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MUNICIPAL FINANCE IN INDIA CAN IT BE MADE TO WORK?

Om Prakash MathurNational Institute of Public Finance and Policy (NIPFP)

24 March 2011

THE 21st Century Indian City: Developing an Agenda for Urbanization in IndiaUniversity of California, Berkeley

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CONTENTS

What is the question?

Municipal Finance: A Reality Check

Challenges and Issues

Making Municipal Finance Work

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WHAT IS THE QUESTION?

• Is the existing Municipal Finance System adequate for India’s changing socio-economic realities?

• Can it deal with the contemporary challenges of urbanization, decentralization as embodied in the Constitution (74th) Amendment, and of globalization?

• Can the existing Municipal Finance System generate enough resources to be able to wipe out the huge urban infrastructure deficits and meet the infrastructure requirements of incremental urban population?

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• Growing concern for municipal finance

i Report of the Thirteenth Finance Commission (Dec 2009)

ii The McKinsey Report on India Urban awakening, building inclusive cities, sustaining economic growth (April 2010)

iii The World Bank Report on Regulatory Framework for Municipal Borrowing (August 2010)

iv Report of the High-Powered Expert Committee on Urban Infrastructure Investment Requirements (March 2011)

v Municipal Finance Matters: India Municipal Finance Report (March 2011)

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MUNICIPAL FINANCE: A REALITY CHECK

• A three-level check -

Municipal finance data aggregated at National, macro level

Municipal finance data aggregated at the level of states

Indepth examination of the finance data of 31 municipalities of different population sizes, from six states viz., Andhra Pradesh, Kerala, Madhya Pradesh, Maharashtra, Rajasthan, and Uttar Pradesh.

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1. Measured in terms of what the municipalities raise with their revenue-raising powers and what they spend, municipal sector is tiny.

• Shrinking own revenue component.

• Level of municipal expenditure maintained, fuelled by state transfers and JNNURM grants.

• Signals failure of municipalities to be able to capture growth; also inability of growth to trickle down to municipalities.

Own tax revenue

Rs. 15,277 crore Per capita Rs. 492

0.35% of GDP

Revenue income

Rs. 44,429 crore

Per capita Rs 1430

1.03% of GDP

Revenue expenditure

Rs. 28,431 crore

Per capita 0.66% of GDP

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2 Large inter-state differences in the levels of municipal own revenues and municipal expenditures.

i Four states accounting for 33% of urban population, generate 75% of municipal resources; five states accounting for 26% of urban population are able to raise just 3.4% of revenues

ii Fall in “municipal own revenue” across states; insufficiency of own revenues for meeting revenue account expenditures.

iii State transfers maintaining the level of municipal spending.

iv Central government grants contributing to meet municipal requirements for asset creation.

Range - own tax revenues

High of Rs. 1079 & low

of Rs 38 per capita

Range -– Revenue expenditure

High of Rs. 1449 &

low of Rs 134 per capita

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What do these facts suggest-

i. Tax reforms of recent decades have’nt reached out to taxes at municipal levels;

ii. States preferred option has been to increase transfers rather than undertake tax and user charge reforms;

iii. Reforms undertaken as a part of the JNNURM and states own efforts not deep enough;

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iv. A new and extraordinarily significant phenomenon is Central government financing of urban infrastructure - -

(a) Transforming inter-governmental relations

(b) Urban development emerging as a multi-tier responsibility, with vastly important long term ramifications

(c) Recognizing macro level stakes in improving urban infrastructure

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3. Poor internal management of fiscal powers

i. Property tax – unquestionably a prime revenue source, 19% of total revenue incomes, but characterized by huge inefficiencies

• the problem of free riders – 41% properties not on Municipal house tax register

• exemptions from payment of property taxes wipes out 11% of revenues from property taxes

• high collection inefficiencies – only 46% of tax demanded is collected

ii. Large subsidy on service provision – conservatively estimated at 35 percent of the cost incurred on their operation and maintenance

iii Erratic transfers not conducive for municipal functioning which require stability in revenue flows

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4. Small-sized municipalities generate 35 percent of the average “own revenues”

5. JNNURM impact on municipal finances and functioning not visible (only two years of experience registered in survey)

6. Revenue-yielding potential is short by 30-80 percent of the standard municipal expenditure norms, meaning that even if municipalities use their revenue-raising powers optimally, they will not be generate enough to reach the norms.

7. Credit rating analysis shows that high revenue-raising capacity is a pre-requisite to achieving investment grade rating

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CHALLENGES AND ISSUES

Challenge 1

• Raising municipal spending to levels necessary for maintaining services at standardized norms -- formidable in the light of -

i declining own revenues

ii limits of a single tax dominated municipal tax system

iii inefficiency load

iv low or zero revenue yielding fiscal space, obsolescence has set in

v subsidies in service provision

vi irregular state transfers and grants.

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Challenge 2

• Redesigning the recent initiatives to improve municipal finances

(i) Neither the SFCs have brought about any change in municipal fiscal space nor has the JNNURM reform agenda begun to impact on municipal finances

(ii) Experiment to engage parastatals in service provision has not produced efficiency gains

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Challenge 3

• Addressing the problems of municipalities in low-income and low-urbanized states which are at high risk

• Smaller municipalities with poor resource bases which are also in the same league

Challenge 4

• Upgrading capacities across municipalities

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A Key Issue

• The role of the Central government in municipal infrastructure financing and municipal finance reform – formalisation – its impact on the country’s federal structure?

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THE WAY FORWARD TOWARDS A MUNICIPAL FISCAL POLICY

Strong evidence that the existing finance system can not generate enough resources to -

i wipe out the deficits estimated at Rs. 12,37,647 lakh crore (HPEC’s estimate)

ii meet the infrastructure needs of incremental population

iii effectively address the 12th Schedule agenda

iv contribute to infrastructure needs arising out of India’s integration into global economy

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EIGHT IMPERATIVES FOR THE WAY FORWARD

1 Restructuring and broad-basing of the existing municipal finance system

2 GST – piggy backing – A pre-requisite for municipalities to undertake growth and equity functions as embodied in the 12th schedule

3 Redesigning state inter-governmental transfers and grant system, with focus on addressing horizontal imbalances and addressing issues of smaller municipalities

4 New role for the State Finance Commissions (SFC)

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5 Central finance commission to look at inter-state variation – the extent to which variant is not caused by state policies and inefficiencies

6 Restructure the JNNURM Grant-cum-Reform Facility

7 Data bases, Performance Monitoring, and Fiscal Responsibility

8 Capacity building

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While the world has changed rapidly, the tax systems that support all levels of governments have largely been the same. The underlying taxes that support local governments were designed and implemented in a different time and for a different economy. With a few exceptions, these taxes have not changed significantly since their inception. Many scholars believe that without radical changes, these taxes cannot continue raising sufficient revenue in the 21st Century.

David Brunori. 2007. Local Tax Policy

A Federalist Perspective. The Urban Institute

Washington D.C.

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Thank you.