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Gaps in tax revenue

December 28, 2015

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IN a rare criticism of the provinces’ failure to significantly boost their tax revenues to pay their bills, the central bank in its report on the state of the economy for FY15 has advised them to increase their taxation capacity and step up collections.

“As usual, the provinces continued to rely mainly on transfers from federal revenues. Despite a significant untapped potential of resource mobilisation, the provinces are still struggling with capacity and procedural issues in collecting their own taxes on sales of services and agriculture,” the bank says as it discusses the government’s lopsided fiscal policy in the context of a higher-than-targeted deficit that it has run up.

As the provinces have a higher fiscal responsibility and resources after the 18th amendment and the 7th NFC Award, the bank argues, “they have to move fast to increase their capacity of taxation” and handling large public projects.


“The shortfall in the FBR’s targeted collection every year has adversely affected the financial position of the provinces — especially Punjab’s”


Taxes collected by provinces grew 8.4pc during the last fiscal to a mere Rs205.9bn from Rs190bn a year ago — the lowest growth in the last five years. Only Sindh showed a robust growth of over 18pc in its tax collection to Rs93.8bn despite a lower rate of GST on services than in Punjab because of a relatively wider tax base and low exemptions.

Punjab’s performance remained pathetic as its tax collection rose by a paltry 1.6pc and reached Rs98.1bn.

The significantly low tax revenue collection and high current expenditures, the SBP says, threw up only a third of the target provincial surplus of Rs289bn for the year despite a substantial reduction in targeted development spending.

The lower-than-targeted provincial surplus, according to the bank, was one of the major factors for the federal government’s failure to increase overall tax collection by over 30pc, as envisaged in the budget. Actual federal tax collection rose by just under 18pc.

A Punjab government official, who asked not to be named, largely agreed with the central bank’s criticism of the provincial fiscal operations. But he adds that “it is unfair to blame the provinces for the fiscal difficulties of the federal government. Islamabad must clean up its own stables before pointing finger at the provinces for its problems”.

He argues that the sharp rise in current provincial expenses in the last five years was inevitable after the devolution of federal departments and functions to provinces under the 18th amendment and the arbitrary raises in the pay and pensions of government employees allowed by the federation.

“Meanwhile, federal tax revenues — and consequently federal transfers to the provinces from the divisible pool — have not increased as envisaged at the time of the finalisation of the NFC award,” he contends.

“If the tax-to-GDP ratio could not be raised to 15pc, it is not because the provinces lagged in their efforts to collect taxes; it is because the FBR has proved to be massively inefficient in broadening the tax base and boosting collection. In fact, the shortfall in the FBR’s targeted collection every year has adversely affected the financial position of the provinces — especially Punjab’s, which is more dependent on its divisible-pool share than other provinces — as well as their ability to deliver development.

“While an increase in provincial tax revenues will help, it will not be enough to fill the gaps created by the FBR’s shortfall. If Islamabad wants us to generate surpluses, it should give us what it promises us instead of asking us to tighten our belt at the expense of the quality of public-service delivery to our citizens.”

Apart from the GST on services, the provinces are required to raise more revenues through untapped areas like agriculture (and even property) to fill their revenue gaps and to lift the low tax-to-GDP ratio, the central bank adds in its report.

Another area of provincial finances that the bank discussed is the significant growth in current provincial expenditure. Total provincial expenditure grew 17.4pc to Rs1.89tr during FY15 against a rise of 9.2pc in FY14, primarily owing to a major surge of 18pc in the combined current expense to Rs1.4tr.

Meanwhile, development outlays remained underutilised at Rs498.8bn against the targeted Rs650bn.

Punjab pushed its current bill by over 20pc to Rs662.9bn against a less than 8pc increase in its development spending of Rs210bn. Sindh enhanced its current expenditure by 17pc to Rs383.4bn, while its development expenditure rose by above 10pc.

KP, on the other hand, spiked its development spending by a third to Rs105.1bn (despite a big resource crunch), as opposed to its non-development expenditure, which rose 18pc to Rs221.8bn. Similarly, Balochistan pushed its development spending by a quarter to over Rs50bn and its current expenditure by less than 10pc to Rs131.9bn.

The development choices of the provinces differed from one another, with Punjab spending a significantly bigger portion of its development funds on roads as compared to health and education. In fact, its expenditure on education and health was lowest among the provinces as a percentage of total utilised development budget.

While the other provinces too focused on infrastructure development, Sindh and KP spent higher amounts on education, health and social protection than they had a year earlier. Sindh also diverted a substantial part of funds on the construction of agriculture and irrigation infrastructure. Balochistan, despite its limited resources, spent a large portion of its development outlay on education, health, housing and community amenities.

Published in Dawn, Business & Finance weekly, December 28th, 2015