NFC’s way forward

Published June 7, 2021
The next budget will set the trend as the government plans major fiscal stimulus for pushing growth in the next two years ahead of the 2023 elections. — Reuters/File
The next budget will set the trend as the government plans major fiscal stimulus for pushing growth in the next two years ahead of the 2023 elections. — Reuters/File

Since his appointment as finance minister, Shaukat Tarin has on multiple occasions expressed his views on what many refer to as implications of the 7th National Finance Commission (NFC) award for federal finances. Being one of the key architects of the award, which was followed by the passage of the landmark 18th amendment to the Constitution to devolve several federal functions to provinces, Mr Tarin has naturally taken a position on the issue that doesn’t match with the one held by many in the ruling PTI, or in the country’s security establishment.

Instead of blaming the award for the federal government’s growing fiscal troubles and public debt, he has pointed out the failure of the successive administrations since 2009 to increase the country’s tax-to-GDP ratio as envisaged in the award for growing the size of the financial pie. He was quoted in the recent weeks to have said the 7th award had assumed that tax-to-GDP ratio would be raised by one per cent every year from less than 9pc (at the time the document was finalised) to 14pc over its five-year life and the federal government would curtail its non-development spending by abolishing the ministries and departments that were to be devolved to the provinces after the passage of the 18th amendment to the constitution.

None of that has happened in the last 11 years: the tax-to-GDP ratio is stuck at between 10pc in 2010-11 and 13pc in 2017-18 and the Centre continues to bleed resources to retain the devolved ministries and departments for political reasons. On the other hand India, Maldives and Nepal have raised their taxes to around 20pc of their GDP. Instead, the existing resource-sharing arrangement between the federal government and the provinces is blamed for bringing federal finances under pressure and worsening macroeconomic imbalances, particularly the budget deficit that Islamabad has been running ever since.

The net increase in the combined provincial share from the federal divisible tax pool under the 7th award works out to be around 1pc of GDP depending upon the actual tax collection in a given year, according to a Punjab government paper on the impact of enhanced transfers under new NFC arrangement. This despite the fact that the award made significant changes in the way the country’s tax resource is shared by the federation and provinces as it cut collection charges from 5pc to 1pc of the collection, allocated 1pc of the pool money to Khyber Pakhtunkhwa to make up for the losses on account of the war on terror, and raised the provincial share from 50pc (including 2.75pc in compensation for the abolition of Octroi taxes) to 57.5pc. Additionally, the GST (general sales tax) on services was finally transferred to the provinces and its contribution excluded from the poll.

Instead of blaming the NFC award for the fiscal troubles and public debt, the finance minister has pointed out the failure of the successive regimes since 2009 to increase the tax-to-GDP ratio as envisaged in the award for growing the size of the financial pie

Long before Mr Tarin was co-opted by the PTI government, he had in a TV interview in May 2020 said it was not possible to devolve new responsibilities to provinces without increasing their share (from the federal divisible pool under the NFC arrangement). “At the time of finalisation of the award, we clearly knew that the existing size of the tax cake would not be enough for everyone: the Centre and the provinces,” Tarin who had headed the commission in his capacity as the country’s finance minister.

“Therefore, we agreed (in the award) to raise the tax from 8.8pc to 15pc of GDP by 2014 and to 19pc by 2019 to have sufficient financial resources (to feed everyone). Besides, it was also agreed that the loss-making state-owned enterprises (SOEs) would be turned around and made profitable and devolved ministries abolished by the Centre,” he had told the interviewers. However, he added, neither the federal government nor provinces took appropriate actions to implement the award (in letter and spirit). The targets set in the award were to be reviewed every three months. But it never happened. In conclusion, he had stated that the tax-to-GDP ratio would have to be increased to 18-20pc to solve the financial problems facing the government.

How Tarin plans to deal with the NFC challenges posed by non-implementation of the important decisions made during the NFC deliberations 11 years later mostly remains unclear. Nevertheless, he’s already urged provinces to cut back on their expenditure and has hinted at undertaking a similar exercise at the Centre. But the provinces are unlikely to respond kindly to this suggestion since they plan to push infrastructure investments to create jobs in the next two years ahead of elections.

For example, a provincial minister from Punjab, the province ruled by Imran Khan’s PTI, recently told Dawn that the province will not agree to produce a surplus to help Islamabad contain its fiscal deficit even if federal transfers to the province double in the next two years. “We do not have room for austerity in the next two years if we want to win the next elections. We will face dire political consequences If we don’t start spending money from next year,” he argued.

The question is whether he can convince the prime minister to abolish the ministries that were renamed by the federal government to keep them? More importantly, is the prime minister ready to pay the political cost of cutting down the size of his government and cabinet?

With the present provincial share from the divisible pool protected by the constitution, the only way forward for the government is to vigorously increase tax collection and reduce its current expenditure since it does not have enough numbers in the assembly to change the constitution. The next budget will set the trend as the government plans major fiscal stimulus for pushing growth in the next two years ahead of the 2023 elections.

Published in Dawn, The Business and Finance Weekly, June 7th, 2021

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