Mr Mohammad Ali Zafar is a student of International Relations at the National Defence University (NDU) Islamabad, Pakistan. He consistently writes news articles, with his work primarily focusing on matters pertaining to the Middle East, Pakistan, and CPEC. In addition, the author has a keen eye for Arctic affairs.
Since the inception of Pakistan, the government has faced criticism from federating units over the centralization of revenue which doesn’t allow the provinces to reach their potential. After the 18th Amendment, federating units observed a major change in fiscal decentralization. So, it is important to declassify the National Finance Commission (NFC) awards, the problems that Pakistan is facing after giving a 57.5% share of annual revenue to provinces, and the possible options it has to improve the next NFC Awards.
What Are the NFC Awards?
Annually, the financial resources of Pakistan are distributed between the federation (capital) and the provinces, and among the provinces by the NFC Award. According to the NFC formula, taxes collected by provinces are pooled, and then the federation re-distributes them to the provinces (on income, sales and purchase, export duties, excise, and other taxes).
Evolution of the Awards
The distribution of revenue between the center and the provinces historically dates back to the pre-partition era—the Government of India Act 1935. In 1952, five years after the formation of Pakistan, the Raisman Award was announced, which was the first award for the distribution of revenue between the center and provinces of the federation of Pakistan, followed by the 1961-62, 1964, 1970, 1974, 1991 and 1997 awards.
The 1979 and 1985 awards were not announced due to a lack of consensus among commission members. Seven NFC awards have been announced to date. The first one of which was announced in 1975, and the most recent was the 7th award signed on December 30, 2009.
Article 160 (1 and 2) of the third constitution of Pakistan provides for the creation of the NFC and its duties to give the president recommendations about net taxes, producing grant aids to the provinces, and matters about finances related to commissions by the president. According to the article, the president is authorized to approve or disapprove the distribution of revenues to the provinces through an order on the recommendation of the NFC.
Formulation Criteria
The basic framework for the management and distribution of revenues is guided by the constitution. To strengthen the provincial resource base and promote fiscal decentralization, the divisible pool has been evolved in a highly progressive manner. The trend of succeeding awards since 1952 shows that the revenue transfers to provinces have been increased continuously except in 1974. As per the recent awards, the provinces have been given a greater share.
| Revenue Sharing Criteria | Vertical Distribution | Provinces | Horizontal Distribution |
|---|---|---|---|
| Population (82.6%) | Federal 42.5% | Punjab | 51.74% |
| Backwardness (10.3%) | Provinces 57.5% | Sindh | 24.55% |
| Revenue (5%) | KPK | 14.62% | |
| IPD (2.7%) | Balochistan | 9.09% |
Why Revisit the NFC Awards
Other than the question of how these weights were designed, the in-flexible nature of the awards because of the 18th Amendment has added complexities where many problems, for instance, massive spending, have raised an enormous burden on the federal government.
The government has to resort to borrowing to support the budget deficit from the State Bank of Pakistan, which makes it difficult for the government to meet development financing needs, pensions, salaries, defense, and debt-servicing from the 42.5% of the divisible pool.
Secondly, it is high time to think about whether or not Pakistan, a federal country, can manage the existing state of affairs or should all the federating units start taking joint responsibility of anchoring sustainability and progress. Is it high time for the federating units to support the burden of debt-servicing, defense, development, and natural calamities (floods) through joint efforts?
Thirdly, the resource distribution formula must contain a mechanism through which every federating unit can provide the best effort without externalizing its expenditures upon others.
Center’s Concerns After 7th NFC Awards
The NFC Award has somewhat raised a pertaining concern for the center, especially when it comes to debt servicing and defense. For instance, if the center wants to take any policy initiative which may have financial implications, such as Covid-19, floods, or the merger of the Federally Administered Tribal Areas (FATA), the center is handicapped. Although provincial status has improved, how will the state manage the financial problems in the long run?
Since the 18th Amendment, a number of ministries have been devolved to the provinces. This brings the federal government into a compromising situation to get into international agreements after the devolution of many ministries into the provinces. This does not mean an increase in centralizations is required, but fiscal efforts, discipline, and a proper workable solution are required to take care of the national responsibilities.
No doubt, the 10% loss to the center was felt by the government as the expected 15% increase in tax-to-GDP under the 7th NFC Award has not been reached to date. The provinces believe that the reason for low tax-to-GDP is because of the Federal Board of Revenue’s (FBR) poor performance.
Despite all of this, is the budget deficit a major concern? After paying the obligations of interest payments on international and domestic debts, along with defense expenditures, the government has to borrow money from internal and external resources to bridge the budget deficit. This is another important development that must be addressed.
Provincial Revenue Generation Problem
Provinces have still, somewhat, been unable to generate provincial revenues as per their capacity. No systematic approach has been adopted to encourage federating units for revenue generation, which has led to financial dependence on the federal. This is one major reason why most of the pressure for revenue generation has been on the center and the FBR.
