SEPTEMBER 2018 ISSUE NO. 257

The Impact of GST on Municipal Finances in : A Case Study of

SAYLI MANKIKAR

ABSTRACT The post-GST Municipal Corporation of Greater Mumbai (MCGM) Budget of 201819 was the first to contend with the abolition of octroi, which was previously its largest and most robust source of revenue. One year after the introduction of the General Services (GST) by the central government, the MCGM has been forced to find new financing sources. While the state government of has assured that the loss of octroi will be compensated, this move raises larger questions about financial power in the hands of urban local bodies (ULBs). It is imperative to discuss issues such as the need to give ULBs a share in the GST, the role of toothless state machineries such as the state finance commission, the failure to implement the 74th Amendment of the Constitution, and the need for long-term strategies to improve the financial situation and level of services offered by large municipal corporations such as MCGM.

INTRODUCTION

Municipal nance is directly correlated with the Municipal bodies are local self-governments economic growth of a , contributes to whose mandate includes the provision of basic fullling the targets of urban policy and services such as healthcare, water supply, planning agendas, and is responsible for educational institutions, housing, municipal-service delivery. Municipal bodies and waste management. Historically, Indian being the powerhouses of growing economies, it municipalities have suered from weak scal is essential to keep their engines well-oiled. capacity, relying heavily on state contributions Indeed, India's long-term economic prosperity to nance their budgets. ey are authorised to will depend largely on how its perform.1 collect various , e.g. those levied on

Observer Research Foundation (ORF) is a public policy think-tank that aims to influence formulation of policies for building a strong and prosperous India. ORF pursues these goals by providing informed and productive inputs, in-depth research, and stimulating discussions. The Foundation is supported in its mission by a cross-section of India’s leading public figures, academics, and business leaders. To know more about ORF scan this code ISBN: 978-93-88262-31-6 © 2018 Observer Research Foundation. All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means without permission in writing from ORF. The Impact of GST on Municipal Finances in India: A Case Study of Mumbai property, entertainment, advertisements combined budgets of several small states in the through hoardings and billboards, and articles country. entering the region (octroi duty or entry tax). For other municipal bodies in the states of ese taxes ensure that ULBs practice a certain Maharashtra and , the Local Body Tax degree of nancial autonomy.2 With the (LBT) was a major source of revenue, introduction of the Goods and Services Tax superseding the octroi and cess system of (GST) in 2017, this nancial autonomy has been taxation. Local civic bodies of India would restricted. Several taxes have been subsumed impose the LBT on the entry of goods into a under the GST. local area for consumption, use or sale therein. e LBT has now been discontinued, and most At the central level: state indirect tax levies such as VAT, CST and entry tax have been subsumed under the GST, as a. Central Excise Duty listed earlier. b. Additional Excise Duty e GST Constitutional Amendment Bill c. Service Tax accounts for the compensation owed to states d. Additional Customs Duty, commonly by the central government for losses to the state known as Countervailing Duty exchequer due to the implementation of GST. e. Special Additional Duty of Customs. States, in turn, must assess revenue losses for civic bodies and compensate them for the same. And at the state level: However, this is not mandated, since the decision is taken at the state level and not 3 a. State Value Added Tax/Sales Tax mentioned in the Amendment Bill. b. Entertainment Tax (other than the tax e 74th Constitution Amendment Act, levied by the local bodies) and Central Sales 1992 (CAA) recognises municipal corporations as the third tier of the government. e 12th Tax (levied by the Centre and collected by the schedule mandates 18 functions 4 that States) municipal bodies must carry out. ese c. Octroi and Entry Tax functions are categorised into three sections: d. Purchase Tax regulatory functions, provision of services, and e. Luxury Tax development. f. Taxes on Lottery, Betting and Gambling. As part of the devolution process, State Finance Commissions (SFCs) were set up to In compliance with the new GST regime, the formulate principles for disbursing adequate Municipal Corporation of Greater Mumbai nances from the state to local governments. In (MCGM) has had to abolish octroi, which on addition to their own revenue handles, these average had contributed almost 35 percent of its ULBs were to be empowered through grants annual total revenue. MCGM is one of the from the centre and respective state largest municipal corporations in India and is governments (which may or may not be tied) as responsible for running Mumbai, the country's well as transfers formulated by the nance nancial capital. Its budget is equal to the commission.5 e expectation was that SFCs

