In the book under review, Prasanna KMohanty seeks to argue for reform in the municipal finance of the urban local bodies (ULBs) in India. The author was Commissioner of the Municipal Corporation of Visakhapatnam and Hyderabad and has also served as Vice-Chairman of the Hyderabad Urban Development Authority, Chief Secretary of Andhra Pradesh and Mission Director of the Jawaharlal Nehru National Urban Renewal Mission (JNNURM) in the State. A bureaucrat cum academic, the author is placed advantageously for dealing with this topic due to his in-depth theoretical knowledge and vast ground level experience.
The author points out that the need for enhancing public spending in urban areas (particularly in infrastructure) is really pressing in India, however, urban local bodies do not have enough resources to do that.
There are three ways to empower the municipalities and the corporations viz. by increasing their own tax and non-tax revenues, by increasing inter-governmental transfers to the urban local bodies (i.e., transfer from Central or State governments to ULBs) and by allowing them to borrow money from the market by floating municipal bonds. The book upholds the benefit principle as the guiding principle for levying taxes and user charges. It also advocates increasing the tax base for the ULBs mainly through land value tax and property tax and also by broadening the tax base through less exemptions. The book also lays emphasis on various user charges including charges for water, sewerage, solid waste collection, public transport etc., and on benefit charges like development charges and impact fees. It talks about vertical and horizontal imbalances (i.e., mismatch between expenditure requirements and own revenue of all the local bodies and inequality among local bodies) in intergovernmental transfers and argues for a formula-based transfer system assigning weights to fiscal need, fiscal capacity and fiscal effort factors. The book suggests comprehensive reforms in municipal finance to enhance the credit-worthiness of municipalities, apart from development of the municipal bond market. It also advocates public private partnerships (PPPs) and points out that tools like tax increment financing (TIF) would enable public authorities to trade anticipated future revenues for a present infrastructure programme. Finally, it suggests a roadmap and sets a target of enhancing the ULBs’ expenditure from 1 percent to 5 percent of GDP with 2 percent of GDP earmarked for the capital expenditure.
To set the context of our discussion, let us first consider the big picture of public finance in India. Our total government expenditure is less than 27 percent of GDP including all the three tiers of government. The combined fiscal deficit of the Centre and the States is around 6 percent of GDP and the government revenue is around 21 percent of GDP. The combined tax revenue is around 17 percent of GDP, which is one of the lowest in the world and the rest 4 percent of GDP is non-tax revenue of the government. It is mentioned in the book that the aggregate municipal expenditure was only 1 percent of GDP in 2012-13, with its own tax revenue of 0.33 percent, non-tax revenue of 0.20 percent and transfer of 0.46 percent. These numbers are much less than that of the OECD countries (see table 10.1); however, the average total tax-GDP ratio in those countries are also much higher than 17 percent of GDP (OECD average is 34 percent). Now, if we have to enhance the ULB spending from 1 percent to 5 percent of GDP, either we need to reduce expenditures of the Central and/or the State governments or we need to increase the tax-GDP ratio substantially or the combined fiscal deficit would go up. The book seems to suggest some combination of the last two by increasing benefit tax and user charges and by floating municipal bonds.
It is an undeniable fact that the government needs to spend more money for urban development. It is also important to decentralize the expenditure pattern and spending more money through the local bodies. I cannot agree more with the author when he argues that the intergovernmental transfers to the local bodies should be made formula-based in the direction of reducing vertical and horizontal fiscal imbalances, keeping both equity and effort aspects in mind. I have a little difference of opinion regarding the strict benefit approach-based framework (same tax rate for rich and poor weighted by use or consumption) with less or no exemptions, given the existence of very high degree of urban inequality in the country. However, the importance of enhancing ULBs’ own tax and non-tax revenues is undeniable. Probably, the ‘benefit approach among those who have ability to pay (relatively well-off section of the population)’ may be a prudent way to go forward. The cost of collection of benefit taxes and user charges to actual collection ratio would be relatively much higher for the bottom 75 to 80 percent of the urban population; additionally, it would aggravate urban inequality. Exemptions of the poorer section of population may actually make the tax/user fee more efficient. The structure of property tax can be made very progressive instead of a flat rate. The criticisms of PPP models, particularly in the Indian context, are also well known—it is public investment for private profit, in most cases. My main discomfort, however, lies vis-à-vis the proposal for developing a vibrant municipal bonds market in India.
First of all, the macroeconomic consequences of fiscal deficit would be the same, at the aggregate level, irrespective of whether it is incurred by the Central government or by the State governments or by the local bodies. Therefore, whether the ULBs borrow directly from the domestic capital market or the Central or the State governments borrow on their behalf and transfer the money to the ULBs does not really make any difference from a macroeconomic point of view. Secondly, it would create further inequality among the ULBs. The author himself acknowledges that ‘the access of smaller municipalities to bonds may not be possible due to their poor finances’. The ULBs would be judged according to their ‘credit-rating’. Even within one municipal corporation, some projects would be rated higher than the other projects from the profit point of view. Unlike other government bonds, the interest rate would vary on the municipal bonds depending on their credit ratings. So, the priorities and preferences of ULBs may be influenced by profitability (credit-worthiness) considerations. The author talks about the US model of municipal bond market. However, after the experience of the financial crisis in the US, we know how risky this municipal bond markets can be. Why do we have to necessarily conceive a financial architecture in the country which is more fragile and vulnerable in nature than the existing one? People have faith in government bonds because they are risk free and the government paper is as good as money. But, the risk would vary in case of municipal bonds across ULBs and projects. Therefore, the expected return and the interest rate would also vary accordingly. Only a few big corporations would be able to attract funds at cheaper rate, that too for some lucrative projects, which would have a flow of revenue/user charge in the days to come. It would surely widen the inequalities among various local bodies. Moreover, at the aggregate level, the ULBs are found to spend significantly less than the available funds. Therefore, the constraints lie elsewhere.
It is an interesting proposal to raise the ULB spending to 5 percent of GDP with 2 percent earmarked for the capital expenditure. Similarly, in India, the government expenditure is abysmally low on health, on education and on many other important things. If everything has to rise as a proportion of GDP, then the total government expenditure has to rise substantially from 27 percent of GDP. Given any cap on the fiscal deficit to GDP ratio, the government revenue has to substantially rise as a proportion of GDP. Our tax rates are not low, given the international standards. The tax-GDP ratio is low in India because of low tax base and because of low compliance due to poor tax administration, lack of information network and corruption. Some urban infrastructures are created directly by the Central and the State governments, too. Many people live in rural areas in our country—rural local bodies are also important. Given all this, I think, the proposal for increasing the ULB spending by 4 percentage points, is in the right direction but on the higher side.
Notwithstanding the critical insights, this is an interesting book which correctly lays emphasis on the serious need to reform urban public finance in India, given the increasing urbanization and the state of the urban areas, cities and small towns, in the country.
Surajit Das teaches at the Centre for Economic Studies and Planning, Jawaharlal Nehru University, New Delhi.