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Punjab fights back to defend NFC

Updated February 19, 2018

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THE net increase in the combined provincial share from the federal divisible tax pool under the 7th National Finance Commission (NFC) award works out to be around one per cent of gross domestic product (GDP) depending upon the actual tax collection in a given year.

A Punjab government paper on the impact of the enhanced fiscal transfers under the 7th award shows the provincial share from the division pool had increased by just 0.81pc of GDP during 2010-11, the first year of operation of the new award.

The award made significant changes in the way the country’s tax resource is shared by the federation and provinces, as it reduced the federal tax collection fee from 5pc to 1pc of the total collection, thus enlarging the size of the divisible pool; allocated 1pc of the pool money to Khyber Pakhtunkhwa to make up for losses on account of war on terror; and increased the provincial share in the pool from 50pc to 57.5pc.

Additionally, the collection of GST on services was finally transferred to the provinces and its contribution excluded from the poll. The finalisation of the award was followed by the passage of the 18th amendment to the Constitution that devolved several federal subjects and functions to the provinces (in line with their increased share under the 7th award) and created a big opportunity for the central government to significantly cut its expenditure.

However, the new resource-sharing arrangement between the federal government and provinces under the 7th award is often blamed for bringing federal finances under pressure and worsening macroeconomic imbalances — particularly wide budget deficit that Islamabad has been running ever since.

The provincial government argues it is incorrect for the IMF and others to compare the provincial share of 57.5pc under the seventh award with 47.5pc under the previous one in 2009-10 to compute growth in the provinces’ share

“There are plenty of people who would like to see the arrangement reversed as a panacea for all federal financial woes if they could find their way to go around the Constitution that protects the provincial share from any downward change,” says a Punjab finance department official on condition of anonymity because he is not authorised to make public statement.

The federal government, for example, is now trying to convince provinces to straight away set aside 7pc of tax pool money for internal security and development of Gilgit-Baltistan, Azad Kashmir and tribal areas of Khyber Pakhtunkhwa. Until the start of the now stalled 9th NFC award negotiations, Islamabad had been forcing the provinces to curb their expenditure to produce cash surplus every year to help it bridge widening national budget deficit to meet International Monetary Fund’s (IMF) loan programme targets.

Recently, the IMF — which has many a time articulated its reservations on the present NFC arrangement for its alleged impact on federal budget deficit — is also reported to have suggested actions that would help remove the imbalances created by the award.

These actions include constituting a technocratic fiscal council under the aegis of the Council of Common Interests, creating a contingency fund under joint supervision of federal and provincial governments, and setting up a permanent tax commission to broaden the tax net in areas of joint jurisdictions.

The Fund believes that implementing its proposals could help improve efficiency, flexibility and responsiveness of the fiscal framework within the “current legal and constitutional parameters”. (The IMF has yet to publicly own the proposals that are said to be part of its yet-to-be-approved Article IV report.)

Punjab government officials argue that Islamabad is tactically using the Fund to bring pressure on provinces to agree to its demand for allocating 7pc from the undivided tax pool for expenditure on internal security and development of GB, Fata and AJK in the next award.

“Islamabad is trying to bypass the constitutional mechanism for curtailing provincial share from the tax pool money to meet the IMF programme target for the fiscal deficit. Simultaneously, it is putting pressure on the provinces to produce cash surplus until they agree to its demand to help narrow budget deficit,” another provincial official contended.

Punjab insists that the budget deficit is persistently high owing to a number of factors relating to the federal government’s own issues.

“The delayed and partial transfer of expenditure responsibilities to provinces (as pointed out by the IMF) could be one factor. But this has happened primarily owing to reasons within the federal government,” the official adds.

“The federal government needs to cut down its establishment dealing with devolved functions in consultation with provinces and curtail its own huge expenditure on loss-making public sector entities like the Pakistan Steel Mills and Pakistan International Airlines. Who is forcing Islamabad to build hospitals when health is a provincial subject? Or keep the tourism department and ministry, another provincial subject, just for political reasons? The federal government must take responsibility for its actions instead of blaming the provinces for its problems,” the official goes on.

The Punjab government believes that “every stakeholder should realise the present arrangement of vertical division of financial resource is a reality that is difficult to reverse even if not impossible. The federation should acknowledge that its failure to control its expenditure and increase the tax-to-GDP ratio is at the heart of its financial woes, and not the enhanced provincial share from the tax pool. Islamabad has a big stake in perusing growth in shared tax revenue because it is the largest source of revenue for both the provinces and Islamabad that still remains the largest individual beneficiary of the tax pool money.”

The official brushed aside criticism that the provinces had not made any serious effort to raise their own tax revenues. All the provinces are making efforts to improve their tax collection because it is in their own interest and will help them reduce their reliance on federal transfers, he insisted.

In the last five years, Punjab has grown its tax collection by an annual average of 20pc. “It is advisable that all stakeholders focus on increasing the size of the pie (divisible pool) so that everyone gets a bigger share instead of expending our energies on stealing from one another as Islamabad is now trying to do using the Fund’s position on the NFC award arrangement,” he concluded.

Published in Dawn, The Business and Finance Weekly, February 19th, 2018