Rolling back the NFC, again

Published March 21, 2024
The writer is a business and economy journalist.
The writer is a business and economy journalist.

IT is getting boring now. Every so often the idea is floated that the government should roll back the provincial allocations under the seventh National Finance Commission (NFC) Award in order to free up some fiscal space for itself. Sometimes, a few years go by between each episode when this suggestion is floated and a conversation flares up around the idea. In this case, only a few months later we are at it again.

The idea was floated in August 2023 when the caretaker government was preparing to enter office. It has been triggered once more following reports that the IMF has asked the government to ‘revisit’ the NFC Award to shore up its fiscal framework.

The arguments are the same. Those who advocate this rollback argue that the provincial allocations in the last NFC Award are unrealistic, frittering away slightly more than 58 per cent of the federal government’s tax take, while the provinces have done little to mobilise any of the revenue lines under their charge, such as taxing agriculture or real estate transactions. As such, they argue the Award creates a perverse incentive for the provinces to let the federal government do all the work while they get to enjoy the perks.

They go on to say that the provinces waste the resources they get under this arrangement. Former finance minister Miftah Ismail, for example, points out in an article that the provinces gave a 455pc increase in payroll expenses and a 480pc increase in development spending since the Award was activated. He even puts the word development in single quotes, perhaps to question whether the schemes on which these funds are being spent actually count as development work.

Clawing back the NFC Award is tantamount to the state cannibalising itself to try and get out of a fiscal straitjacket.

But let us examine these arguments first. It is hard to get exact comparable figures on payroll expenses for the federal government but take two heads in the federal general public service account and see how they have grown since FY11, the first full year when the seventh NFC was in effect.

Superannuation allowances and pensions, for example, increased by 664pc between FY11 and FY24. Executive and legislative organs expenditure increased by 846pc in the same period. Meanwhile, federal development expenditure has increased by 327pc. In fact, take a closer look at the federal government’s current expenditures and you will be hard-pressed to find anything that increased by orders of magnitude less than these during this time period.

Some astute readers would like to point out that you cannot do a rupee-to-rupee comparison across a decade or more, simply because a rupee then is not the same as a rupee today. This is fine, but it should first be pointed out to those, such as Miftah, who would use rupee-to-rupee comparisons from more than a decade ago to argue that provinces are being profligate with the resources devolved upon them.

But let’s continue with the examination of the numbers. Take the total federal taxes collected in FY23, the last year for which we have full-year data available, and divide them as per the terms of the old NFC Award from the Musharraf era. How much difference is there in the provincial shares as per the old versus the new NFC formula?

The answer is Rs889 billion (assuming a provincial share of 45pc as of 2008). This may sound like a lot of money, and in the short term it is. This year they can expect to gain Rs1.1 trillion, if they have clawed back all the space from the beginning of the fiscal year. Again, that may sound like a lot of money, and in the short term it is.

The real question, however, is does it solve more problems than it creates. Clawing back the NFC Award is tantamount to the state cannibalising itself to try and get out of a fiscal straitjacket. It is a little like how a bear will chew off one of its own limbs in order to get out of a trap. The trap in this case is the shrinking resource envelope of the state due to a massive inability to advance documentation of the economy and put in place the apparatus needed to capture the next generation of revenues. The bear is the state, and the limb being chewed off is the stability of the federation.

There is no doubt that a fiscal straitjacket is tightening around the state. This produces within the rulers a hunger for resources, regardless of where these resources come from and at what cost. This tightening has been happening for well over a decade, but the NFC Award is not the cause. The cause is a failure to reform our tax policy and administration in a way so as to capture the next generation of revenues as the services sector surges ahead as the motor force of our economy, but the vast majority of it is undocumented.

It is this failure that feeds the profligacy and irresponsibility of the federal government in managing its ever-tightening fiscal position. One place where this irresponsibility is evident is the inability of federal authorities to draw up — or adhere to — a medium-term fiscal framework. Consider the medium-term budget strategy drawn up in June 2022, which is supposed to govern tax and expenditure targets through next year. According to that document, the federal budget deficit should have been Rs4.6tr last year, whereas in reality it came in at Rs6.4tr. Likewise the same deficit should have been set at Rs4.4tr in FY24, but was, instead, set at Rs7.5tr. Nobody spends it faster than they make it than the federal government.

These are massive gaps that cannot be bridged with gimmicks or short-term band-aid solutions like rolling back NFC allocations. The cost of doing that would be higher than any benefit it would accrue. Those advocating this rollback as a solution should seriously reconsider laying their emphasis on tax reform instead.

The writer is a business and economy journalist.

khurram.husain@gmail.com

X: @khurramhusain

Published in Dawn, March 21st, 2024

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