What are the key features of the 16th Finance Commission’s recommendations regarding fiscal devolution to Urban Local Governments (ULGs)?

The 16th Finance Commission (FC) marks a significant shift in India’s urban fiscal architecture by substantially enhancing transfers to Urban Local Governments (ULGs). It has increased overall grants by nearly 230 per cent, from ₹1.55 trillion under the 15th FC to ₹3.56 trillion for the 2026–31 period. Notably, the urban share of total local-body grants has risen to a record 45 per cent, reflecting recognition of rapid urbanisation and cities’ contribution to economic growth.The grant structure has also been differentiated into four components: Basic Grants (₹2.32 trillion)Performance Grants (₹54,032 crore)Special Infrastructure Grants (₹56,100 crore)Urbanisation Premium (₹10,000 crore) This layered design introduces outcome-based incentives and addresses city-specific infrastructure gaps.A major innovation is the increase in untied funds to 52 per cent, compared to only 21 per cent under the 15th FC. This enhances fiscal flexibility, allowing municipalities to prioritise local needs rather than merely implementing centrally designed schemes. Thus, the 16th FC attempts to balance autonomy with accountability.

Strengthening Local Bodies: The Need for More than Just Grants

Q: Why is increasing untied grants to ULGs considered an important reform in India’s fiscal federal framework?

Untied grants empower Urban Local Governments to allocate funds according to local priorities rather than predetermined sectoral mandates. This is crucial because urban challenges vary widely across cities — from waste management in metropolitan regions to water scarcity in Tier-II cities. By increasing the untied component to 52 per cent, the 16th FC strengthens the principle of subsidiarity, which underpins democratic decentralisation.Previously, excessive tied funding limited municipal discretion and often resulted in fragmented, scheme-driven governance. Untied transfers encourage innovation, participatory budgeting, and context-specific solutions. For instance, cities like Pune and Surat have successfully leveraged flexible funds for integrated waste and sanitation reforms.However, flexibility must be accompanied by robust financial management and transparency. Without audited accounts and capable municipal administration, untied grants may not translate into improved service delivery. Therefore, this reform is significant but must be embedded within institutional strengthening measures.

Q: Critically analyse whether higher fiscal devolution alone can resolve the structural weaknesses of Urban Local Governments in India.

While enhanced fiscal devolution is a positive step, financial transfers alone cannot address structural governance deficits. Indian municipalities generate barely 0.6 per cent of GDP as own-source revenue, compared to 6 per cent in South Africa and 7.4 per cent in Brazil. This indicates deep weaknesses in property tax systems, user charges, and revenue mobilisation capacity.Moreover, democratic decentralisation remains incomplete. Municipal elections are frequently delayed — Bengaluru has not held civic polls since 2015, and Brihanmumbai Municipal Corporation elections were delayed by nearly four years. According to CAG reports, the average delay is 22 months. Such delays undermine accountability and legitimacy, limiting effective utilisation of funds.Administrative capacity constraints, state government control over key functions, and absence of empowered State Finance Commissions further weaken autonomy. Therefore, while the 16th FC’s recommendations are meaningful, they must be complemented by reforms in governance, taxation powers, and institutional accountability to achieve transformative outcomes.

Q: As a policy advisor, what reforms would you suggest to ensure that enhanced fiscal transfers to ULGs translate into sustainable urban development?

A holistic reform strategy should combine fiscal empowerment with institutional strengthening. First, municipalities must enhance own-source revenue mobilisation through property tax reforms, GIS-based mapping, rationalised user charges, and improved compliance mechanisms. International examples like Brazil demonstrate the importance of robust municipal taxation for autonomy.Second, democratic legitimacy must be restored by ensuring timely elections and empowered councils. State governments should devolve functions, funds, and functionaries as mandated under the 74th Constitutional Amendment. Capacity-building programmes for municipal officials and digital governance tools can improve efficiency.Finally, urban planning should adopt a metropolitan and regional approach, integrating climate resilience, affordable housing, and public transport. Leveraging public-private partnerships and municipal bonds — as seen in Pune and Ahmedabad — can diversify financing sources. Thus, fiscal devolution must be part of a broader structural transformation of urban governance.

Assessing the implications of increased untied funds for urban local governance amid India's rapid urbanization challenges.

pocketias team

•February 20, 2026•5 mins read

Boosting Fiscal Devolution to Cities

Not Started

1.Enhanced Fiscal Devolution to Urban Local Governments

The 16th Finance Commission (FC) has significantly enhanced fiscal transfers to Urban Local Governments (ULGs), marking a structural shift in India’s approach to urban governance. The total grants to ULGs have increased by 230%, from about ₹1.55 trillion (15th FC) to ₹3.56 trillion for 2026–31.

