PAKISTAN is a federation of four provinces, unequal in area, population and levels of economic and social development. The ethnic distinction of provinces makes horizontal equity in development across provinces vital to political stability and national cohesion. Common economic interests cement the provinces together in a union based on our Islamic identity. Pakistan has already split once over economic issues. A strong and resource-rich federation is critical to keeping national interests above parochial interests and assisting lagging regions. And the free movement of people, their capital and goods defines the economic entity called Pakistan in the 1973 Constitution.
In a major shift since 1973, the seventh NFC Award and the subsequent 18th Constitutional Amendment in 2010 resulted in a significant fiscal and administrative decentralisation which left the resulting fiscal federal structure unbalanced, unmanageable and posed macroeconomic and political challenges. The seventh NFC Award transferred an unprecedentedly large share of the divisible pool, 57.9 per cent, and other resources to the provinces from the federation without the reassignment of additional expenditure responsibilities to the provinces. This contributed to substantial vertical fiscal asymmetry creating a significant structural deficit at the federal level with serious macroeconomic effects.
The biggest political challenge comes from an 18th Amendment stipulation that the revenue share of the provinces in any NFC Award cannot be less than the share given in the previous award. Equally challenging are interprovincial revenue-sharing formulae in the seventh NFC Award which if unchecked, will contribute to increasing resource disparity between provinces that could result in the unequal pace of development in provinces.
Imbalances triggered by the seventh NFC Award have contributed to many macroeconomic problems.
The ensuing 18th Amendment further significantly curtailed the responsibilities of the federal government and expanded the legislative and executive domain of Pakistan’s four provinces. Some of the reassignments of subjects in the Fourth Schedule exclusively to the provinces have created a governance vacuum at the national level amid conflicting provincial policies with adverse international repercussions. The reassignment of service delivery responsibilities to various levels of governments no longer conform to the modern principles of subsidiarity.
Even the taxation and revenue-generating powers of the federation are under threat. The allocation of taxation powers in the 1973 Constitution reflects the recognition that acute differences exist in the revenue-generating capacity of the provinces.
Committed to equitable development across the country, the framers of the 1973 Constitution pointedly assigned all major sources of tax revenue to the federation so that resources could be transferred down equitably to the provinces via the NFC. Post the seventh NFC, by removing GST on services from the divisible pool, the federal share has been reduced and provincial equity reduced due to differences in their GST revenue-generating capacity. Balochistan and KP will receive far less resources from GST on services than Sindh and Punjab.
Apart from the larger share in the divisible pool, the provinces now have exclusive tax jurisdiction over agriculture and services which account for 80pc of Pakistan’s GDP. This will further skew resource allocation vis-à-vis the federation.
In addition, the seventh NFC Award altered the formula for horizontal distribution of resources among provinces from population-based to multiple parameters including population, poverty, inverse population density and revenue collection. The justification for the first three parameters is consistent with Articles 160 to 164 read with Articles 37 and 38 encouraging equitable distribution of resources but not revenue generation/collection which is a de-equaliser. To give more resources to provinces that collected more revenue is to reward richer provinces with additional resources thus accentuating disparities in development between provinces.
Overall, the reduction in the federal share has seriously constrained its ability to respond to unexpected expenditure needs of national importance or to assist provinces. It has contributed to the persistent federal budget deficit, rising debt and debt service thus reducing available resources for development and security purposes. With 57.9pc of tax revenue going to the provinces, federal efforts to raise revenue for the federal budget needed to be substantially larger. This has resulted in an increase of tax burden on existing taxpayers and businesses with adverse consequences for tax compliance and loss of competitiveness, contributing to the severe balance of payments crisis. The decisions of the Fiscal Coordination Committee to synchronise fiscal policy coordination and budget implementation between the federation and provinces are legally non-binding and have not always been implemented.
The seventh NFC does not address the issue of sharing the burden of financing joint responsibilities which remain with the federation, in particular public debt service of loans used for national projects. The award does not assign responsibility to provinces for line losses and circular debt of the electricity sector despite the unbundling of distribution companies into regional companies (DISCOs) which pose considerable claims to federal finances.
Apart from escaping additional expenditure responsibilities, provinces have failed to strengthen public financial management frameworks, thus provincial governments have vast resources but ineffective mechanisms to ensure fiscal discipline and accountability. In addition, the provincial demand for a larger share in divisible pool resources was rooted in the acute shortage of resources for local governments, yet fiscal decentralisation did not trickle down to local governments notwithstanding some progress in some provinces. And progress in improving basic social service delivery — one of the key economic justifications for fiscal decentralisation — has been mixed.
Post NFC, despite increased tax collection fiscal outcomes worsened. The federal budget deficit was higher despite being on a downward trajectory in the previous three years. Lack of resources with the federal government may have also contributed to a number of related fiscal imbalances in the power sector manifest in the circular debt and pending refunds to exporters, both of which further eroded competitiveness, restricted growth of the manufacturing sector with consequences for unemployment.
Thus the imbalances triggered by the seventh NFC Award directly and indirectly contributed to a range of macroeconomic problems and turned out to be an unmitigated disaster for the federation.
The writer formerly served at the IMF and as federal minister for commerce.