2 ORF ISSUE BRIEF No. 255 • SEPTEMBER 2018 The Impact of GST on Municipal Finances in India: A Case Study of Mumbai would follow the Central Finance Commission contributes more than six percent of the nation's (CFC), which devolves funds from the GDP, 10 percent of factory employment, 60 Government of India to state governments. percent of customs-duty collection, and 30 However, so far, this has not happened.6 percent of income-tax collections. While the constitutional amendment called Being a global city hosting some of the for the devolution of powers and nances from world's top nancial and commercial the centre and state to municipal bodies, the GST institutions puts an added pressure on the has not been implemented with the city in Mumbai municipality to uphold requirements mind.7 Municipal corporations must be better such as adequate infrastructure. For 201819, funded to allow their nances to match their the total budget outlay presented by the MCGM functions. ey should be aligned with a is INR 272,580 million. As such, the city must predictable and growing source of self- perform a complex and large set of functions, sustaining revenue, independent of state and including that of a regulator, service provider central government interventions. and creator of infrastructure assets. It must also e GST has levied a steep tax increase in ensure the eective and ecient administration civic services, especially on labour works carried of these functions. However, with the launch of out by contractors, resulting in increased costs the GST, the MCGM has lost its primary source for road construction and repairs, desilting, of revenue, the octroi, which accounted for conservancy, housekeeping, street lighting, and nearly 35 percent of its direct income source and other similar activities.8 is has raised concerns about 1720 percent of the total budget amount about credit availability for contractors and (See Table 1). corporations, as funds are currently blocked. Table 1: Past Budgets of the MCGM and Annual Octroi Municipalities in India do not have access to Collections (as per BMC Books) taxes from income, business, sales, value added Year Budget (in INR) Octroi (in INR) or goods and services as base, to keep up with the 2015–16 335,140 million 62,760 million 9 economic growth. 2016–17 370,520 million 72,440 million is raises several questions on how 2017–18 247,770 million Subsumed under the GST corporations like MCGM are dealing with this change. Will it impact the compositions of With the discontinuation of octroi, the capital and revenue expenditure? How can it be MCGM has had to depend largely on property ensured that after these changes, the budget still tax as its revenue source, which makes up 22 caters to the people's needs? percent of its income. However, the collection of property tax is riddled with issues: there are MCGM BUDGET 201819 AND CHANGES pending litigations and few people and THEREIN establishments comply, given the lack of strong laws against non-compliance. e income from Mumbai is the nation's nancial capital and the 'building proposals' is around INR 39,000 epicentre of commerce and entertainment. It is million, which has seen a steady drop in the last home to over 13 million people and has an couple of years because of the slowdown in estimated GDP of INR 21,162 billion. It Mumbai's real-estate market.

ORF ISSUE BRIEF No. 255 • SEPTEMBER 2018 3 The Impact of GST on Municipal Finances in India: A Case Study of Mumbai

