Why in the news? 

With the new Lok Sabha and Union government in place, this final piece focuses on how the 16th Finance Commission can drive substantive public finance reforms for India’s cities.

Note: The Sixteenth Finance Commission has been requested to make its recommendations available by October 31, 2025, covering an award period of 5 years commencing 1st April, 2026.

16th Finance Commission can catalyse municipal-level financial reforms     

• Strengthening State Finance Commissions: The Commission should emphasize the need for state governments to constitute state finance commissions on time, provide them with adequate resources, and ensure their recommendations are taken seriously.
• Fiscal Decentralization: The 16th FC should recommend a formula-based approach for predictable fiscal transfers from state governments to municipalities, moving away from the current practice of ad hoc, discretionary grants. This will enhance the financial autonomy of urban local bodies.
• Revenue Optimization: The Commission should incentivize municipalities to enhance their own revenues through measures like property tax reforms, user charges, and leveraging land assets. This will reduce their dependence on state grants and promote fiscal responsibility.
• Fiscal Responsibility and Budget Management: The 16th FC can provide incentives for municipalities to adopt fiscal responsibility and budget management frameworks to accelerate municipal borrowings for infrastructure development. This will enable cities to access capital markets for financing their growth.
• Transparency and Citizen Participation: The 16th FC can encourage municipalities to enhance transparency and citizen participation in urban governance for improved accountability at the neighbourhood level. This will make urban local bodies more responsive to the needs of citizens.

Need for the Reforms

• Inadequate Funding and Resource Utilization: Indian cities face significant financial shortfalls and struggle to effectively utilize the funds they have, leading to underdeveloped infrastructure and services.
• Lack of Accountability: There is minimal accountability regarding how municipal spending improves citizens’ lives, resulting in inefficient use of resources and unmet public needs.
• Fiscal Decentralization: Cities need predictable fiscal transfers for effective planning, but state governments often delay constituting State Finance Commissions (SFCs) and implementing their recommendations.
• Revenue Optimization: Cities underutilize their revenue-generating powers due to outdated valuation processes controlled by state governments. Comprehensive reforms are needed at all stages of revenue collection.
• Transparency and Fiscal Responsibility: The legal framework for financial accounting, reporting, and budgeting is inconsistent across states. Standardized formats, mandatory accounting standards, and management accounting systems are necessary to improve transparency and fiscal responsibility.

Activities by State Governments

• Timely Constitution and Implementation of State Finance Commissions: State governments must ensure the timely establishment and effective implementation of SFC recommendations to support fiscal decentralization and provide predictable funding to cities.
• Updating Valuation Processes: States should regularly update guidance values or circle rates to reflect current market values, enabling cities to optimize revenue collection and ensure financial sustainability.
• Enhancing Legal and Institutional Frameworks: States should establish and enforce standardized formats for financial accounting, reporting, and budgeting to ensure consistency, transparency, and comparability across municipalities.
• Empowering Local Governments: States should delegate reasonable expenditure authority to city councils, reducing dependency on state-level approvals and enabling more efficient and responsive local governance.
• Mandating Transparency and Citizen Participation: States should mandate public disclosure of municipal financial data and project details in machine-readable formats and support the implementation of participatory budgeting to enhance transparency and citizen involvement in governance.

Conclusion: The 16th Finance Commission can drive critical municipal-level financial reforms by strengthening state finance commissions, promoting fiscal decentralization, optimizing revenues, enhancing fiscal responsibility, and encouraging transparency and citizen participation in governance.

Mains PYQ:

Q How is the Finance Commission of India constituted? What do you know about the terms of reference of the recently constituted Finance Commission? Discuss. (15) (UPSC IAS/2018)

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