Debates on Finance Commission awards revolve around the share of revenues to be shared with States and the norms for sharing between States. However, what is less discussed are the financial needs of local bodies, rural and urban. They do need more funds — the question is the form in which this should be provided or raised (grants or own taxes), and the terms, if any, that should accompany grants.
The need to provide more funds is a Constitutional imperative. The 73rd and 74th Amendment mandate regular elections to rural and urban local bodies, respectively. The corollary is that these bodies need the funds to be effective. The 16th Finance Commission has earmarked ₹7.9 lakh crore as grants for local bodies for the 2026-31 period. Such sums have been rising sharply every five years. The latest panel has increased the allocation of grants by 84 per cent in the case of rural bodies to ₹4.35 lakh crore over the 15th panel, and by 230 per cent to ₹3.56 lakh crore for urban local bodies. The rural to urban ratio here is lower than in the past, as there’s a sharp push this time to promote smaller towns and cities. Even so, assuming an average tax devolution to States, from the Centre, of about ₹16 lakh crore annually over this period (41 per cent share), the overall allocation of ₹7.9 lakh crore over five years is still less than 10 per cent.
The key question is whether this share should be raised, or these bodies should be encouraged to step up their own resources. Urban local bodies raise 50 per cent of their resources on their own, but it is also true that they are faced with rising urbanisation and its challenges, such as pollution, poverty and natural disasters. This explains the role of municipal bonds as well as green finance. Rural local bodies raise less than 10 per cent of the resources through own revenues, while supporting over half the population. The Economic Survey FY18 which dwells on transfers to local bodies in depth, raises the question of whether, in the case of rural bodies, the low own taxes share works as a convenient arrangement — where the elected representatives fight shy of antagonising their small voter base. The Survey also cites the basic maxim of taxpayers having a stake in the system and holding it accountable, more so where governments are in proximity. In that case, the power to collect taxes could be shifted to the district level, linking some transfers with rewards for performance. In fact, for new financial instruments to take root, better records and audits are a must; the 16th finance panel recognises this. Half the basic grants accounting for 80 per cent of the total are tied to waste and water management, while performance grants are linked to raising own resources. The devolution between local bodies is based largely on population (90 per cent) and area (10 per cent).
Finally, political and economic institutions for grassroots governance have not done well enough. Elections to panchayats and municipalities are delayed for years. Financial and political reform must go together.
Published on February 26, 2026