In the case of the perennially broke federal government, the 7th National Finance Commission (NFC) Award has recently become the main suspect. The case against it: the Award short-changed the centre, the provinces squandered their windfall, and the cash-strapped Pakistani government can no longer indulge this bad deal gone worse.

In the global context, this case holds water. An Organisation for Economic Co-operation and Development (OECD) study set the benchmark for subnational government revenue (tax, non-tax, transfers) at 21 per cent for lower-middle income, federal countries worldwide.

Of course, there is significant variation around this mean. However, the fact remains that the 7th NFC Award’s formula for a 56pc to 44pc split of the federal divisible pool favouring the provinces appears globally exceptional. If we compare this split with the only other federal state in our South Asian neighbourhood, ie India, the 15th Finance Commission recommended a share of 41pc for states in federal taxes for 2021-26.

Moreover, these data points reflect current practice, which is not necessarily the best practice. Fiscal federalism doesn’t offer much in the way of best practice — only foundational principles. For instance, the subsidiary principle holds that public functions should be performed at the level closest to the people whose lives they will affect.

The 7th NFC Award has gotten the country to a deficit of Rs6.6tr that might have been slightly larger at Rs7.3tr without it

This is exactly what the 18th Constitutional Amendment attempted to achieve. A total of 47 subjects were devolved to the provinces. However, less than a third of the functions performed by dissolved ministries actually went to the provinces.

Ministries were resurrected in new and creative ways, and clusters of attached departments/bodies continued metastasising under their hoods. The Ministry of Agriculture, for instance, became the Ministry of Food Security.

Today, the Ministry’s Livestock and Dairy Development Board is working hard to fatten yaks in Gilgit Baltistan. The government didn’t just claw back devolved ministries, it launched vertical programs. Instead of shrinking, federal spending actually increased in devolved domains from 2009-2022, according to the World Bank.

The belt-tightening required by the 7th NFC Award could not happen because the federal government simply wasn’t willing to lose weight.

But this is not the whole problem. The NFC also envisaged a national tax-to-GDP ratio standing at 15pc by the terminal year of the Award, 2014-2015. From 2011-2023, provincial tax revenue growth (9X) dwarfed federal tax revenue growth (3X). Collectively, however, they failed to reach the NFC’s target.

However, suboptimal revenue collection is a historical default. Tax-to-GDP performance has been poor, but it has been consistently poor, pre-and-post 7th NFC Award. The Federal Board of Revenue (FBR) taxes stood at 9.1pc of the GDP in FY11 which charts as a flat line to 8.5pc of the GDP in FY23. Over the same period, provincial taxes barely moved from 0.4pc to 0.8pc of the GDP.

While the lack of growth is unfortunate, it does not fully explain the present crisis. What has changed over the past two decades? Where does the federal fiscal pressure originate? Who has framed the 7th NFC Award, and what if it didn’t exist?

Suppose we remove it from the equation and develop an alternate fiscal picture for FY23. If we derive compounded growth rates from a 10-year period prior from FY01 to FY10 for federal revenue and expenditure and then project them forward until FY23, what do we get?

This is obviously an oversimplified thought experiment, not a sophisticated economic analysis. But how does this hypothetical position compare with the actual position for 22 years under the 7th NFC?

Well, the government’s net federal receipts would be one-third larger in the ‘no-NFC’ scenario — obvious given the smaller provincial share. We’d also be spending about one-fifth more in federal expenditures — again, no surprises. The more we have, the more we’re likely to spend.

However, the real difference between the ‘no-NFC 2023’ and the ‘actual 2023’ fiscal position would be the federal expenditure exclusive of markup payments. When we remove debt servicing costs, the federal government’s expenditure drops off a cliff in the actual 2023 position compared to the hypothetical 2023 position.

This means the real culprit was right under our noses all along — debt. Interest payments have risen an eye-watering 716pc from FY11 to FY23, growing from 28pc of federal expenditure to 50pc. The jump from FY22 to FY23 may be a blip, but historically, it is still trending skyward, and as the State Bank has warned, we should not bet on a correction in FY24.

The July-December 2023 data certainly supports this pessimism. The irony is that, in terms of overall budget balance, there is not much difference between actual and hypothetical 2023. With the NFC, we have a deficit of some Rs6.6 trillion (7.8pc of the GDP)—without it, we might have had a slightly larger one at Rs7.3tr (8.6pc of the GDP).

The federal government chose a debt feast over an NFC diet. It turns out it’s not about the size of the cake or how it was sliced. The real problem is that the government has been eating cake bought on store credit for over two decades, and the bill has finally come due.

The writer is a public policy analyst.

X: @UsamaBakhtiarA

Published in Dawn, The Business and Finance Weekly, April 8th, 2024