Mumbai shows why India's cities need more tax revenue

By Andy Mukherjee

Acute fiscal stress is building in India’s states and municipalities, including the urban authority that manages the richest city, Mumbai. This matters. Local bodies hold the key to lasting solutions for a broader crisis of financial resources.

The federal government’s chronic deficits dominate discussions about India’s precarious public finances. It’s time to flip this New Delhi-centric approach. State government accounts deserve scrutiny because they collectively spend 36% more than the federal administration. Yet their fundraising abilities are limited. Of the 24 trillion rupees ($340 billion) that Prime Minister Narendra Modi’s team hopes to pull in via taxes in the coming fiscal year, less than a third is intended for the states. A 20% jump looks impressive only because this year’s transfer saw a 14% squeeze from the previous.

Formerly known as Bombay, the capital of the western state of Maharashtra faces a further crunch. Centered on seven Arabian Sea islands that Portuguese colonizers handed to the British in 1662, modern Mumbai has expanded into independent India’s pulsating trading and financial center, a cosmopolitan agglomeration of 26 million people — twice as populous as business hubs like Hong Kong and Singapore combined.

The birthplace of Bollywood boasts the country’s priciest real estate, but the property market is toast, in part because a shadow-banking meltdown choked developers’ access to finance. With unsold homes piling up, Mumbai can’t earn much from homeowners or builders. Up to 34% of the municipality’s recently announced 334 billion-rupee annual budget will rely on compensation. This was offered in 2017 by the federal government to get state and municipalities to agree to scrap inefficient indirect taxes — in Mumbai’s case, a levy on merchandise entering the city for sale — in favor of a nationwide goods and services tax.

GST was a major reform, but awkwardly designed and poorly implemented. Its failure weakened federal finances, though Modi at least has access to the central bank’s printing press. A bigger challenge has opened up at the subnational level. As Mumbai real-estate analyst Vishal Bhargava notes, the city’s compensation deal ends in 2022. Its revenue will fall to what it was a decade ago, only facing higher costs. The authority is already dipping into reserves to meet pension obligations; a further income shock will be a disaster.

Every year, Mumbai’s creaking infrastructure faces a huge risk from flash floods. Yet such are the funding constraints that a city of tycoons, bankers and movie stars — who live alongside masses huddled in shantytowns — can allocate only 9 billion rupees of capital expenditure on storm drains, a fifth of what the civic body will spend on employee pensions.

India’s richest metropolis opens a window on the crippling lack of basic services in smaller cities, towns and villages where 1.3 billion people live. New Delhi, the capital, is at least contained in a mini-state, which gives the city access to a more diversified resource pool, such as taxes on petroleum products. But New Delhi’s air quality is foul. Chennai, the capital of Tamil Nadu, is running out of water. Software powerhouse Bangalore, which has lost its entire greenery to urbanization, punishes commuters with the worst traffic congestion in the world.

The solutions are known. The shallow municipal bond markets must scale up, but that will require cities to adopt internationally acceptable accounting, create own sources of revenue, and bring down endemic corruption. The GST needs to be overhauled so that overall tax collection, which Team Modi expects to rise by 12% next fiscal year, doesn’t repeat this year’s paltry 4% increase.

As the pie grows, distribution must also be fair. A commission that sets the formula for resource-sharing is proposing to leave the states’ portion broadly unchanged at 41%. But as I said, in reality, states are getting less than a third of what New Delhi collects. A lot of taxation now takes place in the form of targeted levies on education, health and sanitation, kept in full by the federal administration. A new bargain between different levels of the government must change this.

At 70% of GDP, India’s overall government debt — at all levels — is too high for an investment-grade sovereign. Without bumping up local capital spending, people’s incomes and their ability to pay taxes and fees won’t rise fast enough to reduce national debt.

Weak national finances will leave India unprepared to deal with climate change and epidemics. The coronavirus isn’t a big headache for India, at least not yet. It’s the next outbreak that planners must worry about. Setting aside more money for drains, sewage management and hospitals will better protect citizens and economic assets. The money circulating in the economy because of municipal-level spending will ease India’s fiscal crisis.

Will it happen? Take Mumbai again. Shiv Sena, the homegrown right-wing party in control of the municipal corporation since 1985, was a long-time ally of Modi’s Bharatiya Janata Party until it broke ranks last year. It now leads a coalition controlling the entire state. The Shiv Sena leader, Uddhav Thackeray, has hinted at pulling the plug on a Japanese-funded high-speed train link between Mumbai and Ahmedabad in Modi’s home state, Gujarat, which is promoting a Mumbai-rivaling international financial center.

For India’s fiscal balance to regain its footing, the economics of public spending will have to become more local. Politics already is.