The surge in the second wave of COVID-19 in several parts of the country in 2021 once again brought attention towards the significance of decentralization and the need for local governments in India to be financially and administratively empowered.
The Brihanmumbai Municipal Corporation (BMC) model of proactively managing the pandemic emerged as a case study on how a fiscally buoyant urban local body (ULB) with an empowered leadership can deliver on crucial services and fulfill citizens’ expectations even amidst a major crisis. While empowered leadership across all levels of urban local bodies still remains a work-in-progress, an important milestone towards making municipal revenues robust and resilient was initiated by the Government of India under its COVID relief package – the Atmanirbhar Abhiyaan.
Municipal Own Source Revenue in India
Own Source Revenue denotes the component of revenue which is levied and collected by the Urban Local Bodies on their own. The other two components of revenue for a ULB include Assigned Revenues i.e. share of taxes from state government and Grants i.e. scheme/development related grants by State and Central Governments.
The own source revenue of municipal bodies in India as a share of GDP has been on a declining trend since 2012-13 and accounted for only 0.43% in 2017-18, the lowest in eight years. There are two components of own source revenue of ULBs – tax revenue which includes taxes on property, professions, advertisement etc. and non-tax revenue which includes other levies like license fee, user charges etc. collected by the ULBs in return for performing certain public services like water supply, solid waste management, among other things.
Property Tax remains the principal source of revenue for most ULBs and contributed about 60% of the total municipal tax revenue in India in 2017-18. However, it accounts for only 0.15% of GDP against the international benchmark of 1% due to the numerous legal, administrative and political bottlenecks associated with property taxation in India. The revenue raising potential of property tax in India will only be realized by reforming many lingering issues such as outdated property enumeration lists, low valuations, no increase in tax rates and an antiquated assessment framework. Correspondingly, user charges and fees for water supply accounted for more than 60% of non-tax revenue in four out of the five years up to 2017-18. However, even user charges can be leveraged further by ULBs in raising municipal revenues, especially given that the rate of recovery of operational and maintenance (O&M) cost from rendering of services stands at a paltry 20 percent.
Atmanirbhar Bharat: 2% Additional Borrowing Scheme
To fight the COVID pandemic, the union government in May 2020 had granted permission to state governments to borrow an additional 2% of Gross State Domestic Product (GSDP) from the open market for 2020-21 and 0.25% of that was linked to Urban Local Body (ULB) reforms. In view of the aforementioned challenges in raising own source revenues of municipal bodies, the ULB reforms stipulated that for States to qualify they need to notify a reforms framework wherein property tax rates are linked to the prevailing circle rates (i.e. guidance rates for property transactions) and to mandate a periodic increase in property tax in line with the rise in valuation. Correspondingly, the scheme stipulated that States notify a framework wherein rates of user charges for water supply, drainage and sewerage reflect O&M costs incurred for rendering the services and mandates a periodic increase in user charges in line with price increase.
Till the cutoff date of 31 March 2021, 11 States managed to qualify for the scheme in order to become eligible for more than INR 16,500 crores of additional open market borrowings cumulatively. States have employed a number of approaches to undertake the relevant reforms pertaining to property taxation. For instance, at least four states have notified a framework wherein property tax will now be charged directly as a percentage of guideline values of properties, published annually by the respective Stamps Departments, alongside provisions for a fixed percentage increase, either annually or every few years. Further, few States even included clauses wherein property tax will be revised as and when guideline values are revised by the respective Stamps and Registration Departments. And, in order to offset the sudden jump in tax rates, states have introduced sensible transitional provisions to ease the burden on the taxpayers in their respective jurisdictions.
The remaining states have deployed similar approaches of linking property tax to guidance values. For instance, either by mandating that the minimum increase in property tax should be the same as the percentage increase in the guideline values published annually by the Stamps Department or by fixing one component of the property valuation formula as a percentage of the guideline values published by the Stamps Departments. The states have similarly included clauses for periodic increases in property tax as well.
Correspondingly, states have employed dynamic methods of undertaking reforms pertaining to user charges for water supply, drainage and sewerage. Few of the states have prescribed comprehensively detailed procedures for ULBs to achieve self-sufficiency/complete recovery in terms of O&M costs incurred in rendering the selected services. These States also prescribe an annual minimum percentage increase in the charges levied. Other states have all prescribed policy roadmaps to achieve complete recovery of O&M costs over a period of time by undertaking a combination of process improvement and policy reforms which include, among other things, expansion in service coverage, reduction in wastage quality control and most importantly, mandating an annual fixed percentage increase in user charges.
Property Tax reforms in qualifying states will ensure that property valuations for the purpose of taxation reflect market rates and are updated periodically which is likely to lead to a measurable uptick in collections over time. Further, user charges reforms provide a pathway towards 100% recovery of O&M costs incurred, over a period of time. The remaining states will be well advised to undertake similar reforms given their potential in generating buoyancy into the two most potent sources of municipal revenue in India.
Property tax reforms, in particular, are going to be crucial, given that one of the mandatory conditions for ULBs to avail the 15th Finance Commission (FC) Grants, will be to evidence an improvement in property tax collections in tandem with growth in GSDP from the financial year 2022-23.
The Atmanirbhar Abhiyaan marked an important intervention in providing incentives to states in carrying out critical municipal finance reforms. Now, the onus for realizing the potential of these reforms lies with ULBs in qualifying states which are advised to uniformly adopt and seamlessly implement the reform mandate without any bureaucratic or political delay. As indicated, this should also serve as valuable guidance in preparing ULBs in the country to qualify for the 15th FC Grants, for which giant strides are demanded to be made in the sphere of municipal finance. If everything performs as intended, a golden era awaits Indian cities.
Taarush Kishore Jain is a Senior Associate at Janaagraha Centre for Citizenship and Democracy. He is a Chartered Certified Accountant from ACCA, United Kingdom and has completed his post-graduation from the Indian School of Public Policy. His interests lie in discovering the complexities of how laws, economics and politics in India inform, enrich and affect one another.
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