Another major problem is that the federal government has overstretched itself by managing matters that purely belong to provinces – SDGs (Sustainable Development Goals) allocations, subsidies on fertilizers, rural development, gender issues, funds for roads, etc.
Such overstretching is against the basic premise of decentralization, therefore, compromising the projected efficiency gains. There is also a need to develop responsibility to the provincial government and empower them with the required resources so that they can develop their planning and development strategy based on local aspirations.
The 18th Amendment did devolve many ministries to the provinces, but there are still concerns that ministries, along with their personnel, need to be transferred to the provinces, which will help in overcoming the capacity deficit. Such efforts will lead to administrative empowerment and will encourage the provinces to contribute to the country’s development.
Suggestions for Reforms
First of all, Pakistan needs to revisit its distribution formula, although there exist impediments in that as well. For instance, the first and foremost concern of the provinces is that the existing mechanism of resource distribution is not implemented in letter and spirit. A case in point can be the non-implementation of the AGN Kazi formula.
Moreover, another concern flagged is that the various constitutional provisions regarding fiscal and administrative devolutions are not fully met. The federal government’s narrative on rolling back some of the provisions of the 18th Amendment worries all the provinces who enjoy the distributions as of now and don’t believe that the existing NFC Award formula has weakened the federation.
So, overall, a trust gap has been developed between the provinces and federal government where bridging this trust gap is important but critical to initiate this debate on resource distribution. Moreover, a shift towards an altogether new formula is not possible; so for that, a reduction in the weight of the population and the inclusion of efficiency-based indicators such as provincial tax efforts must be debated at the initial level.
Also, Pakistan can learn from India’s Finance Commission awards. It needs to learn how the technical nature of the award and its change of distribution criteria works. The Finance Commission (FC) of India is a technical award, not a political one as in the case of Pakistan. India has experimented with different criteria and has tried alternative weights.
The FC has adopted different mechanisms to address horizontal inequalities and clubbed multiple criteria under five broad categories—namely needs-based, equity-based, efficiency-based, fiscal disability, and non-plan revenue expenditure. These criteria, a clear deviation from a needs-based formula to the one based on equity and efficiency, resulted in the progressivity of transfers when implemented through successive FC awards.
In 1996, Pakistan utilized the matching grants mechanism in the NFC awards, and considering the tight fiscal space and increasing targeted spacing, Pakistan must add matching grants under the NFC awards. Under this, the NFC can finance, for instance, SDGs spending on a matching grant basis.
Pakistan must utilize the Council of Common Interest (CCI) to make the NFC build a dynamic resource-sharing mechanism. CCI’s forum will support in deciding common socioeconomic goals for each year on a rolling basis. By this, we mean that the one percent share of KPK for War against Terror can be used for other purposes on a rolling basis, for instance, at the time of Covid-19. It can also be utilized for the purpose of dam construction, which will keep on rolling every year.
Pakistan needs to move towards incentive-based resource allocation. For this, Pakistan needs to reduce the weight of “population” as a criterion, which is just a flat indicator of only expenditures needed. Moreover, Pakistan puts a lot of emphasis on revenue collection, but Pakistan needs to focus more on revenue generation so that provinces start pulling their weight.
For this, incentives must be given to provinces in the form of grants based on their performance. This idea was discussed in 2019 by FCC and was approved as Public Finance Management Reforms. This result-oriented mechanism for the approval of grants might lead to positive results.
Many cities, like Karachi, have raised concerns and demanded more resources to be allocated to them. So for that, the Provincial Finance Commission (PFC) awards must be reevaluated to address this concern by different cities. The Fiscal Coordination Committee (FCC) should also discuss this problem which will allow provinces to address the issue of inter-district disparity.
No doubt inter-district disparity exists and requires provinces to reevaluate their distribution criteria where new indicators need to be added such as Inverse Cultivated Area (ICA) in Balochistan and Khyber Pakhtunkhwa (KPK). These indicators will lead to better statistics in targeted districts where allocation of resources will lead to better results.
Conclusion
Overall, Pakistan is caught in a dilemma. The center is neither willing to provide provinces with their legitimate taxation rights nor is able to collect enough revenue to overcome the fiscal deficit. At the current stage, Pakistan’s existing provinces are unable to pull their weight. At such a time, the debate over the provincial status of Gilgit-Baltistan (GB) raised further concerns for the government.
The government aims to propose a 4% share for the development of GB, AJK, and former FATA, yet, this remains one of the most pressing matters for the next NFC Award. It is high time for the government to address these concerns since the history of Pakistan shows that one of the reasons for the “Fall of Dhaka” in 1971 was the unjust and biased policies of resource distribution. Pakistan needs to introduce new NFC awards with improved distribution criteria, enabling the provinces to pull their own weight and give back to the federal.
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