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Budget deficit: two sides of the bargain

Updated June 24, 2013
The centre’s repeated moves to get cuts in provincial expenditures has shown no results so far.
The centre’s repeated moves to get cuts in provincial expenditures has shown no results so far.

AT the very outset, the four provincial governments have dashed the federal government’s hopes of providing a substantially scaled-down target of cash surplus for the upcoming fiscal year to limit the consolidated budget deficit at Rs1.651 trillion or 6.3 per cent of GDP.

The centre’s repeated moves to get cuts in provincial expenditures, through persuasive-cum-voluntary efforts, in order to produce cash surpluses and cut the consolidated deficit to help it meet unavoidable expenditures like defense and debt servicing, has shown no results so far.

Estimating the federal deficit for the next year at Rs1.674 trillion, Finance Minister Ishaq Dar had projected Rs23 billion in surpluses from the four provinces, to bring down the overall deficit to Rs1.651 trillion.

Instead, the four provinces have come up with a huge collective deficit with one estimate of around Rs100 billion.

Expectations that provinces would generate higher revenue from agriculture and real estate (services being one exception) were also not that high after the four provincial budgets were announced last week. This was tantamount to one of the key premises of the 7th National Finance Comission (NFC) Award: increasing provincial shares from the divisible pool and increasing the tax to GDP ratio to 15 per cent by 2014-15.

The 2009 Award required the “provinces to initiate steps to effectively tax the agriculture and real estate sectors”.

While three provinces have hardly shown any indication, Punjab seeks to increase revenue from agriculture to Rs2.2 billion next year from Rs772 million this year. But even this seems like a humble start, given the huge potential that exists in the province, which seeks to spend Rs28 billion on wheat subsidies alone. An initial estimate suggests that the provinces have not been able to increase their share in revenue beyond eight per cent to meet their own expenditure — they still get 92 per cent from the federal divisible pool.

In a welcome sign, however, Sindh and Punjab have both started collecting general sales tax on services, and have also done a better job at it than the Federal Board of Revenue (FBR). Khyber Pakhtunkhwa and Balochistan are also set to follow in the footsteps of the two other provinces, and they have taken initiatives to put in place the systems and machinery to start collecting GST on services themselves.

Being led by different parties, the provinces seem to be in a political competition, to improve development, social sector and services delivery, although it is too early to bet on their performance.

But provincial budget deficits have been one of the key challenges faced by the federal government since the 7th NFC Award was announced in 2009. All along, the centre has been projecting cash surpluses from the provinces.

This, however, never materialised, partly because of the failure of the federal tax machinery, the FBR in particular, to achieve revenue targets — the mainstay of the federal divisible pool — and also because of the lack of will on the part of provincial leaderships to contain their expenditures.

During the current fiscal year too, the federal government had convinced the provincial governments, as part of budget consultations last year, to collectively provide a cash surplus of Rs80 billion to help it contain the deficit at 4.7 per cent of GDP. That the deficit finally ended up at 8.8 per cent is now well-known. But the four provinces also contributed a cumulative deficit of Rs62 billion, or about 0.25 per cent of GDP.

Under the 7th NFC Award, the financial autonomy of the provinces had been enhanced by increasing their share in the divisible pool taxes from 50 per cent to 56 per cent in the fiscal year 2010-11, and to 57.5 per cent in 2011-12 onwards, by using multiple indicators instead of a population-based, horizontal distribution of resources.

However, it needs to be taken into account that provincial cash surpluses were projected on the basis Rs1.592 trillion in total transfers to the provinces. This, however, could not be achieved, due to a massive Rs380 billion shortfall in FBR’s revenue collection, which brought down the revised estimate at the end of the outgoing fiscal year at Rs1.441 trillion — a gap of Rs151 billion. For the next year, total transfers to the provinces have been pitched at Rs1.728 trillion.

To be fair to the provinces, they had projected their expenditures on the basis of their divisible pool tax share of Rs1.303 trillion. As the federal government kept an optimist posture of its revenue target until the third quarter of this fiscal year, provincial governments found little incentive in an election year to be prudent about their expenditures. At the end of the year, they are expected to have received only Rs1.117 trillion from the divisible pool, short of the budgeted target by Rs186 billion.

To its credit, the federal government provided Rs103 billion in straight transfers (royalty on crude oil and gas, gas development surcharge and excise duty on natural gas) to the provinces, instead of the budgeted Rs101 billion. Also to their credit, the provinces got Rs84 billion as general sales tax on services during the outgoing fiscal year, against a budgeted target of Rs54 billion, because of better collection at the provincial level.

After adjusting for interest payments, the provincial governments were expected to get Rs1.545 trillion during the outgoing year, but ended up receiving Rs1.394 trillion, short by Rs151 billion. For the next fiscal year, the provinces are projected to receive net transfer of Rs1.680 trillion — a 20 per cent increase over revised estimates for the outgoing year.

A hallmark of the provincial development budgets has been the announcements regarding the launch of mass transit projects like the Karachi Circular Railway, and metro services in Rawalpindi, Multan, Faisalabad, Quetta and Karachi, following the launch of a metro bus service in Lahore by Chief Minister Shahbaz Sharif. While all the provinces have followed the federal government in fixing the minimum pension at Rs5,000 instead of Rs3,000 per month, three provinces — Sindh, Balochistan and Khyber Pakhtunkhwa — have increased salaries for government employees by 15 per cent, against 10 per cent by the federal and Punjab governments.

As expected after the devolution of social sectors to the provinces under the 18th Constitution Amendment and the 7th NFC Award, all the provinces have announced marked increases in their allocations for health and education. All four provinces have also made substantial allocations for district governments, keeping in mind expected local bodies elections very soon.

Interestingly, however, all four provinces have also shown lower receipts from their divisible pool share next year, compared to what was announced in the federal budget. For example, the federal government has estimated Rs709 billion in transfers to Punjab during the next fiscal year. The Punjab government has, however, put its estimate for federal transfers at Rs702 billion.

Similarly, Sindh has put its share from the divisible pool at Rs333 billion for the next year, against the federal government’s estimate of Rs400 billion. KP expects federal receipts of Rs198 billion, against the federal government’s estimate of Rs251 billion.

Perhaps the provinces are making an attempt to be realistic, and reign in their expenditures in anticipation of slippages in revenue collection by FBR next year.