OUT of the swirl and dust of acrimonious controversy that was raging for past four years, an Order has been issued by the federal government on January 19, 2006 for the distribution of revenue resources— both vertically between the federal government and the provinces and horizontally among provinces.

The award does not remove all irritants in our inter-governmental fiscal framework but it was the only course left for breaking the impasse.

The most fundamental fault-line developed over decades in the fiscal framework is extreme vertical fiscal imbalance between federation and provinces with the federal government raising and administering revenues of the state to the tune of 95 per cent and the provinces less than five per cent. This structural imbalance arises largely on account of exercise of power and authority by the federal government over some 47 subjects under the Concurrent List of the Constitution.

The other contributory factor is slow and imperceptible manner of arrogation of some bases of taxation reserved for provinces under the Constitution such as taxation power of provinces on ‘services’ such as electricity, gas, telephones, courier services, shipping and stevedoring companies , ushr on agricultural produce, excise duty on hotels, beauty parlors, capital value tax on imported vehicles and international air travel tickets etc.

All this has been done either on the ground of lack of capacity of provinces to levy and administer taxes or on the ground of reduction in multiciplity of tax bases or for the purpose of extension of sales tax regime to excisable duty items.

Recognizing this structural imbalance, the president had himself come out with a statement on February 22, 2005, advising the federal government to transfer the subjects included in the concurrent list to provinces and to share resources on fifty fifty basis. The two issues being inter-linked, one had hoped that the award will be made after removing the structural imbalance in the functions of federal and provincial governments and redetermination of fiscal needs of the federal government and the provinces.

At the same time, it was expected that the vertical imbalance in the taxation power and authority will be corrected by not only restoring the authority of provinces on taxation bases reserved for them under the Constitution but also by devolving some bases from federal government to the provinces. The order issued does not squarely deal with this fundamental issue.

The transfers from a higher level of a government to states or provinces from revenues arising from certain specified federal tax bases along with grants, if necessary, are made to bridge the gap between revenues from own bases of taxes and expenditure needs. This allows a fair degree of fiscal autonomy to provinces/sub-national governments, enabling them to plan and budget their expenditure needs.

In our case, with the provinces heavily depending upon fiscal transfers between 80 per cent (Punjab) and 95 per cent (Balochistan) to meet their expenditure needs for performing their existing functions, provincial budgets and expenditure plans run into snags due partly to delay in releases from the federal government and partly to releases falling short of projected revenue transfers on account of low collection.

In conformity with awards made in past, the new award does allow an additional transfer of revenues to resource starved provinces. It has been claimed that an additionality of some Rs51 billion will accrue to the provinces from the new distribution formula in 2006-07 without taking into account straight transfers as royalty on crude oil and gas, surcharge on gas, excise duty on gas and sales tax on services as per Constitutional provisions.

Had the new formula been made effective in 2005-06, on the basis of a hallmark estimate of revenues in the budget for 2005-06 an additionality of some Rs25.5 billion is likely to result from a raise in the provincial share from 37.5 to 41.5 per cent and a reduction in the federal share from 62.5 to 58.5 per cent in the Divisible Pool taxes. As regards subventions, an increase from the current level of Rs9.4 billion as provided in the budget fro 2005-06 to Rs27.8 billion as contained in the new formula will give another additionality or Rs.18.4 billion.

Thus, in overall terms provinces would have gained an additionality of Rs44.9 billion had the award been made applicable in 2005-06. Considering normal growth in revenues in 2006-07 from divisible pool of taxes, an additionality of about Rs51 billion to the provinces is likely to result from new revenue distribution formula. Undoubtedly, no award in past allowed such a generous additionality to provinces. Consistent with the decision of Inter-Provincial Co-ordination Committee held in May, 1999 it was decided that the present system of octroi and zila tax would be abolished by the respective provincial governments and the loss of revenue would be met from 2.5 per cent increase in GST from 12.5 to 15 per cent. It was further decided that the additional funds so generated would be entirely transferred to the provinces. It is on this account that provinces have been demanding since long for straight transfer of one sixth of total revenues mobilized from sales tax.

However, entire revenues realized from sales tax on goods remained part of Divisible Pool. In 2002-03 it was decided to transfer one sixth share in sales tax revenue apportionment of the federal government from Divisible Pool to provinces. Under this system, the provinces continued to receive grants commonly known as OZT grants. The new Revenue Distribution Order does provide for distribution of one sixth of net proceed of sales tax to provinces for transfer to District Governments and Cantonment Boards.

However, the order does not clearly state whether it would be a straight deduction from total proceeds of sales tax before making it a part of Divisible Pool for distribution between the federal government and provinces or the provinces will earmark one sixth of their share in the proceeds of sales tax accruing from the Divisible Pool. If the intent is latter, the additionality of Rs. 51 billion to provinces is likely to be watered down.

In Pakistan, fiscal management is highly centralized in the federal government. The Fiscal and Monetary Board which lays down and monitors fiscal and monetary policy is entirely federalized with the finance minister as chairman and minister of commerce, Governor State Bank, deputy chairman Planning Commission and Secretaries Ministry of Commerce and Finance as its members. There is no representation of provinces on the Board. This not only deprivers the provinces from fiscal and monetary management of the state but also negates the principle of fiscal federalism. The new award is silent on the subject but one hopes that the point of view of the provinces will be accommodated through an administrative order.

The order continues with the existing criterion of distribution of resources on population basis from the overall share of provinces in the Divisible Pool of taxes because the provinces could not develop consensus on multiple criteria as is in practice in other countries of the world. However, it invites the provinces to develop a consensus on the subject for its subsequent incorporation in the formula.

It is for provinces now to come up with it, consistent with the practices in other countries so as to discard obsolete method of using population as the sole criterion for distribution of resources.

To recapitulate, the new formula falls short of one’s expectations for removing all structural weaknesses in the current system of fiscal governance. However, it will relieve the provinces from immediate financial crunch that they are faced with.