The Efficiency of India's Cities: Is There a Case to Finance Them?

Introduction

The year 2007 was important for urbanization since the number of urban inhabitants surpassed rural dwellers as a percentage of the total world population. The world population is expected to become two-third urban by 2025. The urbanization pattern in India also has been undergoing significant change, consistent with the world-wide phenomenon. The share of urban population in the total population of the country grew from 11% in 1901 to 26% in 1991, and 29% in 2001. While India adopts a very conservative definition of what is ‘urban,’ the ‘urban’ population in India is expected to increase to about 500 million by 2021.

While the urbanization phenomenon is widely accepted as being an inevitable by-product of development, there are many undesirable outcomes that have resulted. According to the Government of India’s Ministry of Urban Development, 20 percent of the country’s urban households do not have access to safe drinking water, 58 percent do not have safe sanitation, and more than 40 percent of garbage generated is left uncollected for want of proper waste management.

There is no consensus on what the cause is of the poor state of such public service delivery in India’s cities. Some studies point to institutional overlaps and governance as factors causing problems in the delivery of public services (Savage & Dasgupta, 2006; Sridhar, 2006). Another set of studies point to weak municipal finances as the core of the problem (see Reedy, 1986; Sridhar & Mathur, 2009). There is evidence that cities that have access to liquid sources of revenue such as octroi¹ are able to provide public services such as solid waste management much better than others (Sridhar & Mathur, 2009). Given this evidence, it is plausible to believe that finances play an important role in public service delivery.

One reason for exploring innovative sources of development finance is that city finances in India are in poor condition. Most of India’s cities have now abolished the highly buoyant source of revenue, the octroi, is now generally accepted to be distortionary in its effects. This is because the tax led to delays at checkposts, related productivity losses and corruption.

Further, the property tax base in India’s cities has not yet become a resilient source of revenue and does not reflect the capitalization that has been occurring in property value as a result of growth of the local economy. The sphere of municipal taxation was in India sometime ago enlarged to include land tax and tax on land values, however, with the exception of a few local bodies in Tamil Nadu, little progress has been reported regarding the levy/enhancement of land taxes by local bodies. A high tax rate on land encourages improvements on land and provides a disincentive for large speculative landholdings. A high land value tax (similar to a vacant land tax) would decrease the market value of land and provide a stimulus to develop land to its full potential.