The third tier of government matters

The 2021-22 edition of the RBI's study of state finances focuses on municipal finances. It proposes enhancing their governance, financial autonomy and revenue-raising capacity. The pandemic has dented the finances of municipalities, as of states, eroding them by 15-25%. Municipalities must raise more tax revenues to invest in civic amenities, urban planning, habitats and lighting. Property taxes are a vital part of their revenue base, against which municipalities can issue bonds to raise resources. But property tax rates and collections are abysmally low. The average collection from the levy as a proportion of the gross domestic product is barely 0.2%. Reform of property taxes brooks no delay.

Property tax is also an important enabler of decentralisation of administrative and financial power. Rightly, the 15th Finance Commission had recommended floor values below which house tax should not fall. Higher property tax rates and strengthening the tax base will boost revenues and bring the finances of local bodies to a better shape, including by issuing bonds against them. Ideally, municipal bonds should become an asset class for long-term investors such as pension and insurance funds looking for stable returns. However, professional tax, levied by local governments on salaried jobs and professions, should be scrapped. It yields paltry revenues. Income tax is charged on the salaried class, and services rendered by professionals attract the goods and services tax. Profession tax is obsolete and inefficient.

Electricity tax makes sense, although as part of GST, rather than as standalone excise. A well-functioning mechanism of devolving taxation powers and funds from state governments would improve the finances of local bodies.