Finance of Local Government in India

Published on 10 Jan 2025

The articles introduced with the 73rd and 74th Constitutional amendments have made devolution of financial powers to the local government only a voluntary provision. This resulted in non-uniformity in the financial position of local governments in various states, largely depending on the discretion of the state government in devolving financial powers to the lower-tier body.

Different funding mechanisms

Central government grants, based on the recommendation of the Finance Commission as per (Article 280).
Programme specific allocation under Centrally Sponsored scheme
Devolution from State government based on the recommendation of State Finance Commission (Article 243I)
Loans or grants from the state government.
Internal resource generation, which is of minimal quantity

Challenges associated with Local government finance

Lack of independent fundraising: Since states have their discretion in granting independent taxation powers, many have opted to keep the power with themselves and not transfer the power to the local government.

Example: Local taxation powers are limited to tax, tax on vehicles, toll tax, festival tax, etc.

Dependence on grants: This affects the independent functioning of the local government as development works must depend on the mercy of grants approved by the centre and state.

Example: Grants worth 1.42 lakh crore have been tied for the implementation of water and sanitation works.

Poor functioning of State Finance Commission: The body has not been timely constituted in many states and even when they are constituted, their reports are not given adequate importance.

Example: The second SFC report of Maharashtra and Karnataka, third SFC report of Gujarat were not even placed in the legislature.

Financial inequality among local governments: There exists a significant financial disparity between local bodies which affects the implementation of programmes and schemes.

Example: Better financial position of South Indian local government when compared to rest of India.

Lack of financial expertise: Many local governments lack trained financial professionals to manage their budgets and investments effectively.

Way forward

Empower State Finance Commission: Law must be strengthened to make their appointment more regular with dedicated time slots for discussing the reports of the commission.
More taxation power: Certain taxes must be mandatorily made as the responsibility of the local government to make them financially independent.
Reducing the tied nature of grants: More decentralized approach to be followed while grant disbursal with at least 50% of the grants to be used at the Panchayat's discretion.
Maintain proper records: Financial data must be well maintained so that the State Finance Commission can better plan the allocation of resources.

The local government institutions can meet the aspiration of the public only if they are given more financial freedom and such a fiscal space can make them more efficient and responsive.