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«Metropolitan City Finances in India: Options for A New Fiscal Architecture Roy Bahl International Center for Public Policy Working Paper 12-33 ...»

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International Center for Public Policy

In Working Paper 12-33


December 2012



Metropolitan City Finances in India: Options for

A New Fiscal Architecture

Roy Bahl

International Center for Public Policy

Working Paper 12-33

Metropolitan City Finances in India: Options

for A New Fiscal Architecture

Roy Bahl

December 2012

International Center for Public Policy Andrew Young School of Policy Studies Georgia State University Atlanta, Georgia 30303 United States of America Phone: (404) 651-1144 Fax: (404) 651-4449 Email: hseraphin@gsu.edu Internet: http://aysps.gsu.edu/isp/index.html Copyright 2006, the Andrew Young School of Policy Studies, Georgia State University. No part of the material protected by this copyright notice may be reproduced or utilized in any form or by any means without prior written permission from the copyright owner.

International Center for Public Policy Andrew Young School of Policy Studies The Andrew Young School of Policy Studies was established at Georgia State University with the objective of promoting excellence in the design, implementation, and evaluation of public policy. In addition to two academic departments (economics and public administration), the Andrew Young School houses seven leading research centers and policy programs, including the International Center for Public Policy.

The mission of the International Center for Public Policy is to provide academic and professional training, applied research, and technical assistance in support of sound public policy and sustainable economic growth in developing and transitional economies.

The International Center for Public Policy at the Andrew Young School of Policy Studies is recognized worldwide for its efforts in support of economic and public policy reforms through technical assistance and training around the world. This reputation has been built serving a diverse client base, including the World Bank, the U.S. Agency for International Development (USAID), the United Nations Development Programme (UNDP), finance ministries, government organizations, legislative bodies and private sector institutions.

The success of the International Center for Public Policy reflects the breadth and depth of the in-house technical expertise that the International Center for Public Policy can draw upon. The Andrew Young School's faculty are leading experts in economics and public policy and have authored books, published in major academic and technical journals, and have extensive experience in designing and implementing technical assistance and training programs. Andrew Young School faculty have been active in policy reform in over 40 countries around the world.

Our technical assistance strategy is not to merely provide technical prescriptions for policy reform, but to engage in a collaborative effort with the host government and donor agency to identify and analyze the issues at hand, arrive at policy solutions and implement reforms.

The International Center for Public Policy specializes in four broad policy areas:

Fiscal policy, including tax reforms, public expenditure reviews, tax administration reform  Fiscal decentralization, including fiscal decentralization reforms, design of intergovernmental  transfer systems, urban government finance Budgeting and fiscal management, including local government budgeting, performance based budgeting, capital budgeting, multi-year budgeting Economic analysis and revenue forecasting, including micro-simulation, time series  forecasting, For more information about our technical assistance activities and training programs, please visit our website at http://aysps.gsu.edu/isp/index.html or contact us by email at hseraphin@gsu.edu.

Metropolitan City Finances in India: Options for A New Fiscal Architecture1 Roy Bahl

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1 Roy Bahl is Regents Professor of Economics, Emeritus, The Andrew Young School of Policy studies, Georgia State University, Atlanta Georgia, USA. (rbahl@gsu.edu).

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India will face great problems in finding a way to finance public services in its large cities in the next two decades. Backlogs in service levels and infrastructure are already great, and migration to urban areas will put even more pressure on state and local government budgets. Metropolitan cities have an economic base of significant size, but have not been empowered to tap this revenue potential.

State governments have more ability to reach a buoyant tax base, and to borrow, but must also use these resources to provide statewide services and to tend to the servicing needs of poorer local governments. The Indian Constitution poses significant constraints on the financing options, and neither the Central Finance Commission nor the State Finance Commissions have shown the way out of this problem. One could correctly say that India has not successfully implemented a strategy to address the fiscal problems of metropolitan areas.

The goal in this paper is to describe and evaluate some of the alternative approaches to developing such a strategy. While most studies of urban finance in India consider good reforms that might be politically possible, and that might lie within the present legal framework (Rao and Bird, 2011: Mohanty, et. al., 2007;

High Powered Committee, 2011), this analysis focuses on the largest metropolitan cities and considers the option of state government status for large metropolitan areas.

We begin with a discussion of the factors driving the budgetary needs that will face big cities in the next twenty years and then turn to a review of the options for covering the growing resource gap that will emerge. Three of these reform choices are the usual suspects: muddling through with the present approach, giving urban local governments access to more revenue raising powers, and increasing the rate of intergovernmental transfers from both the central and the state governments. The fourth, less often discussed reform path is to give state government status to the largest metropolitan cities. Throughout the paper we draw on the recent experiences in middle and low income countries. While every country is unique, there are lessons for India to learn from the international experience in financing urban governments.

