LBT abolition in Maharashtra expected to be revenue-neutral for ULBs due to adequate compensation from state government

The Government of Maharashtra (GoM), on March 18, 2015, decided to abolish the local body tax (LBT) levied by the municipal corporations in the state with effect from August 1, 2015. Over the next four months, GoM will work out a compensation mechanism for the affected urban local bodies (ULBs). CRISIL expects GoM to adequately compensate the ULBs for loss of revenue on account of the LBT abolition, and does not expect any adverse impact on the financial profile of these ULBs rated by CRISIL over the medium term.

CRISIL expects the government move to be net revenue-neutral for the ULBs, with adequate compensation received from increase in collection of value-added tax (VAT). The compensation package is expected to take into account the revenue loss due to abolition of LBT, and the compensation distribution timelines.

To compensate the ULBs for the loss of LBT, GoM is planning to increase the VAT and distribute the additional income in the form of grants. Since VAT, like LBT, is a consumption-driven tax, CRISIL expects the government grants to ULBs will factor in the buoyancy in the state's economy. Hence, CRISIL expects the move to be revenue-neutral for ULBs; however, in case the compensatory grants from the government do not increase annually, the buoyancy in revenue collections that would have been seen in the case of LBT, would be lost to the ULBs.

Furthermore, the ULBs' dependence on timely payment from the state government to meet its revenue expenditure and debt servicing will increase significantly, particularly in the case of ULBs that have a very high proportion of LBT in their overall revenue. The adequacy of compensatory grants and timely distribution of the same will be critical for the smooth performance of the ULBs. Hence, CRISIL is awaiting GoM's announcement of the compensatory mechanism, inter alia, clarity on the hike in VAT rate and the proportion of grant, which will be distributed among the affected corporations.

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