Local Government Organization and Finance: Urban India
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rate setting, local tax autonomy, or even the grants in aid and other forms of transfers—rests with state governments. Within this framework, state governments have specified the taxes that municipalities can levy and collect. Historically,12 these have comprised taxes on land and buildings; taxes on the entry of goods into a local area for consumption, use, or sale therein (octrois); taxes on advertisements other than those published in newspapers; taxes on animals and boats; tolls; taxes on professions, trades, callings, and employment;13 and taxes on entertainment. In addition, there are charges, fees, and fines that form the nontax base of municipalities. Taxes on property and octrois form the backbone of the municipal tax base. Between the two, municipal governments have shown a preference for indirect taxes and levies such as octrois over direct taxes such as property taxes, even when direct taxes are a suitable form of taxation because their incidence is localized. At one time property taxation was so important that scholars theorized that the expenses of government could be funded from site rents. Henry George (1879), whose work on this subject came to be known as the Henry George Theorem, concluded that at an optimal population size, site rents should equal the cost of collective goods. Octrois are among the more buoyant and elastic of local taxes and are currently levied in parts of Gujarat, Maharashtra, and Punjab.14 The revenue base of municipalities in Indian states has shown little sign of change, notwithstanding the 74th amendment; indeed, octrois—a major revenue source for municipalities—have been abolished in many states without being replaced by any other local source, a move that has substantially dented the revenue base of municipalities. Although the municipal revenue base in India may fulfill the criteria for a local tax base (meeting the principles of residence and benefit taxation, low mobility, and stability over a business cycle), and although it may create a link between service use and tax payment, the municipal revenue base is controlled and regulated by state governments. Rate capping and control over municipal spending and taxation are common. Most state governments lay down local tax policies, including policies relating to the choice of tax rates or the determination of who can be included or excluded from payment of taxes. Absence of autonomy (or low discretion) in matters relating to tax rate setting is a key feature of the functioning of municipal governments in India (table 5.5).15
Center-State-Municipal Fiscal Relations Until the passage of the 74th amendment, municipal affairs were an exclusive concern of the state governments. Drawing strength from the constitutional
