Strengthening Fiscal Health of Urban Local Bodies

The concept of decentralisation encompasses a wide variety of institutional restructuring. Fiscal decentralisation is assumed to create incentives for fiscal accountability through assignment of expenditures (deciding the spending responsibilities of national and subnational governments) and taxes (giving subnational governments the option of covering the total or additional expenses with their own resources) among the different levels of governments (Litvacket al 1998). The public economics framework argues that the local government body should be assigned responsibilities for services whose impacts are confined to their jurisdiction (Oates 1999; Dillinger 1993). After the local governments’ functional responsibilities are specified, decentralised arrangements may lead to greater mobilisation of local resources through the greater willingness of consumers of local public services to “share the burden” when they believe that a significant proportion of taxes will be retained locally and spent on projects and services that they value. The possibility of financing basic services from taxes borne by local taxpayers establishes a clear and close link between the costs and benefits of public services and, thus, renders decision-makers more responsive to local residents. However, in most developing countries, expenditure assignments are more decentralised than revenue assignments (Bardhan 1996). Local governments have utilised intergovernmental fiscal transfer and borrowing to bridge the gap between their revenue-raising abilities and expenditure responsibilities. Nevertheless, it is generally believed that greater the financial autonomy, greater the incentives for local decision-makers to be sensitive to both costs and local priorities (Klugman 1994).¹ Financial autonomy makes local decision-makers accountable to local residents. Such accountability can result in improvement in the delivery of urban services.

In India, formal decentralisation of fiscal and political authorities to cities took place through the 74th Constitutional Amendment Act (CAA) of 1993 that devolves various administrative and fiscal functions to urban local bodies (ULBs). In India, urban governance is a state subject. State governments have exercised their discretion in implementing various provisions of the act but, in practice, they have only made partial devolution of finance and functionaries at the municipal level. Although the 74th CAA mandates the constitution of a state finance commission (SFC) every five years to review as well as recommend measures for improving the financial health of municipalities, ad hoc and discretionary state transfers have failed to address ULBs’ expenditure needs. Only recently the Fourteenth Finance Commission strengthened the urban fiscal decentralisation framework by devolving larger amounts of grants to ULBs (Mehta and Mehta 2015). For incentivising ULBs to perform as local self-government institutions, grants are linked to proper accountability of local finance and service delivery as per nationally accepted service level benchmarks.