) world class infra.

    A detailed concept paper is here:

  • Really a very pragmatic article on the condition of urban local body but if governments have really focused on rural development mostly as written in this article, then why is the condition of rural areas worse than cities. More or less cities have the basic infrastructure of roads, drinking water, sewage canals, transportation etc but still most villages of North India lack it. It’s true that urban regions contribute the majority of revenue from taxes but it is rural areas which has ensured the food security and isn’t it injustice to expect high taxes from a region which has hardly anything in terms of infrastructure. The main economic activity of rural areas which is agriculture was artificially controlled till recently in which the prices of food grains were kept artificially low due to which agriculture has mostly been a business of loss. If our leaders would have followed the ideals of MK Gandhi and would have worked to make villages independent economic identities as envisioned by him, I am sure migration of people from rural to urban areas would have been very less.

Abhishek Malhotra

Abhishek Malhotra is a PhD Scholar in Economics at the University of Hyderabad. His research work is on Urban Infrastructure Financing.

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