Town upgrades can be achieved by donating bells to your Town Fund, through Pelly or Phyllis at the Town Hall (the Civic Center Window).
It takes a lot of bells - here are the levels (unaccumulative):
200,000 bells: A new Bridge will be built in your town. This can be great news if your map makes it hard to get around. Each player in the town gets to vote on where the bridge will be built.
+ 400,000 bells: A
Fountain will be built in your town. The fountain helps you get the
Silver Axe and the
Golden Axe.
+ 1,000,000 bells: Your town will get either a Windmill or a Lighthouse. You pick which one you want and you can't have both.
+ 1,000,000 bells: You can choose to replace the item (Windmill or a Lighthouse) that you upgraded your town with.
Each upgrade takes a week to appear.