Strengthening City Governance: How the 16th Finance Commission Reinforces Urban Local Bodies

Why in News?

The latest report of the 16th Finance Commission, tabled in Parliament on February 1, 2026, has proposed enhanced financial support for Urban Local Governments (ULGs), marking a significant push towards strengthening urban governance in India.

16th Finance Commission: Overview and Key Recommendations

The Sixteenth Finance Commission, chaired by Arvind Panagariya, submitted its report covering the period 2026–27 to 2030–31.

Under Article 280 of the Constitution, the Finance Commission recommends:

• Distribution of tax revenues between the Centre and States
• Allocation of funds among States
• Grants-in-aid to local governments

Key Recommendation on Vertical Devolution

The Commission has retained 41% of the divisible pool of central taxes for states — the same as recommended by the Fifteenth Finance Commission.

(The divisible pool excludes cesses, surcharges, and cost of tax collection.)

Criteria for Horizontal Devolution Among States

The introduction of “Contribution to GDP” (10%) marks a significant shift, rewarding economically productive states.

16th Finance Commission Boosts Urban Local Governments

The most notable reform is the increase in grants for Urban Local Bodies (ULBs).

Share of Local Body Grants to Urban Areas

• 13th FC: 26%
• 15th FC: 36%
• 16th FC: 45%

Absolute Allocation

The Commission has recommended ₹3.56 lakh crore for Urban Local Bodies —

• More than double the 15th FC’s ₹1.55 lakh crore
• Nearly 15 times the 13th FC allocation (post-2011 Census)

This substantial increase reflects recognition of India’s rapidly urbanising population and expanding city-level responsibilities.

Rising Urbanisation and the Need for Greater Urban Funding

India is projected to reach 41% urbanisation by 2031.

Why This Matters:

• Higher demand for urban infrastructure
• Increased pressure on housing, sanitation, water supply
• Rising transport and pollution challenges
• Greater need for digital and climate-resilient urban systems

The 2011 Census recorded urbanisation at 31%, but estimates vary widely. A 2015 World Bank assessment suggested over 50% may already be living in urban or peri-urban clusters — highlighting measurement challenges.

Uncertainty in demographic data complicates fiscal planning, making proactive financial support crucial.

Uneven Distribution Across States

Since grants follow population-based and formula-driven criteria, outcomes vary significantly:

• Kerala: Over 400% increase
• Maharashtra: Over 300% rise
• Odisha: 13% growth
• Bihar: 8% reduction

This reflects differences in demographic structure, economic output, and formula weightage changes.

16th FC’s Financial Cushion

The 45% allocation acts as a forward-looking buffer. If Census 2027 reveals urbanisation at 45–48%, urban governments will not be financially underprepared — unlike earlier cycles when urban grants were comparatively lower.

This anticipatory approach strengthens fiscal resilience at the grassroots level.

Broader Significance

1. Strengthening Fiscal Federalism

Reinforces third-tier governance under the 73rd and 74th Constitutional Amendments.

2. Urban Transformation

Supports Smart Cities, climate adaptation, waste management, and digital infrastructure.

3. Addressing Infrastructure Deficit

Cities contribute over 60% of GDP but historically receive limited fiscal autonomy.

4. Encouraging Accountability

Larger grants increase pressure on states to improve urban governance and transparency.

5. Balancing Demography and Productivity

Introduction of GDP contribution parameter attempts to reconcile equity and efficiency in devolution.

Challenges Ahead

• Capacity constraints in urban local bodies
• Weak revenue mobilisation at municipal level
• Dependence on state governments
• Data inconsistencies on urban population
• Implementation and monitoring challenges

Financial empowerment must be accompanied by administrative reforms..