Finance Commission grants to cities
Urbanisation and economic importance of cities
Urban areas are becoming the main engines of India’s economic growth. Cities concentrate industries, services, infrastructure, and labour markets, making them the primary centres of capital accumulation and productivity.
Urban centres generate around 67% of India’s GDP.
Nearly 90% of total government revenue is generated from urban economic activity through taxes, business activity, and consumption.
India’s urban population is expected to reach around 41% by 2031, reflecting rapid urbanisation.
Despite their economic contribution, cities receive relatively limited fiscal support from the Union government through Finance Commission transfers.
Finance Commission transfers to urban local bodies
15th Finance Commission
The Fifteenth Finance Commission recommended grants to local bodies for the period 2021–2026.
Urban Local Bodies (ULBs) received approximately ₹1.2–1.3 lakh crore over five years.
During the same period, India’s GDP was around ₹200–210 lakh crore.
Thus, transfers to cities amounted to only 0.12–0.13% of GDP.
This level of funding is considered insufficient given the infrastructure and service demands of rapidly growing cities.
16th Finance Commission
The Sixteenth Finance Commission has recommended:
₹3.56 lakh crore to urban local bodies for the 2026–2031 period.
This equals roughly ₹75,000 crore per year.
However, with India’s GDP projected to reach about ₹400 lakh crore, the share of urban transfers still remains around 0.13% of GDP, indicating no significant increase in the relative allocation to cities.
Per capita funding challenge
Urban population growth reduces the impact of grants.
Urban population in India:
Around 470 million in 2020
Expected to exceed 600 million by 2030
When Finance Commission grants are distributed across a much larger urban population, per capita funding remains stagnant or may even decline in real terms. This limits the ability of cities to invest in infrastructure and services such as housing, sanitation, public transport, and climate resilience.
Issue of unspent funds
Another concern relates to the utilisation of grants by local bodies.
Under the 15th Finance Commission:
Total grants to local governments: ₹4.36 lakh crore.
Around ₹90,000–95,000 crore remained unspent or pending utilisation.
Of this amount:
₹30,000–35,000 crore belonged to urban local bodies.
This reflects problems such as:
Weak administrative capacity of local bodies
Delays in project implementation
Complex approval procedures
Tied grants and fiscal autonomy
Meaning of tied grants
Tied grants are funds that must be spent only on specified sectors. Cities cannot divert them for other priorities.
Typical sectors include:
Drinking water supply
Sanitation
Wastewater management
Solid waste management
Impact
Tied grants limit fiscal flexibility because cities cannot allocate funds according to local development priorities. Urban governments may need funds for transport, housing, or climate adaptation but are restricted by sectoral conditions.
Performance-based grants
The 16th Finance Commission has strengthened the system of performance-linked grants.
Cities will receive funds only if they meet certain conditions, such as:
Maintaining fiscal discipline
Conducting regular local body elections
Publishing audited accounts and financial statements
Constituting State Finance Commissions
Increasing Own Source Revenue (OSR)
Own Source Revenue requirement
Cities are expected to generate revenue through:
Property taxes
User charges for services
The benchmark set is approximately ₹1,200 per household.
Concern
About 20% of total grants are conditional. If cities fail to meet these criteria, they will lose that share of funding.
Federal concerns
Urban development is a State subject under the Seventh Schedule of the Constitution. However, certain recommendations of the Finance Commission raise concerns about federal balance.
Peri-urban merger incentive
The 16th Finance Commission has proposed a ₹10,000 crore one-time incentive to encourage the merging of peri-urban villages with populations above one lakh into urban local bodies.
Concerns
Interference in State jurisdiction
Urban planning and local governance fall under State authority.
Administrative complications
Some States have strong rural local governments.
For example, in Kerala, rural panchayats function effectively.
Forced integration with urban bodies may disrupt governance structures.
Revenue-driven urbanisation
Mergers may be motivated mainly by increasing property tax revenues, rather than planned urban development.
Issue of cess and surcharge revenues
The Union government collects significant revenues through cesses and surcharges, which are excluded from the divisible pool of taxes shared with States.
Total cess collections are estimated at about 2.2% of GDP.
This equals roughly ₹8.8 lakh crore.
A significant portion of these revenues originates from urban economic activity, yet cities do not receive a corresponding share through Finance Commission transfers.
Limited focus on climate change
The recommendations of the 16th Finance Commission have been criticised for giving limited attention to climate change adaptation in cities.
Urban areas are increasingly vulnerable to:
Urban flooding
Heat waves
Water scarcity
Infrastructure stress
Adequate funding is necessary to support climate-resilient urban infrastructure.
Way forward
The central concern raised is that cities should be allowed greater fiscal autonomy.
Instead of imposing strict conditions and tied grants, the Union government should:
Act as an enabler
Provide untied financial support
Allow cities to plan their own development priorities
This approach would strengthen urban governance, fiscal federalism, and sustainable urban development.
Key exam points
Cities generate 67% of GDP and 90% of government revenue.
Urban population projected to reach 41% by 2031.
15th Finance Commission urban grants: ₹1.2–1.3 lakh crore.
16th Finance Commission urban grants: ₹3.56 lakh crore (2026–2031).
Urban transfers remain around 0.13% of GDP.
Tied grants restrict fiscal autonomy of cities.
20% of grants linked to performance conditions.
Cess revenues: about 2.2% of GDP (₹8.8 lakh crore) but outside divisible pool.
Concerns related to fiscal federalism, urban planning autonomy, and climate funding.
Prelims practice MCQs
Q. Consider the following statements regarding Finance Commission grants to Urban Local Bodies (ULBs):
The 15th Finance Commission recommended grants of about ₹1.2–1.3 lakh crore to urban local bodies for five years.
The share of urban transfers recommended by the 16th Finance Commission is significantly higher than that of the 15th Finance Commission as a percentage of GDP.
Urban local bodies are institutions of local self-government mentioned under Part IXA of the Constitution.
Which of the statements given above are correct?
A. 1 and 3 only
B. 1 and 2 only
C. 2 and 3 only
D. 1, 2 and 3
Answer: A
Explanation:
The 15th Finance Commission recommended about ₹1.2–1.3 lakh crore for urban local bodies.
The 16th Finance Commission allocation (~₹3.56 lakh crore) still remains around 0.13% of GDP, similar to the previous cycle, so the share is not significantly higher.
Urban local bodies are provided constitutional status under Part IXA of the Constitution (74th Constitutional Amendment).
Q. Which of the following are examples of “Own Source Revenue (OSR)” for urban local bodies?
Property tax
User charges for water supply
Share in Goods and Services Tax
Fees and local levies
Select the correct answer using the code below:
A. 1 and 2 only
B. 1, 2 and 4 only
C. 1, 3 and 4 only
D. 1, 2, 3 and 4
Answer: B
Explanation:
Own Source Revenue refers to revenue generated directly by local governments, such as:
Property tax
User charges
Fees and local levies
GST revenue is collected by the Union and States, not directly by ULBs.
Q. With reference to “tied grants” provided to local governments, consider the following statements:
They must be spent only for specified sectors.
They increase fiscal autonomy of local governments.
Water supply and sanitation are common sectors for such grants.
Which of the statements given above are correct?
A. 1 and 3 only
B. 1 and 2 only
C. 2 and 3 only
D. 1, 2 and 3
Answer: A
Explanation:
Tied grants are funds earmarked for specific sectors such as water supply and sanitation.
They reduce fiscal autonomy, because funds cannot be used for other local priorities.