The 73rd and the 74th Constitutional (Amend.) Acts of 1992 marked the beginning of a historic reform to decentralise powers to the third tier. The amendment inserted a new Schedule the 12th Schedule that assigned functions and responsibilities to the local bodies. It designated 18 functions to urban bodies and 27 to rural ones. Thus, the amendments, for the first time, laid down the foundation for a strengthened and an effective local government.
Although these Acts have increased the functions assigned to local bodies, matching resources have not been provided. However, Article 243(I) of the Constitution (73rd) and Article 243(Y) of the Constitution (74th) Amendments, Acts 1992, statutorily require the states to constitute the state finance commissions (SFCs), once in five years to recommend measures to improve the finances of local bodies. The SFCs are also obligated to recommend measures needed to augment the consolidated fund of the state government. Accordingly, the SFCs have been appointed in all the states. In most states they have already submitted reports.
The task of the SFCs has been difficult. However, allowing for some variations in their approach, most of these have recommended large transfer of resources to local bodies to facilitate them to be financially autonomous. This raises the question of increasing the size of the consolidated fund of the states.
In the context of increased revenue requirements for local bodies and additional resource requirements for the states to have larger devolution, it is important that an adjustment is made in the overall assignment of taxes between different tiers of governance. Accordingly, the following measures would be useful.
Assignment of taxes: Local bodies should be assigned some broad-based and income-elastic taxes to cope with their responsibilities. However, it should be obligatory that all of them mop up the assigned taxes. This would not allow any political factors in the levy of any assigned tax. The important among these is a local-VAT. This could be an elastic source of revenue. Even if a low tax rate (say 5 per cent) is levied on the pattern of the local sales taxes in the US, or on the pattern of surcharge on sales tax in TN (Madurai area), the local bodies could raise substantial resources. If this tax is collected by the state along with VAT, it would have to be distributed to the local bodies on the principles suggested by the SFCs.
Property taxes (including water, sewerage, scavenging, education cess, street cess, fire tax, etc.) have been another major source of revenue for local bodies, especially where octroi is not levied. However, over the years, its fiscal importance has declined. It is, therefore, important that efforts are made to rationalise it structure and the administration.
Development charges on vacant land are a potential source of revenue. Many local bodies levy such a tax. Some states levy vacant land tax, in others it is development charges or tax on transfers. Irrespective of its nomenclature, such a tax could be a potential source of revenue.
Revenue from licenses and permits is also important for local bodies. There are a variety of fees on shops, construction activities and fines for violation of rules, especially for parking vehicles and construction. In view of the structural reforms in the economy, these measures attain a significant place in maintaining regulations.
A tax on entry of vehicles in cosmopolitan towns could be levied to help municipal corporations cope with environmental degradation. Similarly, user charges should be considered an important source of financing services.
In addition, rural bodies could also levy a house/building tax differentiated on the basis of kachha or pucca structures, and graded according to use for residential or commercial purposes. Another useful source is a tax on non-agricultural land and on any vehicle or automotive device (automobiles, tractors, pumpsets etc). Some local bodies levy a cess on land revenue or a betterment levy on land or construction activities. These could be related to developmental activities and can be charged from those who benefit from such schemes.
Transfer of resources: Local bodies need to have a balance between resources and overall expenditure needs. Since they have limited capacity to generate resources, this balance could be obtained through transfer of resources from the states. This task could be performed by the SFCs.
At present, transfers to local bodies account for roughly one-third of the total revenue of municipalities and three-fourth of the total revenue of rural bodies. They must base any increase in transfer on the criteria of performance, efficiency and tax effort. In addition to grants-in aid, it is important that local bodies have larger access to more buoyant state-level taxes through a larger sharing-in mechanism. In this context, the adoption of state VAT would enable the states to share a larger pool with local bodies.
This, in turn, will strengthen the resources of local bodies. At present, many states share motor vehicle tax and stamp duties with local bodies. However, the practice being ad hoc, it would be useful if some taxes (viz, motor vehicle tax, passenger and goods tax, stamp duty, profession tax and entertainment tax) form the base of a shareable pool. The distribution can be done through the SFCs.
The 73rd and 74th Constitutional Amendment Acts have increased the expenditure assignments for local bodies. No similar matching revenue assignment has been made. It is, therefore, important to examine the possibilities of augmentation of resources for the states and local bodies. This could be done through the introduction of a state-VAT.
(The author is professor, National Institute of Public Finance and Policy, New Delhi)