e introduction of GST on 1 July 2017 has perpetual arrangement is guaranteed through raised various concerns. Octroi was a buoyant an escrow account to ensure an annual direct tax, which meant that it increased as the prices deduction of the promised compensation of commodities did, without any need to raise amount to the MCGM. the tax percentage. GST, on the other hand, is an e MCGM has been assured that the indirect tax and not directly linked with the revenue resource would be completely prices of goods. us, there has been protected. However, for 201819, the Mumbai apprehension about whether GST would take civic body is promised only INR 85,000 million care of annual increases in interest rates, since from the government as compensation for its there is no direct mechanism by which it would loss of revenue from octroi, despite the revenue get passed on to the MCGM. However, the state being pegged at INR 240,000 million. e amendment in Maharashtra, which xed a expenditure is estimated to be INR 275,000 compensation clause to the loss of octroi, has million, and the corporation thus faces a decit resolved this to some extent. of INR 35,000 million. e abolition of octroi e local bodies need assurance that has also meant less cashow for ongoing and GSTto be collected by the central and state new projects. governments will be channelled to the In 201819, the MCGM, for the rst time, MCGM, since the transfers from the state decided to draw funds from the corporation's governments in India are neither guaranteed special reserves of INR 690,000 million to tackle nor predictable. Moreover, octroi's daily cash- this decit over the next few years. ese are collection method ensured cash inow to the xed deposits in 31 banks drawing an annual MCGM, taking care of its urgent needs. On the interest of 7.5 percent, available to the other hand, the GST compensation is a xed corporation on zero-interest loans. While INR amount given on a xed date, forcing the 210,000 million is kept aside in the banks as corporation to borrow from banks during duciary fund for provident fund, gratuity, emergencies. e situation further depends on deposits and bank guarantees, the remaining the state's own nances, i.e. if nances worsen, INR 480,000 million has been allocated for the state will not be able to full commitments. infrastructure projects that need cashow, e.g. To protect the interests of the MCGM, after the coastal highway, GoregaonMulund Link several negotiations, the government passed the Road, GargaiPinjal water sources, hospital bed- Maharashtra Goods & Services (Compensation capacity upgradation in suburban Mumbai, and to Local Bodies) Act, 2017, which guarantees Sewage Treatment Plants (STPs). ese will be compensation for the loss of revenue following withdrawn as and when needed. Additionally, a the abolition of octroi. e law protects the fund of INR 27,440 million has been set aside for current nancial year's octroi collection and mega projects. ensures that the state pays the current amount e launch of the GST has weakened the of octroi with an eight percent compounded cash-holding status of the MCGM. e only interest in perpetuity to the MCGM every year, sizeable source of tax revenue that has remained in monthly instalments. is process is ongoing with it post-GST is the property tax. In the case and has already gained momentum. e of the MCGM, when the share of other sources

4 ORF ISSUE BRIEF No. 255 • SEPTEMBER 2018 The Impact of GST on Municipal Finances in India: A Case Study of Mumbai of revenuesuch as fees, user charges and 2530 percent of the state's share of GST be penaltiesare added to the revenue from given to the municipal bodies. is was to property tax, the total is only 50 percent of the compensate for the losses that they were bound amount that the corporation needs to perform to suer because of the GST regime. However, its functions. When octroi was still an active this suggestion was not factored in when the income source, the MCGM made 86 percent of GST Act was nalised. Since no devolution the total funds required. Under the GST system, formula was part of the Act, it resulted in a loss therefore, Mumbai will not be able to of revenue by removing an important tax like independently generate more than 50 percent of octroi and not compensating the ULBs its revenue requirements. adequately. Moreover, almost half of the functions of the While any form of octroi is undesirable, and MCGM are mandated but not funded. No the LBT is not a good replacement for octroi in nance is provided, for instance, for education, theory, the legitimate concern of cities across health, running a bus company and providing India to have one or more taxes that match the electricity. is situation will only exacerbate revenue potential and buoyancy of octroi is a key with the continuing and rapid urbanisation of municipal reform that must be addressed by the Mumbai. central and state governments.11 Some more Some changes must be made within the GST revenue could come out of property tax with regime to mitigate this predictable crisis: proper compliance systems in place, but it will not have the capacity to compensate the entirety 1. Reconsidering Revenue Sharing from States to of the projected losses on account of octroi's ULBs abolition. Various other measures of earning more revenue for municipal corporations have It is necessary to consider adequate revenue- been proposed, including developer exactions, sharing between the centre and the states on the wherein a land developer or builder must one hand and the cities on the other. A formula contribute towards on-site and o-site must be drawn up based on indicators, so that a infrastructure facilities needed to serve new share of the GST is mandatorily passed on to development. Suggestions have also been made cities. is must not be left to states to be paid as to have a local-body grant and municipal compensation. incentive funds to help local bodies access the According to a news report, Maharashtra capital market. recorded a 26-percent jump in revenue collection from GST in 201718. e state 2. Strengthening State Finance Commissions received INR 1,140,000 million in revenue from taxes.10 is increase should be shared with the e 7 4 t h A m e n d m e n t to t h e I n d i a n ULBs as a xed amount transferred on the basis Constitution instituted SFCs, which were of a mutually agreed-upon percentage. is idea entrusted with the task of identifying the was also mooted by the Union Ministry of Urban functions to be performed by the municipal Development in 2015, when the GST was being corporations and mapping the nancial formulated. e ministry had suggested that requirements to do so. e objective was to

