India’s cities are widely recognised as engines of economic growth. They generate over half of the GDP. Yet, there is a persistent paradox: India has rich cities, but city governments are chronically underfunded.
The introduction of the Goods and Services Tax in 2017, while a landmark reform for the national economy, has further strained municipal finances. It raises the issue of how India shares its tax revenues – particularly GST – with the third tier of government.
The mismatch between the economic importance of cities and their ability to raise funds is a structural problem that threatens India’s development ambitions. Cities cannot deliver quality infrastructure, reliable services, or build climate resilience if they lack predictable, adequate resources.
Shrinking fiscal space
An analysis of union budgets over the past three years shows that the Ministry of Housing and Urban Affairs has spent, on average, about Rs 0.5 lakh crore annually, which is less than one-fifth of the estimated minimum investment required by cities for urban infrastructure.
This inadequate funding has led to inadequate transportation systems, unreliable water supplies, poor sanitation, increased traffic congestion and heightened vulnerability to floods and climate-related shocks.
Municipal revenues have also weakened. Traditionally, cities worldwide levy taxes on business activity to finance local services. Indian cities were no exception.
Various taxes on goods entering the city and services were important sources of municipal income: like octroi and entry tax, which were levied on goods entering civic limits, local body tax, which replaced octroi in Maharashtra, and taxes on advertisements and entertainment. The rollout of GST subsumed many of these local taxes, significantly eroding municipal revenue autonomy.
Mumbai illustrates this loss of local revenue. Before GST, octroi alone contributed to nearly 35% of the Municipal Corporation of Greater Mumbai’s total revenue.The abolition of octroi had created a major fiscal hole.
Although Maharashtra promised a compensatory share of GST revenues to urban local bodies, transfers have been irregular and insufficient – cities like Nagpur, Pune, and Nashik have not received their due share of compensation. For example, Pune had a shortfall of Rs 500 crores, and Nashik and Nagpur’s compensations are caught up in dispute.
Inter-governmental transfers
Globally, inter-governmental transfers are a key pillar of urban finance. These are grants from the central and state governments to local governments.
Compared to other countries, India performs poorly on this front. Inter-governmental transfers to local governments in India amount to only about 0.45%-0.5% of gross domestic product. This is far below countries such as Mexico (1.6%), South Africa and the Philippines (2.5%), and Brazil (over 5%).
The Philippines offers a particularly instructive example. The Local Government Code mandates that 40% of national internal revenue collections be transferred to local governments. These transfers are formula-based, predictable and accompanied by borrowing powers for local governments. As a result, cities in the Philippines enjoy significantly greater fiscal capacity and autonomy.
In India, urban local bodies received an estimated Rs 1.3 lakh crore as inter-governmental transfers in 2024-’25. These estimates are based on the authors’ projections from the report tabled during the interim budget in February 2024 and a March 2019 report of the Indian Council for Research on International Economic Relations.
Nearly a quarter of this came through centrally-sponsored schemes such as AMRUT, Swachh Bharat Mission, and Smart Cities. However, much of this funding is routed through state parastatals – agencies like Maharashtra’s Jal Pradhikaran, which develops water and sewage infrastructure – or special purpose vehicles, such as the Metro Rail Authorities in cities. Of the 1.3 lakh crore, about one lakh crore was transferred to cities through the central and state finance commissions.
Despite these transfers, the overall level of support to urban local bodies has remained stagnant relative to GDP since the introduction of GST.
Fixed share of GST for cities
To correct this imbalance, there is a growing consensus among policymakers and scholars that urban local governments must receive a direct, fixed share of GST revenues.
The High Powered Expert Committee on Indian Urban Infrastructure and Services, chaired by Dr Isher Judge Ahluwalia and established in May 2008 by the Ministry of Urban Development, had argued that GST should have been shared across all three tiers of government from the outset. Similarly, former urban development minister Venkaiah Naidu advocated for an assured share for municipalities in the GST.
In its 2019 report, the Indian Council for Research on International Economic Relations described municipal finances as the “worst hit” by the GST reform. Similarly, in a research paper published that year, economist Vijay Kelkar highlighted the vertical fiscal imbalance in India and proposed allocating one-sixth of GST revenues to the third tier of government. This share could then be divided equally between rural and urban local bodies.
In 2024-’25, India’s net GST collection stood at about Rs 19.5 lakh crore. One-sixth of this will be roughly Rs 3.25 lakh crore. Even if only half of this – around Rs 1.6 lakh crore – is allocated to urban local bodies, it would nearly double current transfers. It would still raise IGTs to cities only modestly in GDP terms, underscoring how underfunded Indian cities currently are.
A predictable GST share would not only strengthen municipal finances but also incentivise cities to support economic growth, improve compliance and invest in productivity-enhancing infrastructure.
Constitutional status of local finances
Beyond increased transfers, there is a deeper constitutional issue at play. The 74th Constitutional Amendment assigned functions to urban local bodies through the 12th Schedule but it did not provide a corresponding list of revenue sources. Municipalities remain dependent on state governments for financial devolution.
State Finance Commissions, tasked with addressing this gap, have largely underperformed. The Fifteenth Finance Commission noted that State Finance Commissions remain the weakest link in India’s fiscal federal structure, leading to inadequate and delayed transfers.
As early as 2009, the High Powered Expert Committee on Urban Infrastructure recommended creating a separate “Local Bodies Finance List” in the Constitution, similar to the Union and State Lists. This recommendation has gained renewed urgency in the post-GST era, where local revenue powers have been further curtailed.
If India’s cities are expected to drive growth, innovation, and climate resilience, their governments must be financially empowered. Providing cities with a fixed share of GST, alongside constitutional recognition of their revenue powers, is essential. Strengthening city finances is about securing India’s economic future.
Meera Mehta and Dinesh Mehta are Senior Advisers, Professor Emeritus Dhruv Bhavsar is Head, and Saubiya Sareshwala is a Senior Research Associate at the Centre for Water and Sanitation, CRDF, CEPT University, Ahmedabad.