Metropolitan cities’ finances or local taxes for development

The fiscal year 2024/25 has commenced, and almost all local governments have presented their budgets. Municipalities are now busy preparing their procurement plans to ensure a smooth budget execution during the year. As budget sizes have grown, there is an expectation among the public for better service delivery and improved development outcomes. At the local government level, the country’s six metropolitan cities command the largest budgets. Given their larger land area and population size, they receive a higher share of grants from the federal government. Besides federal grants, metropolitan cities generate a significant amount of own-source revenue (revenue generated by levying local-level taxes).

Own-source revenues (OSR) have become a major source of financial resources for metropolitan cities and now comprise a large share of their budgets. For the ongoing fiscal year, Kathmandu Metropolitan City presented a budget of Rs 25.7bn, of which 75 percent came from OSR. Among the six metropolitan cities, Kathmandu and Lalitpur have the highest OSR capacity while Biratnagar and Birgunj have the least. The direct effect of this capacity is on the size of the budgets metropolitan cities present. In the current fiscal year, metropolitan cities with higher OSR have presented the largest budgets while those with weaker OSR have the smallest budget sizes. The resulting difference in budget sizes (which runs into billions) has led residents of Birgunj and Biratnagar to feel neglected by the federal government in budget allocation.

Locals of Birgunj, including the city’s chief, have alleged the federal government of allocating a smaller budget to the city despite the state collecting a large share of its customs revenue from the Birgunj Customs Point. They blame the federal government’s disregard for the city as the main reason behind its consistently small budget size. However, evidence suggests otherwise. Analysis of the last five years’ data on aggregate intergovernmental grant transfers (IGGT) to metropolitan cities suggests that Birgunj is the second-highest recipient of federal grants, sitting only behind Pokhara. The real reason why the budget size of Birgunj, and by extension Biratnagar, has not been able to take off like other metropolises is because of poor OSR capacity. It is easy for local government chiefs to shift the blame to the federal government, but it is difficult to boost taxation and bring more people under the tax ambit.

Other metropolitan cities like Bharatpur and Pokhara have robust and growing budget sizes, thanks to their success with effectively utilizing the taxation rights available to local governments. These cities command budgets more than double the size of Biratnagar and Birgunj, which have seen slower progress with OSR. For the ongoing fiscal year, the budget size of Pokhara and Bharatpur metropolises are Rs 7.5bn and Rs 7.4bn respectively, while the same figures for Biratnagar and Birgunj are Rs 3.5bn and Rs 2.9bn. Taken over the long term, such a large difference in budget sizes can result in significant disparities in development levels across metropolises. The resulting variations in local infrastructure, quality of life, and economic opportunities could affect migration trends, drawing people to better-performing metros while making other cities less desirable. Such migration patterns could induce inequity tendencies given that a growing population in more prosperous metros would lead to a wider tax base and higher OSR capacity; thus making them more developed.

The discussion about metropolitan cities’ budgets and their OSR is important because it has a direct bearing on the quality of life of the growing Nepali urban population. As cities expand and urban demands increase, the need for robust financial management becomes more critical. Providing for local infrastructure, creating planned urban settlements, and undertaking big-ticket projects like waste management require larger budget envelopes for the metropolises. With the adoption of federalism, local governments are now responsible for primary education, healthcare, and sanitation, meaning their finances also impact human development indicators. The large population residing in the metropolises lends further importance to this issue, as their budget performance directly affects the lives of a vast number of people. 

To avoid potential inequities and to strengthen Nepal’s urban centers, metropolises need to take the issue of OSR more seriously. It is understandable that federalism is still taking root in Nepal and that local governments are still in the process of fully assuming their responsibilities, but the more they delay exploiting their taxation rights, the slower growth they will witness in the long term.

It is a well-established fact that local governments are not fully utilizing their taxation powers, particularly business tax and house rental tax. Poor tax administration, lack of proper databases, and insufficient institutional capacity drive the underutilization. In order to enhance their revenues, local governments must conduct detailed studies on the scope of their OSR potential. Collecting data and maintaining accurate records of taxpayers, businesses, and property owners is essential to improve tax management. A community engagement strategy that improves awareness among people about their tax duties can also enhance OSR capacity. Given there is ambiguity on taxation rights between provincial and local governments on certain taxes, the federal government needs to play a more active role in clarifying these rights. A few donor-funded programs capaciting sub-national governments on tax administration have been introduced, but their coverage remains limited. 

Hence, local governments, and particularly laggard metropolises, need to pay more attention to their own-source revenues. While some problems arise from inadequate action on the part of the federal government, a lot can be done by local governments themselves, as some metropolises have shown. Going forward, the performance of Nepal’s metropolises, and by extension all local governments, will be greatly determined by how well they perform on this front. The emerging urban centers will be the driver of Nepal’s future growth and stakeholders must work collectively for their financial empowerment.