OREANDA-NEWS. A ruling by the Polish Constitutional Tribunal coupled with a pledge by the new government to raise the personal income tax (PIT) threshold is likely to reduce revenues for Poland's cities and municipalities from 2017, Fitch Ratings says. Without offsetting measures, this would put pressure on their operating performance, and potentially their ratings.

The Law and Justice (PIS) party pledged to raise the PIT threshold for the first time since 2009 during its successful election campaign (see 'Fitch: PIS Win May Drive Polish Fiscal Easing, Hit Bank Profits'.) to PLN8,000 from PLN3,000, but did not say when it would do so. The Constitutional Tribunal said last week that the absence of a mechanism to keep the PIT threshold no lower than the minimum subsistence level (currently estimated at PLN6,500) was unconstitutional. The law governing how PIT contributions are calculated will become invalid from 30 November 2016, effectively setting a deadline for the incoming government to introduce a new system and deliver a substantial part of its commitment.

Increasing the threshold would reduce the aggregate PIT-generated revenues that Polish local and regional governments (LRGs) receive from the central government by PLN8.7bn, according to a Ministry of Finance estimate. This is equivalent to around 5% of their total budgeted current revenue for 2015. The overall impact on cities and municipalities would be greater than on the regions, since they receive the bulk of PIT proceeds that are allocated to LRGs, while regions rely more on their share of corporate income tax revenues.

We therefore expect city and municipality budgets to be hit from 2017 via lower revenue streams. The impact on their operating performance, which has improved overall in recent years, will vary depending on the contribution of PIT to total current revenues (which tends to be higher in large cities under the formula used to redistribute PIT revenue). It will also depend on the policy responses from the central and local governments, and on economic growth.

Local governments may have less scope for compensating expenditure measures, having already curtailed spending to comply with the LRG debt limit introduced in 2014 and with limited flexibility to make cuts in more rigid budgetary items like education and social care.

Falling current revenues may have the secondary effect of constraining future borrowing capacity, as the LRG debt limit is set with reference to the average current balance over the previous three years. This could reduce financing flexibility and reduce or delay investment, potentially reducing the absorption of EU grants made available to Polish LRGs in the 2014-2020 Multiannual Financial Framework.

We expect cities and municipalities to seek compensating revenue support from the central government, but there is no indication what form this might take. When the central government granted tax relief to families with children and then cut PIT rates in 2007-2009, no offsetting support was immediately available to counter the fall in PIT revenue received by LRGs (which dropped by 5.5% yoy in 2009), although central government grants to finance LRGs' operations were subsequently increased in 2010.

The emergence of a new mechanism for determining the PIT threshold and any related policies and the impact on operating performance will be important factors in our ratings assessments for Polish cities and municipalities over the medium term.