ORF ISSUE BRIEF No. 255 • SEPTEMBER 2018 5 The Impact of GST on Municipal Finances in India: A Case Study of Mumbai articulate a mechanism by which the centre and yet to be formulated. the states would devolve funds to the city In 1985, a committee on octroi had corporations. Such SFCs mimic the role of the recommended that the tax be replaced with CFC at the city level. alternatives such as surcharge in sales tax, entry Article 243Y of the Constitution of India tax, terminal tax, road tax and tax on motor mandates that SFCs must review and vehicles. e proposal suggested that if this was recommend measures to improve municipal found insucient, additional funds could be nances. However, no SFCs in the past have obtained from property tax, entertainment tax provided any road map for property-tax and profession tax. Only if the total was still reforms. Moreover, the recommendations made insucient would the state be allowed a grant- by committee members often get rejected or in-aid. inordinately postponed. In 2011, the High-Powered Committee in its In his commentary12 for ORF, Abhay Pethe, Report on Indian Urban Infrastructure and who was a member of the Maharashtra SFC, says Services examined this issue of revenues that almost all states reject the awards of their assigned to municipal bodies and recommended SFCs and that there is no formulaic devolution a municipal nance list of revenue sources to of resources from a state to the local bodies. It is be included in the constitution as an alternative not as if there is no fund ow downwards from to octroi. the states, but it is largely of the type of inexible 'agency transfer' not necessarily catering to the It categorised the taxes into three brackets: felt needs of the local bodies or indeed, riddled with pure political pork barrelling, he wrote. i. exclusive taxes, which included property Several urban economists have suggested tax as well as vacant-land tax, profession tax, that a measure of decentralisation should be entertainment tax and advertisement tax; included in the devolution formula for a share in central taxes and that release of any grants ii. revenue-sharing taxes, including all taxes should be done evenly over a scal year. It has on goods and services levied by the state also been recommended that the way SFCs government, which is now GST; and function must change, and until then, the central government must have direct iii. non-revenue taxes, such as user charges, conversations with the local bodies. trade-licensing fee, oor-space index (FSI) With the implementation of GST, it is time charge, betterment charges, impact fee and for SFCs to proactively address the issue of development charge. having abysmally low user charges for services such as water supply, sewage and solid-waste. CONCLUSION

3. Pushing the Tax Portfolio for ULBs While a 'one nationone tax' regime is a move towards better transparency and accountability, Despite several recommendations from the GST has not been well thought-out for dierent committees, an alternative to octroi is municipal bodies. It has replaced a buoyant

