THE discussions over the new National Finance Commission award are going to be tough and possibly take much longer to throw up a deal on a revenue-sharing arrangement between the centre and the federating units for the next five years through 2019-20.

The demands for a change in the present formula for the division of federal taxes amongst the provinces could also make the whole process quite intricate.

“While the central government will focus on reforming the existing revenue-sharing system under the award — as it’s committed with the International Monetary Fund (IMF) under the three-year $6.7b loan — the provinces will try to grab a bigger share from the pie,” says a Punjab finance department official.

The government plans to establish the new Commission by the end of August, as promised with the Fund, to “seek a new agreement to ensure that the terms of fiscal decentralisation find a balance between devolution of revenue and expenditure responsibilities and is consistent with the imperatives of macroeconomic stability”.

The provinces are upset they have to cut their development spending to provide cash surpluses to the centre

The IMF wants the revenue-sharing system revamped to raise incentives for provinces to rely less on federal transfers and more on their own revenue-raising efforts, so as to lift the pressure on the central government and cut its fiscal deficit to below 4pc through 2015/16.

In the Memorandum on Economic and Financial Policies signed with the IMF, the federal government complained that the most recent NFC award, which granted 57.5pc of most revenues to the provinces, had left it with an imbalance between its remaining expenditure responsibilities and revenue.

The present award, which is in its last year of its five-year life, significantly devolved “spending responsibilities and taxation authority in agriculture, property and services” to the federating units. A research report by the Institute for Policy Reforms (IPR) estimates that full implementation of the 18th amendment, which devolved most federal functions and departments to the provinces in 2010, months after the finalisation of the present award, would spike expenditure liabilities of the four provinces by Rs125b to Rs150b.

However, IPR and many others don’t think the central government will succeed in bringing about a major change in the next award in the presence of protection provided by the 18th amendment. The provincial share, for example, say the IPR report authors, is protected at its present level under the amendment.

“Therefore, the floor to the combined share of the provinces in the net divisible pool of taxes is 57.5pc, according to the present award. [At the same time], in the presence of large cash surpluses, it is unlikely that the provinces will be able to argue for an increase in share.”

The provinces produced a cash surplus of 0.8pc of the size of the national economy in the last final year to help the federal government consolidate its deficit to just above 6pc under an agreement reached between the federation and the federating units at the Council of Common Interest. The provinces are expected to post a cash surplus of about the same size in the current fiscal as well.

Analysts argue the provinces are being forced to cough up cash surpluses to support the centre at the cost of investment spending on improving the quality of public services like education, health and drinking water, as well as economic infrastructure. They agree that the provinces will be required to “pursue an aggressive policy to mobilise their resources if the devolved functions and expenditure obligations are transferred to them without any change in their share from the divisible pool” if they have to improve the quality and coverage of public services.

Ever since the agreement on the new revenue-sharing system under the present NFC award was reached, everyone had expressed huge disappointment over the provinces’ lack of interest in mobilising their own tax resources. Many blame this disinterest as responsible for the country’s fiscal difficulties and development woes.

The State Bank of Pakistan in its third quarterly report for the last financial year through March says, “...the substantial increase in the provincial share of federal revenues in the absence of binding fiscal targets for provincial revenue generation discourage them to increase their revenue generation efforts”. It also advises the federal government that this “anomaly should be taken into account while finalising the new NFC award with the provinces”.

Indeed, many are expecting greater assertion for a rise in their share by the governments of three provinces — Sindh, Khyber Pakhtunkhwa and Balo­chis­tan. The Balochistan government has repeatedly called for an increase in federal transfers in its last two budgets, as its gas reserves decline, hitting its share in straight transfers. KP cites backwardness, poverty and lack of infrastructure, and wants to be given greater weight in the horizontal revenue-sharing formula. Sindh has shown a deficit in its budget.

Punjab finance department official said, “In a way each province is taking its position, developing a case for its revenue needs for public service delivery and even creating alliances with each other. So, expect a lot fireworks when the NFC negotiations formally get under way”.

Published in Dawn, Economic & Business, July 14th, 2014