# **Foreword**

Over the next 25 years the number of people living in Indian cities will increase by about 230 million, almost doubling in size. Thus, over roughly the next generation, India will need to expand its infrastructure services to an **_incremental_** population that is about as large as the current urban population of the United States. Besides these new demands for infrastructure in Indian cities, there is a substantial backlog of demand for services to meet today’s needs—the needs of one of the most extensive systems of cities in the world, with an existing urban population of about 300 million, 32 agglomerations with a million or more residents, and three of the world’s 10 largest cities, Mumbai, Kolkata, and Delhi, all with populations in excess of 12 million.<sup>1</sup> Over 20 percent of people in Indian cities live in slums, and there is no major city in India that provides safe water on a continuous basis. If the demands implied by this demographic transition were not enough, recently an influential study indicates that urbanization plays an important role in generating higher rates of economic growth. A McKinsey Company study<sup>2</sup> identifies urban real estate markets as perhaps the single most important constraint on India’s ability to sustain the increased growth in the years since the country’s liberalization program took hold.

In response to this significant urban challenge, the Government of India (GOI) has initiated a centrally driven urban real estate reform process. GOI has moved to empower and encourage local reform initiatives by creating an Urban Reform Initiative Fund (URIF) that rewards States pursuing market-friendly real estate reforms. In addition, the Tenth Plan underscores a growing recognition of the need to dismantle the extensive controls on urban real estate markets, many of which were established during the Emergency of 1975-77, and which have deprived cities of the tools to effectively ensure an adequate market-driven supply response to growing urban demand for land and services. As this reform proceeds, land and housing markets can rely more fully on prices to allocate resources, rather than bureaucratic mandates and the corruption that tends to accompany excessive regulation. One of the reforms supported under the URIF program is a progressive reduction in the stamp duty on immovable property transfers.

Stamp tax reform is a key to this process because high stamp duty rates (most of the rates in Indian states are well above those documented internationally) strongly discourage real estate transactions and thus impede the development of efficient and flexible urban real estate markets. An appropriately designed reform also has the potential of unlocking the real estate wealth in cities, which has typically been a foundation of municipal finance. Nonetheless, since stamp duties amount to a significant source of revenues for most State governments, often the third or fourth most important source of own tax revenues, finding alternative sources of State revenue is crucial to moving the reform process forward.

This paper examines both the distortionary impacts of stamp duties and possibilities for alternative revenue sources. A key finding from the paper is that evasion of stamp taxes through underdeclaration of property values in transactions has an impact on a number of other revenue sources, including the federal capital gains tax. In addition, the linkage of underdeclaration and black money further saps the fisc of tax revenues across the board. Simulations indicate that

> 1The data cited here are from the United Nations’ _World Urbanization Prospects: The 2001 Revision,_ March 2002.

> 2 McKinsey Company Report: The Indian Growth Imperative. 9/10/01

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