The provinces aren't very happy with the federal government for allowing lavish tax cuts to different powerful business lobbies over the last several months.

Their objection against the generous tax handouts given through SROs (statutory regulatory orders) by Federal Board of Revenue is not without strong justification. After all, they are a major stakeholder in FBR taxes and any dip in revenue collection directly hits their income as well as their budget estimates and programmes.

The provincial share from the federal divisible tax pool is 57.5 per cent. Therefore, it shouldn't be surprising that Kaiser Bengali, Sindh's member (technical) on the last NFC (National Finance Commission) calls these tax cuts as “subversion of the budget”.

A report appearing last week quoted him as saying the 'provinces were facing the brunt of the (federal) government's actions (leading to lower-than-estimated revenue collection and consequent decline in the transfers to them from the divisible tax pool)'.

In the first half of the current financial year to December, for example, the provinces had received 37.8 per cent of the total annual commitments under the NFC award. They insist that the disbursements should have been 45 per cent of the federal commitments in this period.

With the forecasts of a shortfall in revenue collection for the current year, the tax cuts and exemptions like withdrawal of one per cent withholding tax on manufacturing and halving of federal excise duty on sugar and sales tax on steel meters will cost Rs30 billion to the tax revenues.

Like Bengali, a Punjab finance department official says all SROs and other decisions affecting share of the provinces should be approved by either the parliament or the Council of Common Interests (CCI). Quite a legitimate demand, especially in view of the growing expenditure of provinces on development.

Still there are many in the FBR who defend what the provinces describe as unilateral tax breaks and exemptions to different sectors of the economy.

"When a sector gets tax concessions from the government it is not without a reason and after a lot of discussion on its possible impact on the revenue side," an inland revenue official said. He said in certain cases reduction in the rate of a particular tax or levy on one particular sector could help generate greater revenues.

He, however, admitted that there was no harm in taking the provinces on board while making such decisions because of their stake in federal tax revenue collection. "I understand that the federal government does consult the provinces in many tax revenue generation-related matters. But it is also a federal prerogative to determine and change the rates of federal taxes from time to time."

There are also those who support provincial demand for increased participation in such matters especially in the wake of greater financial autonomy given to the federating units under the new NFC and the 18th amendment rather than leaving such crucial decisions exclusively in the domain of the FBR bureaucracy.

"I believe that all matters related to new taxation, tax reductions and exemptions should be approved by the parliament. The provinces should also be consulted in matters that can have impact on their share under the NFC," an economist, who has served at both the World Bank and Asian Development Fund.

At the same time he is not happy with the failure of the provinces, particularly Punjab and Sindh, to develop their provincial taxes for revenue generation with a view to increasing the share of provincial own revenue receipts in their finances.

Both the finance ministry and the State Bank of Pakistan (SBP) have repeatedly pointed out the exponential rise in the provincial expenditure and stagnant provincial own tax revenues, he noted. "It is sad that the provinces have not developed and raised new taxes falling within their domain as decided during the NFC negotiations because of political reasons," he contended.

The total provincial expenditure has been growing at an average of 27 per cent during the last three years, according to the new fiscal policy statement released by the finance ministry a few day back. Nevertheless, their tax effort has not been in line with the understanding reached during the NFC award, it notes.

In not very different words, the central bank says: "Although provincial expenditure has been growing at a CAGR of 21 per cent during the last four years, their tax effort has not been in line with the understanding reached during the NFC Award."

While discussing growing fiscal imbalance in its state of the economy report for the last financial year, the bank laments that the provinces were unable to support the federal government as had been envisaged in the fiscal devolution process. More specifically, the provinces’ share in total expenditure increased to 34.9 per cent in last fiscal year from 31.1 per cent the previous year whereas their share in revenue generation remained almost the same at six per cent of the total (federal plus provincial) revenues, the report notes.

Unlike the previous year, when the combined fiscal balance (of all provinces) was in surplus, the provinces showed a deficit in the last financial year.

While the surplus of Rs134.5 billion in 2010/11 was due to upward revision in the share of provincial governments to 56 per cent in divisible pool, the deficit in 2011/12 was driven by sharp rise in provincial expenditure.

Of the four provinces, Punjab has a share of 44.5 per cent, both in total provincial revenues and in total provincial expenditure. It is followed by Sindh with a 28.8 per cent share in total provincial revenues and a 30.4 per cent share in total expenditure. These two provinces drive the whole outcome of provincial fiscal operations. This is why, despite a budget surplus of Rs19.1 billion in Balochistan, the overall provincial balance was in deficit last year due to Sindh and Punjab.

The situation is unlikely to undergo a major change unless the provinces start making efforts to tax the untaxed and under-taxed sectors like agriculture, property, services, etc to fully tap their revenue potential. More importantly, their development will continue to depend on the performance, or lack of it, of the FBR.