Center-State-Municipal Fiscal Relations

Local Government Organization and Finance: Urban India 181

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 ofgoods 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 ofmunicipalities.

Taxes on property and octrois form the backbone ofthe municipal tax base.Between the two,municipal governments have shown a preference for indirect taxes and levies such as octrois over direct taxessuch as property taxes,even when direct taxes are a suitable form oftaxation because their incidence is localized.At one time property taxation was so important that scholars theorized that the expenses ofgovernment 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 ofcollective goods.Octrois are among the more buoyant and elastic oflocal taxes and are currently levied in parts ofGujarat,Maharashtra,and Punjab.14

The revenue base ofmunicipalities in Indian states has shown little sign ofchange,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 ofmunicipalities.

Although the municipal revenue base in India may fulfill the criteria for a local tax base (meeting the principles ofresidence 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 oftax rates or the determination ofwho can be included or excluded from payment oftaxes.Absence ofautonomy (or low discretion) in matters relating to tax rate setting is a key feature ofthe functioning ofmunicipal governments in India (table 5.5).15

Center-State-Municipal Fiscal Relations

Until the passage ofthe 74th amendment,municipal affairs were an exclusive concern ofthe state governments.Drawing strength from theconstitutional