THE National Finance Commission made an unsuccessful attempt at reaching consensus on the distribution of resources before elections in 2002. Before a fresh commission has been summoned to make its recommendations to the president for the constitutionally overdue NFC award, the legislatures of two provinces have already passed unanimous resolutions stating their demands.

Positions are wide apart and emotions run high on some contentious issues. While the existing population-based formula is not acceptable to some provinces, reaching consensus on any other formula would be difficult since it will necessarily involve a reduction in the share of at least one province if others are to gain. A consensus will be easier to reach if the Commission adopts a set of principles that would govern its recommendations. The federation and the provinces should commit to abide by it.

Recognizing that differences exist today between the provinces in terms of the average level of social and human development, the first principle should aim at reducing those disparities and eliminating them over a reasonable period of time. The reasons for the disparities could be natural resources, location or the unequal distribution of resources over the last 55 years; whatever the reasons, we have to look forward now and eliminate those differences to strengthen the federation. The NFC can consider differences between the average levels of social and human development across the provinces, and not the relative backwardness of some areas within a particular province; the latter needs to be addressed by the respective provincial finance commissions.

Secondly, if we try to correct the disparities created over decades in a very short period, it will retard the growth of the advanced provinces. Hence the second principle should ensure that the distribution of resources, while reducing disparities, does not retard the social and human development of any province. The third and final principle should constrain the federation and provinces to make their demands within the ambit of the 1973 Constitution. What belongs to the federation is theirs and what belongs to the provinces must be given to the provinces.

Having stated a set of proposed principles, it is important to understand the nature and implications of the existing federal fiscal structure in the country before distributing its resources. Pakistan is a federation of four provinces, unequal in area, population and levels of economic and social development. The ethnic distinction of provinces makes horizontal equity across provinces in development vital to political stability and national cohesion. The country now has three tiers of functional governments — federal, provincial and local.

The prime function of all three is to deliver various services. These can range from providing defence to supplying water and sanitation. In order to provide these services, governments need resources. Apart from borrowed resources, governments in Pakistan collect various taxes, user charges and non-tax revenues as well as royalties and profits from the exploitation of natural resources.

Assigning service delivery and taxation responsibilities at various levels of government is a fundamental issue in fiscal federalism. In Pakistan, the distribution of regulatory and service delivery functions conforms to international practices. These are specified in the 1973 Constitution in Article 70 (4), (Fourth Schedule). The Federal Legislative List includes the functions to be performed by the federal government, while the Concurrent Legislative List includes all those functions that can be undertaken by the federal and/or the provincial governments. The Constitution assigns all remaining functions to the provincial governments.

Local governments in Pakistan do not have any distinct status in the 1973 Constitution but are established by provincial government ordinances (currently LGO of 2001) which also determine their powers and responsibilities.

Similarly, the allocation of taxing powers to various levels of government are determined by considerations of efficiency, national equity, administrative costs and fiscal need. In Pakistan, the responsibility of the federal government in the area of taxation is spelled out in the Fourth Schedule of the 1973 Constitution. Following the last NFC award in 1996, the federal government collects all revenues from income tax including corporation tax, sales tax, custom duties and federal excise duties. The major sources of provincial revenues are user charges and tax revenues made up of agricultural income tax, provincial excise duty, stamp duty, motor vehicle registration tax, entertainment tax, and various types of cess. Similarly, there are few sources of revenue left with the local governments.

An important implication of the constitutional assignment of taxing powers and expenditure responsibilities is that while all broad-based and buoyant sources of tax revenue are assigned to the federal government, the provinces (and local governments) are left with only residual authority and sources. On the other hand, the provinces and local governments are entrusted with substantial expenditure responsibilities. As a result, public finances are characterized by persistently large vertical fiscal imbalances between the federal and provincial governments. The federal government collects about 93 per cent of total revenue collected in Pakistan, while it accounts for only 72 per cent of aggregate national expenditure. By contrast, the provinces collect only seven per cent of the total national revenue but account for nearly a quarter of total expenditures.

One possible response to the vertical imbalances in the budgets of the three tiers of government could be to reassign taxation authority downwards to the provincial and local governments. While this could be supported on grounds of better fiscal accountability and greater autonomy for provinces, it will increase regional disparities. The latter because fiscal capacities of provinces (also of districts) are diverse, so that devolving taxation authority will result in growing differences in public revenues and service delivery in the provinces (and districts). Another possible response would be to reassign upwards service delivery responsibilities to the federal government and provinces. In fact this is what happened in the period prior to 2001. The impact is well known: poor governance, poor service delivery, etc.