The urban share of total local-body grants has been raised to a record 45%, up from 36% under the previous commission. This is the highest allocation to urban bodies in Finance Commission history, reflecting the growing economic contribution of cities amid rapid urbanisation.

Urban India is emerging as a major driver of growth, employment, and infrastructure demand. Therefore, fiscal architecture must align with demographic and economic realities.

“The vitality of local institutions is the vitality of democracy.” — K.R. Narayanan

Enhanced fiscal devolution strengthens the third tier of government. If fiscal transfers do not match the scale of urbanisation, infrastructure gaps and governance deficits may constrain economic growth.

2. Design Innovation: Differentiated and Flexible Grant Structure

The 16th FC has introduced a differentiated urban grant structure that combines flexibility with accountability. This reflects a transition from scheme-driven allocation to a more performance-oriented and outcome-based framework.

Composition of Urban Grants (2026–31):

Basic Grants: ₹2.32 trillion
Performance Grants: ₹54,032 crore
Special Infrastructure Grants: ₹56,100 crore
Urbanisation Premium: ₹10,000 crore

A significant reform is the rise in untied funds to about 52%, compared to 21% under the 15th FC. This allows ULGs to prioritise locally relevant needs instead of being restricted to predetermined schemes.

The remaining tied grants focus on critical sectors such as sanitation, solid waste management, water supply, and wastewater management. Performance grants incentivise governance reforms, while infrastructure grants and the urbanisation premium address city-specific gaps.

“Finance is the lifeblood of municipal government.” — Report of the Municipal Taxation Enquiry Committee (1953)

Greater fiscal flexibility enables local innovation and responsiveness. However, without institutional capacity and transparency, flexibility alone may not guarantee improved service outcomes.

3. Urban Financing Gap: Structural Fiscal Constraints

Despite increased transfers, India’s urban financing gap remains substantial. A World Bank report estimates that India requires annual urban capital investment of 1.18% of GDP (2021–36).

However, municipal revenues in India are barely 0.6% of GDP, indicating limited fiscal capacity. In contrast:

South Africa mobilises 6% of GDP through ULGs’ own revenues.
Brazil mobilises 7.4% of GDP through ULGs’ own revenues.

This comparison highlights structural weaknesses in India’s municipal revenue base, including limited property tax mobilisation and dependence on state transfers.

When municipalities lack adequate own-source revenue, fiscal autonomy remains constrained. Without sustainable revenue streams, enhanced grants may not be sufficient to meet long-term urban infrastructure needs.

4. Governance Deficits and Democratic Decentralisation

The 16th FC has retained reform-linked eligibility conditions such as timely municipal elections, audited accounts, operational State Finance Commissions (SFCs), and submission of action taken reports.

However, democratic decentralisation remains uneven. Municipal elections are frequently delayed. The Brihanmumbai Municipal Corporation polls were held nearly four years late, and Bengaluru has not had civic elections since 2015. According to Comptroller and Auditor General reports, the average delay in municipal polling is 22 months.

Delayed elections weaken legitimacy, accountability, and citizen responsiveness. Financial dependence on states further restricts autonomy, as limited own revenues compel municipalities to rely on state transfers.

“Local self-government is the best school of democracy.” — Mahatma Gandhi

Fiscal devolution without timely elections and institutional accountability risks creating financially stronger but democratically weaker local bodies.

5. Complementary Budgetary Measures and Institutional Risks

The Union Budget has proposed ₹5,000 crore per City Economic Region over five years for Tier-II and Tier-III cities. This allocation can complement the 16th FC’s framework if funds are channelled through empowered municipal institutions.

However, if such funds create parallel, centrally driven mechanisms, they may undermine decentralisation and weaken municipal authority. Urban governance reform requires consolidation rather than fragmentation of institutional responsibilities.

Urban transformation depends on aligning fiscal reforms with institutional strengthening. Parallel administrative layers can dilute accountability and weaken decentralised governance.

6. Way Forward: Strengthening Institutional Foundations

The 16th FC’s reforms are meaningful but must be accompanied by structural changes to ensure effective utilisation of funds.

Priority Reforms:

Strengthening own-source revenue mobilisation
Ensuring timely municipal elections
Operationalising State Finance Commissions regularly
Enhancing technical and administrative capacity of ULGs
Improving transparency through timely audited accounts

A calibrated approach combining fiscal empowerment, accountability, and administrative reform is essential to achieve sustainable urban development.

“Good governance is perhaps the single most important factor in eradicating poverty and promoting development.” — Kofi Annan

Urban India’s future depends not only on higher transfers but on empowered, accountable, and financially sustainable local governments.

Conclusion

The 16th Finance Commission marks a significant step in strengthening fiscal federalism at the urban level by increasing grants, raising untied funds, and introducing performance incentives. However, fiscal devolution must be accompanied by democratic accountability and revenue reforms.

