Eventually, a revamp of the revenue-sharing formula will be required when the next NFC Award is negotiated over the next two years, says a recent IMF staff report.

The report justifies its assertion on the grounds that a better match needs to be obtained between revenue and expenditure sharing responsibilities, which will not leave the federal government with the chronic deficit while provinces have budget surpluses.

If the proposal of the IMF staff is accepted by the next National Finance Commission — which is yet to be constituted — it would erode the fiscal autonomy of the federating units.

Revenue surpluses were inevitable in a transition period, owing to the provinces’ historically low absorbing capacity of funds under an over-centralised system run by Islamabad. Besides, under the 18th Amendment, provinces’ future share in the NFC cannot be reduced from existing levels.

Currently, 57.5 per cent of the revenue collected at the federal level is automatically transferred to provinces, against 45 per cent in 2009-10. The NFC Award is valid up to 2015-16.

Another objective of the new formula, says the IMF report, should be to better divide revenue responsibilities to facilitate an improved tax system. Currently, income tax responsibilities are divided by the type of income, and sales tax responsibilities are split between goods and services, which complicate tax administration.

The report also suggests that the fiscal reforms should increase provincial incentives to rely less on federal transfers and more on their own efforts. Islamabad should reach an agreement to set statuary limits on provincial fiscal imbalances, supported by limits on provincial borrowings.

Revenues raised under a fiscal consolidated plan should be used for deficit reduction, rather than for facilitating additional provincial spending.

Similar views have been expressed in the State Bank of Pakistan’s Annual Report 2012-13. The report suggests that taxes should be redistributed on the basis of four guiding principles. According to the ‘economic efficiency criterion,’ the SBP argues for ‘taxes on mobile factors and tradable goods,’ and for ‘national equity consideration,’ ‘income tax should be assigned to the centre’ (meaning federation).

Going by ‘administrative feasibility,’ it proposes that ‘property, land and betterment taxes are good candidates for sub-national assignment.’ Finally, ‘revenue adequacy’ should be the criterion for raising revenues from one’s own sources to match with expenditure needs.

However, in the context of perpetual and widening consolidated fiscal deficits, the overarching, guiding principle should be to match revenue with spending. This is only possible by empowering provinces/districts with taxation powers to raise enough funds to balance their budgets while accessing federal resource transfers, which is their inalienable right and not an act of benevolence on the part of the ‘centre’.

The distribution of taxes among the three tiers of government should be based on the principle that what can be managed by districts or provinces should not fall under the jurisdiction of the federation, but for areas where coordination is required between the ‘provinces’ and the ‘centre’.

Fiscal federalism should enable the ‘provinces’ to manage their affairs on the basis of self-reliance. All other considerations should be subordinated to this cardinal principle.

As nation building activities are the responsibility of the federating units, the best way to promote ‘national equity’ is to let them fend for themselves. After all, a decades-old centralised system has not helped do away with imbalanced regional economic growth within the country or within the provinces.

The SBP report cautions that “too much fragmentation on tax system can increase economic costs, so the selection of which taxes to decentralise should be should be made with care.”

But it ignores an emerging trend from which there is no escape. Capitalism, which tended to concentrate capital in a few hands, population in cities and workers in factories, is now moving in a new direction of networking (creating value chains through outsourcing), abandoning production facilities under one umbrella. This fragmentation is bringing about a transformation both in economics and politics, and is making traditional ways of doing things dysfunctional.

It must to be acknowledged that revenue generation by provinces is at a low one per cent of GDP, owing to decades-old over-centralisation of tax collection and distribution, with sales tax usurped by the ‘strong centre’ soon after the country’s independence. The administrative capacity of the provinces has thus remained ‘dormant’ and has been drastically restricted.

There is a need for capacity building of the provinces to further improve collection of GST on services and effectively enforce collection of the income tax on agriculture. Efficiency is no longer an attribute of centralisation or economies of scale, with advent of IT, as the country’s low tax- to-GDP ratio demonstrates.

It cannot be denied at this point of time that there has to be a happy blend of ‘top down’ and ‘bottom up’ approaches to tackle consolidated fiscal imbalances. But if the federal government runs huge fiscal deficits, it loses its moral authority to persuade the ‘provinces’ not to run budget surpluses.

In fact a new system of accountability should be evolved in which lower tiers of government are responsible to higher tiers and vice-versa.