Engines sans drivers: 16th FC and fiscal future of urban local bodies

As the 16th Finance Commission (FC) begins its deliberations, one must ask: Why, after 30 years of constitutional mandate under the 74th Amendment, have urban local bodies (ULBs) failed to emerge as autonomous, accountable, and financially resilient institutions? Why are cities, despite their growing centrality to national development, still governed by structures that rely more on transfers than on their own strength?

The problem is neither new nor unexplored. The 74th Constitutional Amendment provided for the functional devolution of 18 subjects to urban bodies, created a constitutional mandate for State Finance Commissions (SFCs), and gave ULBs a formal role in governance. Yet, implementation has remained half-hearted. The core issue lies in the weak fiscal foundations of ULBs. The introduction of the Goods and Services Tax (GST) in 2017 made matters worse. Key municipal revenue sources like octroi, entry tax, and local advertisement tax were absorbed into GST, but unlike state governments, ULBs were neither given a share of GST proceeds nor compensated for the loss. The net result has been a shrinking fiscal space for ULBs at a time when urban demands are escalating.

Given this, successive FCs of India have tried, but certainly not succeeded, to address the foundational gaps. Rs 23,111 crore was earmarked by the 13th FC for local bodies in the form of tied grants to reforms like accounting and improved tax administration. Indeed, theoretically encouraging.

Stronger municipalities capable of meeting compliance metrics mostly benefitted from this model, leaving behind weaker and smaller ULBs. Moving in the opposite direction, an untied grant worth Rs 87,144 crore was recommended by the 14th Commission. The intent was to encourage autonomy and flexibility, but when the states used their discretionary power to transfer funds to the ULBs not ensuring the performance-linked conditionalities, the net outcome was a lack of accountability and reform inertia. A middle ground was preferred by the 15th FC by recommending Rs 1.21 lakh crore. 15th FC reintroduced conditions around property tax reform, floor rates and timely audits. However, perhaps the 15th FC missed the broader governance and institutional issues and mainly viewed ULBs through a fiscal lens. Also, there was silence on any compensatory mechanism for dodging the structural blow dealt by GST to ULB revenues.

The performance of SFCs has been even more disappointing. While the Constitution mandates that SFCs be constituted every five years to decide on vertical and horizontal devolution to local bodies, compliance has been erratic. Tamil Nadu has historically constituted all SFCs on time and was an early adopter of formula-based devolution. However, recent SFC reports have been delayed, and the state’s reluctance to update property valuation registers or empower ULBs to access land-based financing mechanisms undermines real reform. In contrast, Karnataka has maintained relatively better compliance. The 3rd and 4th SFCs suggested clear expenditure norms and formula-based transfers.

Further, the adoption of GIS-enabled property tax assessment in Bengaluru led to a sharp increase in collections. But, genuine decentralisation is restricted when state-level parastatals like the Bengaluru Development Authority retain key urban functions like planning and land regulation. Kerala, often celebrated for its decentralisation model, instituted participatory planning and devolved sizeable funds. But even here, property tax remains unreformed in many municipalities, and ULBs continue to lack autonomy over recruitment and project implementation. The overarching trend across these states points to a paradox — even when formula-based transfers exist, they are not accompanied by functional devolution or fiscal empowerment.

This is where the 16th FC must break from precedent. The Commission’s role cannot be confined to apportioning grants. It must act as a constitutional conscience-keeper and institutional architect. First, it must formally recognise the fiscal vacuum created by GST. ULBs need to be compensated through a designated share of SGST or through a new urban services surcharge that directly flows to them. Second, the Commission should institutionalise performance-linked transfers, but with differentiated benchmarks that account for the diverse capacities of municipalities. Rewarding Bengaluru and penalising smaller towns under the same rubric only deepens inequity. Third, the FC must clearly distinguish between revenue and capital expenditures and recommend a separate Urban Infrastructure Window, especially for smaller ULBs unable to raise market borrowings. Fourth, it should frame conditionalities for the constitution and functioning of SFCs — including timelines for submission, principles of horizontal equity, and transparency in implementation. Unless the architecture of SFCs is rebuilt, state-level decentralisation will continue to falter. Lastly, the 16th FC must recommend a national capacity-building mission for ULBs, not merely in training but in embedding dedicated municipal finance and planning professionals at the city level. India’s urban challenge is no longer one of infrastructure alone — it is about institutional capability. FCs must evolve from being a periodic allocator to a strategic enabler of decentralised urban governance. Its legacy should be judged not by the volume of transfers but by the architecture it creates to let Indian cities govern themselves with purpose, predictability, and power within ULB budgets and recommend the creation of a dedicated Urban Infrastructure Support Fund. This fund can enable ULBs — particularly those in Tier-II and Tier-III cities — to finance core infrastructure like water supply, mobility, and waste management. The fund should also be structured to incentivise ULBs that leverage private capital or issue municipal bonds. There must be a push for land-based financing instruments. The power to plan — and thus to capture land value — still largely resides with state-level parastatals. The 16th FC should recommend conditional devolution of funds to states that actively transfer town planning functions to municipalities. Mechanisms like betterment levies, development charges, and tax increment financing can then be operationalised at the city level.

Debdulal Thakur is Dean, Vinayaka Mission’s School of Economics and Public Policy

Shrabani Mukherjee is Associate Professor, Shiv Nadar University, Chennai