The third alternative response to vertical fiscal imbalances is to transfer resources from the federal to provincial governments and from provincial to local governments. Equitable transfer mechanisms can address regional resource redistribution objectives and ensure efficient service delivery at the appropriate level of government. This is the route adopted in the 1973 Constitution and LGO 2001. The NFC and PFCs are required to come up with such equitable transfer mechanisms.

The last NFC award was made in 1996. According to it, the federal share in the net proceeds of divisible pool was fixed at 62.5 per cent with the remainder 37.5 per cent to be distributed between the four provinces on the basis of population. As a result Punjab received 57.88 per cent, Sindh 23.28 per cent, the NWFP 13.54 per cent and Balochistan 5.30 per cent of the provincial share. In consideration of their relative backwardness, the NWFP and Balochistan received special grants/subventions, which in 1997-98 were Rs. 3,310 million and Rs. 4,080 million respectively, set to increase at 11 per cent annually.

The 1996 NFC Award also recommended straight transfers to the provinces in lieu of net profits on account of generation of hydroelectricity and net proceeds of development surcharge, royalty and excise duty on natural gas and oil.

What was wrong with the 1996 NFC award and how can it be improved?

* The share of the federation was too large, leaving very little resources for the provinces to fund their annual development programmes out of their own cash resources and to address poverty related responsibilities. For political reasons, the federation financed a number of federally designed and funded programmes in education, health and the social sector with funds which could have been left to the provincial governments.

* The use of population-based formula for distributing the bulk of the divisible pool resources between the provinces could not address the needs of the poorer provinces. While the formula is simple, objective, measurable and reflects broadly the per capita needs of each province (after all, many provincial expenditures escalate generally in proportion to population), the formula assumes that the level of development of people in all the provinces is the same, which is contrary facts. A formula based purely on population cannot rectify the disparities in development between the provinces.

* Allocations for subvention grant were grossly inadequate in relation to the relative backwardness of the two provinces. In 1997-98 subvention grants were less than two per cent of the divisible pool, and by 2002-03 since the divisible pool had grown faster, subvention grants were less than half a per cent of the pool. The difference between the provinces in social and human development is much more.

* Recommendations on straight transfers were not implemented according to the Constitution. The federation and its executing department Wapda have not paid to the NWFP its full share in the profits on hydroelectricity generation. As a result, the accumulated arrears exceed Rs. 200 billion without taking account of interest payments.

Looking ahead to the next NFC award, the share of the provinces must be increased substantially to allow them to assume a larger share in development spendings. Similarly, provincial equity considerations should play a greater role in the context of the Federal Annual Development Programme, which is outside the ambit of the NFC. In view of the needs of the local governments, which receive their funds from the provinces, and the urgent need to address poverty-related issues, the total provincial share should be no less than 45 per cent of the divisible pool. An increase in the provincial share will facilitate the acceptance of a change in the provincial revenue-sharing formula, since all provinces could then receive more than in 1996.

The provincial share should be distributed between the provinces on the basis of a formula that reflects their needs as well as reduces the disparities between them. The multi-indicator formula should include population (since many of the provincial needs are directly proportional to it), area (since the density of population affects the per capita cost of delivering some public services) and an indicator of relative social and human development (to reduce disparities). The weight of the development indicator in the formula will depend on the speed with which the NFC chooses to correct regional disparities.

In case an acceptable indicator of development cannot be agreed upon, a formula using only population and area would have to be supplemented with a large subvention grant for those provinces that are below the national average in human development. This may include two or three provinces. But the amount of subvention grant will need to be at least ten per cent of the divisible pool to make any difference in reducing disparities between the provinces. The division of the subvention grant will also need to reflect the relative positions of the provinces.

Sindh has demanded that the divisible pool be divided on the basis of revenue collection, implying that provinces have some claim on federal revenues collected within its provincial boundaries. This is not in accordance with the 1973 Constitution. The basic law is very clear on the division of taxation powers and has given the federation exclusive right to particular tax bases. No province can lay claim to federal resources.

If revenue collection were used as a basis for dividing resources, provinces which are better off and therefore collect more revenue would get a disproportionately larger share of the public resources and thus increase the disparities that already exist. And if the revenue collection basis was used within the province as well in the PFC, Karachi and Hyderabad would receive all the provincial resources with little left for rural Sindh — a politically explosive proposal.

In any case, the revenue collection potential of provinces today reflects, to a considerable extent, the allocation of resources over the last fifty-five years which the two small provinces may not consider to have been equitable. Thus revenue collection as one or the only factor in the NFC formula will aggravate disparities and provoke divisive debates about the country’s past development priorities.

The next NFC will succeed if the federation ensures full compliance with the Constitution. The demand of the provinces for their profits and royalties from natural resources is based on the Constitution. If there are differences over the calculation of provincial shares, these can and should be addressed according to the norms of accounting, decisions of the Council of Common Interest and the Constitution. To ignore valid and justified demands is a disservice to the federation and the country.