6 ORF ISSUE BRIEF No. 255 • SEPTEMBER 2018 The Impact of GST on Municipal Finances in India: A Case Study of Mumbai taxoctroithat provided exibility in cash declining with each passing year. e gure, spending. Although municipal bodies are being which was 0.39 percent in 200203 and 0.40 remunerated for the loss, it is in the form of percent in 200708, declined to 0.33 percent in compensation. is cannot be compared to an 201213. In contrast, the local tax-to-GDP ratio arrangement where the ULBs share the GST was more than two percent in 22 of the 34 OECD with state governments. Following the countries in 2010. It was 16.1 percent in implementation of the GST, civic bodies have Sweden, 12.7 percent in Denmark, 10.4 percent lost their autonomy and have become in Finland, 7.2 percent in Japan, 4.2 percent in increasingly dependent on states for nancing, Korea, and four percent in the United States.14 thus defeating the intent of the 74th However, under the GST system, the local tax- Amendment, which sought to give ULBs greater to-GDP ratio is bound to go down, unless autonomy. revenue gains are included in it. If MCGM, one of the most robust municipal e 74th Constitution Amendment Act, bodies in the country contributing to a sizable 1992 (CAA) declares municipal corporations as portion of the GDP is feeling the heat, then the the third tier of the government and mentions smaller ULBs are even more likely to be aected. devolving powers, which includes nancial ey are, after all, much more dependent on independence. e GST system undercuts this intergovernmental transfers. Prior to GST, idea. municipal bodies' own revenues comprised 53 e government must rethink tax structures percent of the total revenue, and the balance was and nd revenue sources for corporations, accounted for by assignment, devolution and considering the scope of their services, which grants-in-aid from states (33.4 percent), central goes beyond those dened in the Constitution. government grants (5.3 percent), and grants Since it has only been a year since the from the nance commissions (two percent).13 implementation of the GST, the government Globally, India's municipal corporations are still has the opportunity to reconsider the ner the least funded; the implementation of GST has issues of municipal nance and examine how made them even weaker. e country's urban bodies can function more independently municipal tax-to-GDP ratio is small and is from the state.

ABOUT THE AUTHOR Sayli Udas Mankikar is a Senior Fellow at ORF's Mumbai office. She works on urban and governance issues.

ENDNOTES 1. P.K. Mohanty, Give cities a share of GST to make them viable, Civil Society Online, accessed 5 May 2018, http://www.civilsocietyonline.com/cities/give-cities-a-share-of-gst-to-make-them-viable/. 2. Jitendra, GST regime could reduce local self-governing bodies to mendicancy, Down to Earth, 30 June 2017, accessed 7 July 2018, https://www.downtoearth.org.in/news/a-blow-to-autonomy--58119. 3. Compensation to States GST Council, http://gstcouncil.gov.in/sites/default/les/GST-Compensation-to- States-Law.pdf.

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4. Constitution of India, Twelfth Schedule, accessed 5 May 2018, https://www.india.gov.in/sites/ upload_les/npi/les/coi-eng-schedules_1-12.pdf, 356. 5. Abhay Pethe, Metropolitan Public Finances: e Case of Mumbai, in Financing Metropolitan Governments in Developing Countries, eds. Roy W. Bahl, Johannes F. Linn and Deborah L. Wetzel (Lincoln Institute of Land Policy, 2013), 244245. 6. Financing Urban Infrastructure, Report on Indian Urban Infrastructure and Services, Ministry of Urban Development, Government of India, 2011, 119. 7. P.K. Mohanty, op. cit. 8. Bhagwan Parab, Cost of municipal services may increase thanks to GST, e Asian Age, accessed 5 May 2018, http://www.asianage.com/metros/mumbai/070717/cost-of-municipal-services-may-increase- thanks-to-gst.html. 9. Prasanna K. Mohanty, Financing Cities in India: Municipal Reforms, Fiscal Accountability and Urban Infrastructure (Sage Publications, 2016), 45. 10. Priyanka Sahoo, Maharashtra sees 26 per cent revenue jump after GST kicks in, accessed 7 July 2018, https://indianexpress.com/article/india/maharashtra-sees-26-per-cent-revenue-jump-after-gst-kicks-in- 5120104/. 11. Prasanna K. Mohanty, op. cit., 64. 12. Abhay Pethe, Devolution of nancial resources and tax handles a must for better city management, ORF online, accessed 7 September 2018, https://www.orfonline.org/expert-speak/41225-devolution-of- nancial-resources-and-tax-handles-a-must-for-better-city-management/. 13. A Macro View, Municipal Finance Matters: India Municipal Finance Report, National Institute of Public Finance and Policy, August 2011, 35. 14. Prasanna K. Mohanty, op. cit. 44.

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