Earlier this month, a World Bank economist brought to the fore that the cash-strapped federal government continues to annually spend Rs710 billion or nearly 1.3 per cent of the country’s GDP by retaining 17 devolved ministries and funding development projects in areas that under the constitution fall in the provincial domain.

This is in spite of the severe financial crunch, resulting in high fiscal deficits (averaging 6.2pc of GDP for the last 10 years) year after year and the accumulation of a mountain of debt.

Briefing journalists, the World Bank economist Derek Chen, said the government was spending Rs328bn on the devolved ministries even after 15 years (of the passage of the 18th amendment). He said the federal government was not only retaining the devolved subjects (to accommodate politicians and bureaucrats) but also increasing its spending. According to the lender’s estimates, the federal spending on devolved subjects has gone up from 0.39pc of the GDP in 2009 to 0.59pc in 2022.

Likewise, the federal spending on development projects in areas that fall in the domain of the province stood at Rs315bn or 0.5pc of the GDP in 2022. On top of it, the federal government spends Rs70bn to finance higher education despite education being a provincial subject under the devolution process.

“This is a duplication of the task,” Mr Chen said, adding that the devolution process should have been completed at the earliest. “Let the provinces invest and develop health, sports, education and similar other areas so that the federal government could take care of its core responsibilities,” he argued.

Pakistan can save about 4pc of GDP through proper fiscal management and revenue generation by benefitting from devolution

This incomplete devolution has led to spending overlaps between the federal and provincial governments, which is likely to have led to redundancies, duplication of tasks and costs, and overall higher-than-optimal expenditures at the federal level.

The huge duplicate spending is contributing to higher fiscal deficits and public debt, besides keeping many initiatives of the centre underfunded. The cuts in this expenditure can result in large savings and help the government somewhat address its chronic fiscal deficits.

The World Bank’s analysis of federal spending takes a lot of steam out of the argument against administrative and fiscal devolution under the landmark 18th amendment to the Constitution and the 7th National Finance Commission (NFC) award that transferred the bulk of tax revenues to the federating units.

The criticism against the incomplete devolution process is based on three contentions. One, it has increased the budget deficits incurred by the federal government, something that the World Bank analysis of duplicate federal spending reveals doesn’t have a leg to stand on.

Two, the transfer of massive resources has disincentivised the provinces from raising their own revenues. That is partially correct since the provinces, especially Punjab and Sindh, have focused on and boosted services sales tax but ignored to develop property, agriculture and other provincial taxes.

The other two provinces, Khyber Pakhtunkhwa and Balochistan have underdeveloped economies and are reeling under militancy, and hence cannot be expected to collect enough taxes.

Three, the availability of the funds under the NFC award has led to an increase in non-development provincial expenditures like pay and pension. That’s also only partially correct. Indeed, the provincial salary bill has increased significantly. But the repeated and heavy federal increase in the salaries of its employees doesn’t leave the federating units with much of a choice to not follow suit.

At the same time, however, the provincial expense on education, health and other social sectors has also risen sharply ever since the provincial share from the federal divisible tax pool was enhanced from 50pc under the previous arrangement to 57.5pc.

Additionally, the provinces have, in the recent past, produced budget surpluses to help the federation hold down consolidated federal fiscal deficits. Apart from the federal spending on the devolved subjects and financing of development in provinces to ensure the reelection of the ruling members of the National Assembly, the other major reason behind the federal financial woes is the failure to build up tax-to-GDP ratio to 15pc in five years to 2015, the last year of the award, as agreed under the award.

The 18th Amendment and the NFC Award represent a major shift in the country’s fiscal architecture as pointed out by the World Bank in its new report released on Friday. The report, the Pakistan Federal Public Expenditure Review (PER), says that while the provinces together have been typically running small surpluses over the fiscal years 2010-22, the federal government has been consistently running large budget deficits.

“The 18th Amendment and 7th NFC Award together have resulted in significant vertical fiscal asymmetry,” it says. This is the first PER report and also the first one at a federal level since the implementation of the 18th Constitutional Amend­ment and the 7th National Finance Commission (NFC) Award in 2010.

The report estimates that Pakistan can save about 4pc of GDP through proper fiscal management and revenue generation by benefitting from devolution.

While it would be a mistake to reverse the devolution process, the provinces should take it further down to the district level and align their spending with service delivery targets and outcomes.

Some kind of mechanism needs to be evolved for a consolidated budgetary framework to set both current and development expenditure and revenue generation priorities for the provinces and ensure coordination between the federal government and the provinces on their budgetary allocations.

The framework can be evolved at the Council of Common Interests. Nonetheless, the process should start with the federal govt reducing its size consistent with the 18th Amendment and stopping development spending in the provincial domain.

Published in Dawn, The Business and Finance Weekly, April 17th, 2023

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