Metropolitan City Finances in India: Options For A New Fiscal Architecture 3


Urbanization and the public financing and governance adjustments that it will call out are a world-wide issue (Bahl, 2010). The expectation is that the demand for new infrastructure and maintenance and for enhanced public services will grow dramatically. Ingram, Liu and Brandt (forthcoming) estimate that annual urban infrastructure needs will be equivalent to about 3 percent of GDP for new construction and 2 percent for maintenance. The sources of this increased demand include migration to urban areas, growing per capita incomes, business demand for enhanced public services, and the need to upgrade slum neighborhoods. On top of this are the needs to address the negative externalities that come with urbanization, such as pollution (solid waste collection) and congestion (transportation).

Population Growth.

The workers and families that will move to cities from smaller places and from rural areas will pressure the budgets of urban local governments. The rate of urbanization in developing countries is now projected to reach the 50 percent mark in the next decade (United Nations, 2008). According to current estimates the world population will likely grow from approximately 7 billion in 2012 to over 9 billion3 by 2050 and virtually all of the population increment will be absorbed by urban areas in developing countries.

The number of megacities (population greater than 10 million) is projected to increase from 19 now to 27 in 2025, when about 10 percent of the world’s urban population will reside in these cities. Of the projected 27 mega-cities, 21 will be in less developed countries. By 2025, there will be 48 cities with populations between 5 and 10 million, and three-fourths of these will be in developing countries (United Nations, 2008). The rate of population growth in the largest metros may be slower than that in other urban areas, but the size of the populations to be serviced will be larger than anything seen before.

2 For a detailed discussion of these determinants, see Bahl, Linn and Wetzel (forthcoming).

3 US Census Bureau Website (last accessed 21 July 2012) http://www.census.gov/population/international/data/idb/worldpopgraph.php

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The distribution of population in India will follow these international trends.

Between 2001 and 2031, the urban share of total population is projected to double, though India’s rate of urbanization will still lag that in the rest of the world. The number of cities with populations greater than one million will increase from 35 to 87 (High Powered Committee, 2011). The United Nations (2008) projects that by 2025, Mumbai (26 million) and Delhi (23 million) will be the second and third largest urban agglomerations in the world. About half of the increase in urban population over the decade of the 1990s was due to natural growth, but this share will fall as urban job opportunities will bid in more migrants.


Urban economic growth (and national economic growth) is fueled by a strong competitive position of businesses operating within the metropolitan area.

“Competitiveness” means production at lowest costs consistent with the quality necessary to sell in international markets, but it also means an ability of urban enterprises to absorb new technologies, take advantage of agglomeration economies, and to attract foreign direct investment and a high quality labor force.

Maintaining competitiveness requires a setting in which innovation can take place, e.g., technology parks, linkages with universities, and incentives for incubation and small business development (OECD, 2006).

The competitiveness of a city’s businesses in international markets is enabled by the infrastructure and public services offered. Transportation services have long been recognized as a key to urban economic development. This has led to heavy investment in mass transit and freeways that have reduced congestion, and in seaports and airports that have facilitated trade (Yusuf, forthcoming). A communications network that allows an efficient transfer of information is key to all of this (Glaeser and Gottlieb, 2009). Another part of the strategy to maintain competitiveness is to make cities more attractive to high quality labor. This leads to public investments in improving amenities, such as provision of modern health facilities, education curricula that support the new economy, recreational and cultural activities, and security.

Metropolitan City Finances in India: Options For A New Fiscal Architecture 5 The Indian economy is increasingly driven by its urban sector. Projections are that the urban share of GDP will reach 75 percent by 2030. The industry and service sectors are the primary contributors to urban economic growth, particularly IT, telecoms, banking and “smart” manufacturing such as engineered goods and pharmaceuticals (High Powered Committee, 2011). It is estimated that between now and 2030, 70 percent of net new employment will be generated in cities (McKinsey Global Institute, 2010).

As in other countries, the competitive challenge in India will be to capture the agglomeration benefits of urbanization without being overwhelmed by congestion costs. This will call out a strategy of investing in basic infrastructure to allow the communication among firms that is necessary to capture the benefits of proximity, and to attract a skilled labor force. At the same time, virtually all cities must invest heavily in transportation to reduce congestion and air pollution. The pressure will be on to get the government institutions arranged so that good decisions can be made, and to mobilize the resources needed.

Poverty and Slum upgrading

Many large metropolitan areas in low and middle income countries face the problem of addressing the special needs of a heavy concentration of poor and badly housed families, often in sprawling slums which call for major infrastructure investments by metropolitan governments. The magnitude of the slum problem is staggering. One estimate is that about $60 billion per year will need to be spent on slum improvement and prevention during the next 15 years (Freire, forthcoming).

While the problem of urban poverty has been a focus of policy action in low and middle income countries during the past two decades, it is also the center of much debate. Two fundamental issues are how poverty should be measured, and what are the relative sizes of the poor population in metropolitan cities, other urban areas and rural areas. Another is which policy instruments are likely to yield the greatest returns in terms of poverty reduction (Linn, 2010). This same debate takes place about poverty in India.

56 International Center for Public Policy Working Paper Series

How will migration to urban areas in India affect the rate of poverty? About onefourth of the Indian population now lives below the poverty line, though the share is considerably lower in urban areas.4 Moreover, the evidence suggests that new migrants are no more likely than non-migrants to have incomes below the poverty line (Singh, 2009) The Indian problem in cities is probably better described as “shelter poverty”.

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