Urban finance

Municipal government finances are secured from a range of sources. Central government transfers are the most significant, based on formulae that cover recurrent and capital spending, but they can be erratic. Municipal borrowing enables regional and local governments to finance capital investments. It helps to address infrastructure deficits by shifting the burden of current expenditure into the future and away from grant funding, over which local governments have little or no direct control (see Topic Guide on Sub-national Financing for Urban Infrastructure, Slater & Goyal, 2015). Prerequisites for municipal borrowing are a sound framework for decentralisation and a mature and liquid domestic credit and capital market, which are often absent in developing countries.

City governments can also generate finance locally. Locally-generated revenue falls into three broad categories: property taxes, business taxes and user fees. Property taxes have significant revenue-raising potential and incentivise efficient property use. However, they are under-used in many cities owing to lack of up-do-date address registers and mapping, limited staffing and political opposition. Similarly, land taxes can be used to ensure that land does not sit idle and is used efficiently. Significant differences remain in the generation of per capita municipal finance between cities in developed and developing countries. Cities need to establish reliable fiscal databases, billing and collection capacities and communication programmes to inform stakeholders of the benefits of taxation. (See Topic Guide on Communication and Governance, Haider et al., 2011.)

Discussions of taxation have traditionally focused on two aspects: (i) how to improve revenue collection to finance redistribution and public services; and (ii) how to design tax policy to strengthen incentives for economic growth. In recent years, there has been increased interest in the role taxation can play in improving governance. Taxation is considered fundamental to sustainable development and can be a catalyst for the development of responsive and accountable government and the expansion of state capacity (see Box 2 below).

Slater and Goyal (2015) identify land assets owned by subnational governments as an important element of finance in most developing countries. Land is generally the most valuable asset available to subnational governments and can be used in multiple ways. The influence of municipal government on land markets is of particular importance in determining where and on what terms individuals are able to obtain housing and access services (McGranahan & Satterthwaite, 2002). Direct land sales are the clearest example of capital land financing. Transparent land sale mechanisms (e.g. auctions) can have broader effects (e.g. reducing the scope for corruption). Other instruments for converting public land rights to cash or infrastructure include land pooling approaches adopted for regional economic development. Land can be used as collateral for borrowing and is often an important public contribution to public-private partnerships (PPPs) that build infrastructure. Slayer and Goyal (2015) caution that the volatile nature of land assets and an over dependence on such financing may pose risks to subnational capital budgets. A strong fiscal framework is therefore required.

Research suggests that many municipal governments lack the requisite skills to raise or manage municipal finance and that subnational capacity development assistance should be embedded in all urban development projects (Sood et al., 2012). Such assistance involves building the capacity to improve local sources of revenue (especially property tax); financial management; debt absorption; debt management and monitoring; and project development and implementation to demonstrate creditworthiness and enable access to financial markets. Further, capacity development is required to establish legal provision and regulatory frameworks necessary to enable the flow of market funds to urban development sectors.

Utility companies could also be targeted to improve performance and financial viability and creditworthiness. Technical assistance should be provided for benchmarking, establishing sound regulation and performance standards, strengthening financial management systems and preparing capital investment programmes and bankable projects (Sood et al., 2012).

Box 2: Lagos (Nigeria) – taxation, urban development and social capital

Over the past 15 years, the Lagos state government has increased its tax revenues, and mobilised resources for investment in infrastructure, service delivery and law enforcement. Electoral pressures as well as elite ambitions have driven reform commitments, with revenue collection identified as critical to urban transformation.

The tax system was overhauled, taxpayer compliance increased and the government pledged to be more accountable for tax expenditure. Annual tax revenues rose from approximately $190 million in 1999 to over $1 billion in 2011. With strong support from governors, the Lagos Internal Revenue Service increased its outreach and monitoring capacities. Teams of revenue staff regularly visited formal businesses and informal sector organisations to identify taxpayers, explain taxation and verify payment certificates. Audits increased in number from 1,500 in 2006 to over 6,000 in 2011.

Bureaucratic reforms have enhanced the state’s ability to track tax revenues, identify taxpayers and create a credible threat of enforcement. However, the government has scarce financial and human resources and the logistical and political costs of attempting purely coercive tax collection are high. Progress has been made in encouraging greater tax compliance by presenting tax payment as a civic duty and part of a social contract. State revenue officials have gained the cooperation of powerful business and informal sector associations to encourage their members to pay taxes.

Positive public perceptions of state government have influenced readiness to pay taxes. A 2010 survey found provision of public goods and satisfaction with state use of revenues was correlated with willingness to pay tax: 74% of responses were somewhat or very satisfied with use of tax revenues. A national survey found Lagosians expressed the highest support among urban residents in Nigeria for the statement that ‘citizens should always pay their taxes’.

Sources: Alemika et al. (2011); Bodea & LeBas (2014); de Gramont (2015).