The writer is a former federal commerce minister. The views expressed here are his own.

THE recent visits of parliamentary and trade delegations between India and Pakistan indicate that both sides have now begun to realize the futility and unwisdom of the two major countries of South Asia continuing to be in a perpetual state of isolation from each other.

The report that the India-Pakistan Chamber of Commerce and Industry has signed a document of joint recommendation for the promotion of bilateral trade between the two countries is very encouraging. In the interest of economic growth of both countries, there is need for friendly relations and economic cooperation between them.

Closer economic cooperation, particularly trade, presupposes settlement of outstanding political disputes. Continued tension over a number of unresolved issues has created hindrance in the way of promotion and successful working of bilateral trade and other arrangements. Pakistan has given a fresh call for a composite dialogue with India to tackle all outstanding problems, including the core issue of Kashmir.

President Musharraf has asked New Delhi to show flexibility in talks with Pakistan. This country is certainly not going to allow a single issue to block progress on other key issues. It expects India to reciprocate.

The need for promoting trade between India and Pakistan can hardly be overemphasized. this need has become particularly pressing in view of the emerging division of the world into large trading blocs. This calls for initiation of programmes of closer economic cooperation among regional countries such as those of South Asia to counter the adverse effects of such groupings in the industrial world. Greater bilateral and multilateral economic cooperation among Third World countries enables them to have a better bargaining position vis-a-viz other countries.

The present bilateral trade between India and Pakistan is guided by the principles agreed at the secretary-level meeting held in New Delhi in 1987. A list of 249 items importable in the private sector from India was announced in 1988. This was followed by another additional list of 322 items.

Pakistan’s trade with India does not present a very bright picture and certainly does not match the potential that exists. The share of Pakistan’s exports to India in the country’s total exports during the decade of 1981-91 averaged about one per cent whereas the share of imports from India in the country’s total imports averaged only 0.30 per cent. This shows that each country has treated the other as its residual trading partner and that a genuine trade relationship between the two still remains to be developed.

There has been a series of deliberations between India and Pakistan on the subject of promoting bilateral trade at various levels. As a follow-up of Simla Agreement, a trade agreement, valid for one year, was signed in January 1975. This was extendable automatically for a further period of two years. As the negotiations to examine and redefine the agreement did not materialize by 1978, the agreement lapsed. After a deadlock on the trade front for a period of three years, the subject was again taken up in 1981 with the visit of a joint delegation of the members of the Karachi and Lahore Chambers of Commerce and Industry to India.

In July 1982, Pakistan announced a list of 40 items which could be traded between the two countries in the private sector. An Indo-Pakistan joint commission was set up in 1983. To provide further impetus to economic cooperation, four sub-committees set up under the aegis of the Indo-Pak Joint Commission, met in January, 1984, in Islamabad and New Delhi and identified various areas in which both countries could cooperate to their mutual benefit. The sub-committee on trade identified a large number of items for commodity trade, including bulk trading.

In January, 1986, Pakistan’s minister for planning and economic affairs visited India and as a result some improvement took place in economic cooperation. A remarkable achievement was the opening up of private sector trade between the two countries without routing Indian exports to Pakistan through the Trading Corporation of Pakistan. The proposal of enlarging the list was also discussed and it was agreed to enlarge it from 42 to 250 items.

Hopes of closer economic cooperation and collaboration among the countries of South Asia, particularly between India and Pakistan, have not materialized yet. Also, not much progress has been made in respect of the recommendations of Saarc for a special trade area in South Asia, gradually removing non-tariff barriers, giving each other most favoured nation status, creating a payment union and a regional fund for development.

One good development is that the Saarc summit of leaders will be held in Islamabad in January next year. It is encouraging to know that a draft on South Asian free trade will be presented at that meeting. Let us hope that Saarc special trade area will come into being in the near future.

It is now widely recognized that trade liberalization has only a limited role. Pakistan and India must seek economic cooperation and their mutual trade should be substantial and capable of rapid expansion. A new trade agreement between India and Pakistan should be concluded keeping in view the non- competitive industries of both countries and selective promotion of trade without harming existing industries already operating in a competitive environment or impeding future industrialization. The ban on using each other’s shipping lines should be removed to facilitate overseas trade.

The importance of trade in international relations cannot be overemphasized. But can trade alone help normalize politically strained relations and top bickering due acrimony? There exist far too many points of friction and misunderstanding between India and Pakistan. The journey from trading charges to establishing trading ties is a complex one. It comes up against stumbling blocks of visas denied, of books banned, artists black- listed, intellectuals hounded and intentions misinterpreted. These ought to be removed to promote progress towards normalization.

The writer is a retired major-general of the Pakistan Army.

Email: genumar@yahoo.com