MUNICIPAL FINANCE IN INDIA CAN IT BE MADE

MUNICIPAL FINANCE IN INDIA CAN IT BE MADE TO WORK? 24 March 2011 Om Prakash Mathur National Institute of Public Finance and Policy (NIPFP) THE 21 st Century Indian City: Developing an Agenda for Urbanization in India University of California, Berkeley 0

CONTENTS What is the question? Municipal Finance: A Reality Check Challenges and Issues Making Municipal Finance Work 1

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 (74 th) 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? 2

• Growing concern for municipal finance i Report of the Thirteenth Finance Commission (Dec 2009) ii The Mc. Kinsey 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) 3

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. 4

1. Measured in terms of what the municipalities raise with their revenueraising powers and what they spend, municipal sector is tiny. Own tax revenue 15, 277 Rs. crore Per capita Rs. 492 0. 35% of GDP • Shrinking own revenue component. Revenue income • 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. Rs. 44, 429 crore Per capita Rs 1430 1. 03% of GDP Revenue expenditure Rs. 28, 431 crore Per capita 0. 66% of GDP 5

2 Large inter-state differences in the levels of municipal own revenues and municipal expenditures. Range - own tax revenues i High of Rs. & low of Rs per capita ii 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 Fall in “municipal own revenue” across states; insufficiency of own revenues for meeting revenue account expenditures. 38 1079 Range -– Revenue expenditure 1449 & low of Rs 134 per capita High of Rs. iii State transfers maintaining the level of municipal spending. iv Central government grants contributing to meet municipal requirements for asset creation. 6

What do these facts suggesti. 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; 7

i. 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 8

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 i. ii. Large subsidy on service provision – conservatively estimated at 35 percent of the cost incurred on their operation and maintenance ii. iii Erratic transfers not conducive for municipal functioning which require stability in revenue flows 9

(ix)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 10

CHALLENGES AND ISSUES Challenge 1 • Raising municipal spending to levels necessary for maintaining services at standardized norms -- formidable in the light of i ii iv v vi declining own revenues limits of a single tax dominated municipal tax system inefficiency load low or zero revenue yielding fiscal space, obsolescence has set in subsidies in service provision irregular state transfers and grants. 11

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 12

Challenge 3 • Addressing the problems of municipalities in low-income and lowurbanized 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 13

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? 14

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 12 th Schedule agenda iv contribute to infrastructure needs arising out of India’s integration into global economy 15

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 12 th 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) 16

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 17

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 21 st Century. David Brunori. 2007. Local Tax Policy A Federalist Perspective. The Urban Institute Washington D. C. 18

Thank you. 19