Bridging disparities: 7th Finance panel and TN's fiscal faultlines

Tamil Nadu established the 7th State Finance Commission (SFC) under the leadership of retired IAS officer K Allaudin at a pivotal moment. With accelerating urbanisation, fiscal pressures and widening developmental disparities, Tamil Nadu must now fundamentally reassess the fiscal architecture governing its local bodies.

The SFC is mandated to examine the financial position of rural and urban local governments and recommend a robust distribution formula for tax proceeds, fees and grants. Yet, this is not merely a technical exercise, it is a socio-political-economic challenge that strikes at the heart of decentralised development.

Like elsewhere, here too local bodies continue to struggle with severe revenue constraints. While flagship urban bodies like the Greater Chennai Corporation (GCC) raised Rs 200 crore in 2024 through municipal bonds for stormwater infrastructure, such successes are exceptions. Usually, local bodies heavily depend on state and central transfers with minimal access to capital markets.

A case in point is the Madurai corporation, improving its April 2025 property tax collection to Rs 54.91 crore through digital enforcement and early payment incentives. True, this is more than double the Rs 23.21 crore collected in April 2024, but it also attests to a deeper truth that revenue generation in most local bodies remains suboptimal, irregular and overly dependent on the state's allocations.

This reality is neither new nor unforeseen. The 5th SFC (2012–2017) had recommended allocating 10% of the state's tax revenue to local bodies with a 56:44 split between rural and urban institutions. Although the government accepted many of its recommendations, the follow-through was weak. The 6th SFC (2017–2022) continued with the 10% devolution but realigned the rural-urban ratio to 49:51, recognising the pace of urban expansion. It also introduced fixed and variable components in the devolution formula to encourage performance metrics like audited accounts and timely budget submissions. However, its vision faltered in implementation, particularly with performance-linked grants and structural reforms that never materialised in full.

As the 7th SFC takes up its task, several core expectations must be foregrounded.

Foremost is the question of fiscal autonomy. The 6th SFC reported that own-source revenue (OSR) formed only 18% of the total income for rural local bodies and about 35% for urban local bodies, far below the recommended norms. This reconfirms that local bodies lack both the authority and the incentive to revise property taxes, user charges, and service fees, many of which have not been updated in more than a decade. While the success of Madurai and Chennai models offers templates, the 7th SFC must institutionalise frameworks for periodic revision, backed by legal mandates and robust capacity-building to scale it up across the state.

Second, performance-based incentives need to be elevated from intent to execution.

The variable component proposed in the 6th SFC was never implemented rigorously. Yet, these can drive accountability, especially when connected to quantifiable indicators like sanitation coverage, e-service delivery and grievance redressal efficiency. Kerala’s SFC successfully operationalised such indicators, leading to more effective convergence with centrally sponsored schemes. Tamil Nadu must adapt such models contextually, making fiscal rewards contingent upon transparent and equitable outcomes.

Third, institutional and human capacity remain a bottleneck. No generous fund allocations can overcome this. A 2022 Comptroller and Auditor General (CAG) report found that nearly 20% of sanctioned technical posts in panchayats were vacant, and digital financial management systems in over half of Tamil Nadu’s municipalities were either inoperative or underutilised. The 7th SFC should earmark a portion of transfers specifically for administrative strengthening, IT infrastructure, and training programmes in public finance and e-governance.

The fourth critical issue is the widening urban-rural gap. Census projections (2021) suggest that urban areas now account for nearly 49% of Tamil Nadu’s population, and the fiscal and service delivery burdens have grown disproportionately. Further, many rural areas remain underserved in critical areas like piped drinking water, rural roads and waste management. The 6th SFC’s 49:51 rural-urban ratio was a start, but the 7th SFC must shift toward a need-based and deficit-sensitive devolution formula. This means incorporating dynamic variables such as poverty incidence, infrastructure gaps and climate risk into the allocation logic, rather than using static metrics like population alone.

The issue of delayed fund disbursement further compounds these problems. Across multiple audit cycles, local bodies have flagged the erratic and unpredictable timing of fund releases. This disrupts procurement cycles, derails service delivery, and reduces citizen trust. Maharashtra’s adoption of a fixed calendar for intergovernmental transfers offers a replicable model. In tandem, institutions like the Tamil Nadu Urban Finance and Infrastructure Development Corporation (TUFIDCO) and the Tamil Nadu State Rural Livelihoods Mission (TNSRLM) could be mobilised as nodal agencies for real-time monitoring and decentralised audit.

From an economic lens, the opposition’s apprehensions about inadequate devolution and poor accountability are not entirely unfounded. The state’s local governance ecosystem continues to function more as an administrative extension than as an autonomous tier of government. Despite political decentralisation, fiscal decentralisation remains patchy. Economically, this translates into suboptimal public goods delivery, weak infrastructure creation, and missed opportunities for citizen-led innovation. As Tamil Nadu aspires toward becoming a $1 trillion economy by 2030, local bodies will need to play a central role, not merely as implementers of top-down schemes, but as planners and providers with genuine autonomy and accountability.

The 7th SFC must bridge the gap between rhetorical commitment to decentralisation and the operational realities of capacity, equity, and responsiveness.

Thakur is Professor and Dean at Vinayaka Mission’s School of Economics and Public Policy, Chennai