If institutional foundations are strengthened alongside fiscal support, India’s cities can become engines of inclusive and sustainable growth. Without such reforms, enhanced allocations may not translate into transformative urban outcomes.*

Quick Q&A

Everything you need to know

The 16th Finance Commission (FC) marks a significant shift in India’s urban fiscal architecture by substantially enhancing transfers to Urban Local Governments (ULGs). It has increased overall grants by nearly 230 per cent, from ₹1.55 trillion under the 15th FC to ₹3.56 trillion for the 2026–31 period. Notably, the urban share of total local-body grants has risen to a record 45 per cent, reflecting recognition of rapid urbanisation and cities’ contribution to economic growth.

The grant structure has also been differentiated into four components:

Basic Grants (₹2.32 trillion)
Performance Grants (₹54,032 crore)
Special Infrastructure Grants (₹56,100 crore)
Urbanisation Premium (₹10,000 crore)

This layered design introduces outcome-based incentives and addresses city-specific infrastructure gaps.

A major innovation is the increase in untied funds to 52 per cent, compared to only 21 per cent under the 15th FC. This enhances fiscal flexibility, allowing municipalities to prioritise local needs rather than merely implementing centrally designed schemes. Thus, the 16th FC attempts to balance autonomy with accountability.

Untied grants empower Urban Local Governments to allocate funds according to local priorities rather than predetermined sectoral mandates. This is crucial because urban challenges vary widely across cities — from waste management in metropolitan regions to water scarcity in Tier-II cities. By increasing the untied component to 52 per cent, the 16th FC strengthens the principle of subsidiarity, which underpins democratic decentralisation.

Previously, excessive tied funding limited municipal discretion and often resulted in fragmented, scheme-driven governance. Untied transfers encourage innovation, participatory budgeting, and context-specific solutions. For instance, cities like Pune and Surat have successfully leveraged flexible funds for integrated waste and sanitation reforms.

However, flexibility must be accompanied by robust financial management and transparency. Without audited accounts and capable municipal administration, untied grants may not translate into improved service delivery. Therefore, this reform is significant but must be embedded within institutional strengthening measures.

While enhanced fiscal devolution is a positive step, financial transfers alone cannot address structural governance deficits. Indian municipalities generate barely 0.6 per cent of GDP as own-source revenue, compared to 6 per cent in South Africa and 7.4 per cent in Brazil. This indicates deep weaknesses in property tax systems, user charges, and revenue mobilisation capacity.

Moreover, democratic decentralisation remains incomplete. Municipal elections are frequently delayed — Bengaluru has not held civic polls since 2015, and Brihanmumbai Municipal Corporation elections were delayed by nearly four years. According to CAG reports, the average delay is 22 months. Such delays undermine accountability and legitimacy, limiting effective utilisation of funds.

Administrative capacity constraints, state government control over key functions, and absence of empowered State Finance Commissions further weaken autonomy. Therefore, while the 16th FC’s recommendations are meaningful, they must be complemented by reforms in governance, taxation powers, and institutional accountability to achieve transformative outcomes.

The 16th FC has retained reform-linked eligibility conditions such as timely municipal elections, publication of audited accounts, constitution of State Finance Commissions, and action taken reports. If strictly enforced, these conditions can institutionalise accountability and transparency in urban governance.

Performance grants incentivise better governance practices, encouraging municipalities to adopt reforms in revenue mobilisation, digital accounting, and service delivery standards. Special infrastructure grants and urbanisation premiums can help bridge infrastructure deficits in rapidly expanding Tier-II and Tier-III cities.

Additionally, integration with the Union Budget’s allocation for City Economic Regions could promote regional planning and economic clustering. However, such funding must flow through empowered municipal bodies rather than parallel bureaucratic structures. Effective implementation would thus enhance fiscal capacity, service delivery, and democratic responsiveness.

A holistic reform strategy should combine fiscal empowerment with institutional strengthening. First, municipalities must enhance own-source revenue mobilisation through property tax reforms, GIS-based mapping, rationalised user charges, and improved compliance mechanisms. International examples like Brazil demonstrate the importance of robust municipal taxation for autonomy.

Second, democratic legitimacy must be restored by ensuring timely elections and empowered councils. State governments should devolve functions, funds, and functionaries as mandated under the 74th Constitutional Amendment. Capacity-building programmes for municipal officials and digital governance tools can improve efficiency.

Finally, urban planning should adopt a metropolitan and regional approach, integrating climate resilience, affordable housing, and public transport. Leveraging public-private partnerships and municipal bonds — as seen in Pune and Ahmedabad — can diversify financing sources. Thus, fiscal devolution must be part of a broader structural transformation of urban governance.