Distortion of Tax: Legal Flaws & Urban Inequality in India

The Importance of Tax for Urban Equity

Indian cities sit at the very core of the country's development ambitions. They play a pivotal role in the funding of housing, transport, climate adaptation and basic public services for the rapidly growing population. In fact, by 2036, India's towns and cities are projected to be home to nearly 40% of the population, a sharp increase from 31% in 2011, while urban areas contribute almost 70% to the national GDP.

However, even as Indian Cities become more central, they are still fiscally peripheral. The municipalities possess less than 1 percent of the fiscal architecture of the country, which makes them structurally reliant on state and central transfers. This disparity has been aggravated by the introduction of the Goods and Services Tax in 2017 that replaced local revenue instruments like entry taxes and octroi, causing further revenue loss to urban local bodies. As the responsibility of service delivery continues to grow without the financial autonomy, cities are being left with little ability to address local needs, a reality that rekindles the focus on the inefficient property tax as a source of urban self-government.

Why Indian Cities Remain Fiscally Disempowered

The financial crisis in Indian cities is based on the inherent lack of responsibility and authority. The 74th Amendment gave 18 functions to the municipalities, but the power to tax was left with the state legislatures. In reality, states devolve very little own-source revenues, leaving fewer than two-thirds of municipal functions with corresponding financial arrangements. As a result, municipal taxes are still grossly insufficient to meet urban requirements, as it has been pointed out in the empirical evaluations of urban finance on a number of occasions. Such structural imbalance forces cities to be very dependent on intergovernmental transfers which leads to a declining portion of own-source revenue and an increasing reliance on state and federal grants.

Political resistance is usually used to perpetuate this imbalance with senior state politicians and bureaucrats often fearing the competition of empowered local governments hence stalling real fiscal devolution. This limitation is well exemplified in Mumbai. After the abolition of octroi in Maharashtra, the Brihanmumbai Municipal Corporation was given state-level GST compensation, but this was only grant and not a sustainable own-source revenue that can replace a stable municipal tax base. Even a city with Mumbai's administrative capacity remains constrained by transfer-based financing to meet routine obligations. On the national level, municipal revenues have stagnated at about 1 percent of GDP, much lower than those of other countries in the world such as Brazil and South Africa, where local revenues constitute a significantly higher proportion. To resolve this structural dependence, pragmatism and incentive-based reforms are necessary where transfers are linked to quantifiable property-tax reforms and service-delivery standards. By creating direct formulaic channels while simultaneously strengthening municipal staffing and digital records, cities can begin to overcome a system where disempowerment is most visible in the design and performance of property taxation.

The Structural Limits of Property-Based Urban Finance

At its theoretical core, property-tax and land-based financing should be at the heart of municipal self-governance. Internationally, there is a strong consensus that local tax-raising capacity strengthens municipal finances and increases citizen-government accountability. However, in India, this potential has yet to materialize. It was not an accident that property taxation failed in India, but rather because of a structural flaw. There is chronic undervaluing of properties, incomplete and out-of-date registries, many exemptions for taxpayers, and very little administrative capacity in municipalities to administer their own tax systems. More importantly, municipalities have no authority to set rates, determine the cycle of values, or establish exemptions, these decisions continue to require State approval. The Supreme Court has clearly stated in cases like Municipal Corporation of Greater Mumbai v. Kamla Mills Ltd., that municipal taxing authorities receive their authority solely through State statute and therefore, while they have administrative duties, they have limited financial power.The design failure of property taxation goes far beyond the fact that it may generate less than adequate revenue for cities, it can affect the level of urban equity. Since property taxation has been ineffective and alternative forms of taxation are not available, cities increasingly turn to user-charges and flat-fee based service delivery to fund basic public services, thereby placing the cost of those services on already economically disadvantaged residents. Weaknesses in land records, the prevalence of informal housing, and the limited administrative capacity of municipalities further limit the ability to utilize land-based financing mechanisms, and thus, the majority of residents in informal settlements are excluded from participation. Therefore, the failure of property taxation is not simply a matter of "fixing" the technology of the tax system, it represents a deep-seated institutional contradiction that requires cities to deliver inclusive urban development, but does so without providing them with the financial resources needed to support such development.

These results are not predetermined by international practice, and such cities as Kampala have successfully increased revenues through digitization, taxpayer education and flexible payment plans, but other examples, like Kisumu, demonstrate the constraints of technical reforms in the face of political opposition, administrative incompetence, and political vested interests. They claim that the rise in own-source revenues is not merely a question of tax increases, but more a question of legal authority, administrative ability, and incentives. In the event that these conditions are not fulfilled, property tax is a feeble and retrogressive alternative to real municipal fiscal independence.

Law as a constraint, Law as a catalyst: Reforming Urban Fiscal Governance

Indian courts continue to express that municipal finance is not just an administrative issue, but also a constitutional issue. The Supreme Court has found that user charges and fees are a permissible cost-recovery mechanism, as long as there is a reasonable relationship between the charge or fee and the service being delivered. In doing so, the Supreme Court implicitly recognised the importance of fiscal sustainability to the ability of municipalities to deliver effective services. In cases like Akola Municipal Corporation v. Zishan Hussain Azhar Hussain, the judiciary has supported the power of municipalities to vary property taxes and procedures for valuing properties, at the same time affirming that the source of this power is ultimately with the state legislatures. Together these decisions create a legal paradox: cities are to fund increasing public functions but are dependent upon state authorisation to do so. However, the answer is not to amend the Constitution, but to reform the statute. Statutes governing municipalities in states can be amended to require regular reassessments of all taxable property, to limit state discretion over municipal taxation, and to provide municipal authorities with the legal entitlement to use user charges as mechanisms of cost-recovery as opposed to political compromises. The use of financial incentives through the Finance Commissions can also encourage compliance with these requirements without compulsion. Experience across countries, including Brazil's systems for capturing value generated by land and South Africa's constitutionally protected municipal tax base, demonstrate that when property law confers predictable fiscal authority on cities, then urban equity increases. Indian law is moving towards this result; it now requires implementation.

Conclusion

Legislation can clarify what local governments are allowed to do, but it will not correct a whole system that is inherently averse to financial responsibility for municipalities. Meaningful change will require much more than legislation alone; that is, changing State municipal law to provide cities with rule-based, rather than discretion based, fiscal authority to create true urban equity. Examples from other countries indicate that true urban equity is predicated upon providing cities with a stable source of funding through an enforceable and predictable source of revenue via strong property law.

Although the legal foundations for such a transformation already exist within the Indian framework, the final hurdle remains the political will to allow cities to govern by law rather than by mere state concession.