Despite having a turbulent constitutional history that is replete with experimenting with different forms, methods and doctrines of government, one on which there has been a consensus is “Pakistan’s federal structure of government with defined legislative powers at federal and provincial level”.
An important pre-requisite for effective functioning of the federal structure is the framework of distribution of fiscal powers and the manner in which the revenues are collected and distributed between the federation and the provinces. Thus, revenue distribution is an extremely sensitive and critical factor for the long-term sustainability of a country having a federal system.
For obvious reasons, this issue has always remained a thorny affair and has been a cause of much discord, bitterness and acrimony between the federation and the provinces. More specifically, the unfair distributions resulting in the paltry revenue flows to the smaller provinces in the past had generated considerable animosity. Further, such distributions that were aimed at keeping the bulk of the kitty with the federal government also resulted in wasteful and reckless spending of resources.
Historically, the system of revenue distribution has evolved from the pre-Independence arrangement that prevailed under the framework of the Government of India Act, 1935. The first revenue sharing award under the 1935 Act, was the Niemer Award of 1937. The most important aspect of the pre-independence revenue sharing arrangement, which was unfortunately revised after independence, was the issue of Sales Tax that was then a provincial tax. After independence, the revenue sharing award called the Raisman Award of 1951, was notified on April 1, 1952 in which Sales Tax, hitherto a provincial tax, was temporarily handed over to the Centre, subject to allocation of 50 per cent of proceeds to the provinces. Unfortunately, this temporary period has still not ended as the Sales Tax continues to be a federal subject.
After the 1951 award, there were three NFC awards of 1961, 1964 and 1970. All of these were given in unusual circumstances. The first two awards were during the period of one unit, when the existing provinces formed part of West Pakistan and the later award was given during the second martial law and a year before East Pakistan seceded. One reason for this secession was also their resentment on the revenue distributions of the past.
1973 Constitution: Article 160 of the Constitution of the Islamic Republic of Pakistan provides the framework of the National Finance Commission (NFC), a constitutional body, which is required to make recommendations to the President on the formula of distribution of federal revenues between the federation and the provinces every five years. The Commission, is headed by the federal finance minister, and includes finance ministers of all the four provinces as its members and such other persons, as may be appointed by the President after consultation with the provincial governors. The scope and the terms of reference of the Commission are determined by the President, which in other words means the federal government.
In a country which took over a quarter century to get its first constitution passed from an elected parliament, and in a period of barely five years relegated the same constitution (that had been adopted unanimously by the parliament), to the status of prolonged suspension under the proverbially famous “doctrine of state necessity”, it is not surprising that this part of the constitution has been as ineffectual as the constitution itself. Consequently, we have had only three NFC awards during the last 29 years after the 1973 constitution, viz. the awards of 1974, 1990 and 1996.
Interestingly, most of the revenue sharing awards between the federation and the provinces have been finalized during unrepresentative regimes, with the exception of 1974 and 1990 awards. Consistent with our history, all important decisions such as the system of democracy at gross roots level through devolution of power to the districts and union councils, redistribution of powers between the federation, provinces and districts and the sharing of revenues between these three tiers of government plus a whole range of constitutional amendments are being worked out under the current dispensation, when significant part of the constitution has been put in abeyance. Accordingly, the President has thought it proper to constitute a National Finance Commission, comprising of non-elected people, which is required to complete its recommendations by the end of this fiscal year (being the 5th and the last year of the 1996 NFC period) so that the revenue sharing from the ensuing year could be based on the new award. A strong argument of the supporters of the present setup is that such an important task can not be left to the lesser mortals (public representatives).
In the following paragraphs, I have discussed some critical issues and implications of the last two NFC award (1990 and 1996 award), focusing more particularly on the financial difficulties of the province of Sindh resulting from these awards, to provide some insights with the hope that new award may be framed on more equitable basis in the interest of achieving a durable and sustainable federal structure.
Basically, there have been three major distortions in the past awards, which need to be corrected Firstly, all these awards were designed with the intent to retain bulk of the resources with the federal government. A primary reason for this has been our culture that creates and encourages concentration of financial and administrative powers and resources to whoever is at the helm. The other reason is the enhanced requirements for defence and debt resourcing. The biggest victim of this lopsided arrangement has been the criminal neglect of Pakistan’s social sectors such as education, health, agriculture, public health and sanitation, environment, population welfare that fall in the domain of the provincial governments. Consequently, this is also a major cause of the country’s backwardness, as through large allocations to the federal government, greater part of such resources have been spent on unproductive expenditure. I sincerely believe that the country’s economic development is not possible without enhancing both, the share of provincial resources to be spent on the above sectors and strengthening the administrative capacity of the provincial governments.
Second major distortion is the complete control on all major sources of revenue by the federal government, including sales tax, which is universally recognized as a provincial/state level tax being a consumption tax. As also described above, sales tax was a provincial tax in the pre-independence awards and was federalized for a temporary period soon after independence on the pretext of increased defence needs. In India it remains a state level tax. Similarly, in the United States, which is another model federal structure of government, and almost all other countries with federal structures, this tax is levied and collected by the states or provinces and not by the federal government.
As a matter of fact, in the 1990 award virtually an agreement was reached between the federation and the provinces on the transfer of sales tax to the provinces in terms of its recommendation reproduced below:
“As part of future reforms, net sales tax on domestic consumption should be collected by the provinces. The collection of net sales tax at retail level should be entrusted to the provinces after arrangements for collecting this tax at consumer level have been put in place.”
While significant work has been done on establishing the general sales tax and retail level sales tax is also under implementation, it is essential that in line with the above agreement and commitment of 1990 NFC award that the proceeds of the Sales Tax should be given to the provinces on collection basis. In fact, a real reform would be to transfer the CBR’s sales tax staff and entrust this tax together with its collection to the provinces in the new NFC as per the original commitment of the federal government when it was federalized, the commitment in the 1990 award and the international practices. This would enable the provinces to establish their own tax bases and rely more on their self-generation rather than depending entirely on the federal government for their revenues.
The third distortion is the unique and totally untenable formula for distribution of revenues between the provinces on the basis of population only. This practice, which clearly benefits the biggest province, exists nowhere and cannot be justified on any logical grounds. It ignores other relevant factors such as extent of poverty and underdevelopment (backwardness), contribution in terms of tax collection, etc. Under the present formula, Sindh which makes largest contribution to the national exchequer of around 65 to 70 per cent, suffers the most. Similarly, Balochistan being the largest province (area-wise) is also not adequately compensated due to low population density. This also rewards provinces which have the largest growth of population, thereby defeating the objectives of population control to alleviate poverty. In all other countries with federal structures, the revenues are shared on the basis of combination of factors. Also, in almost all jurisdictions, different taxes are shared based on different bases unlike the practice in Pakistan where the entire federal divisible pool is distributed on a sole criterion of population. For instance, in the case of India, the two federal taxes are distributed to the provinces with weightages shown in Table I keeping in view their nature:
1990 NFC award: Sindh’s financial difficulties originated during the first two years of the 1990 award when Jam Sadiq and Muzaffar Shah were installed as the chief ministers of this province, partly due to extremely lavish expenditure and partly due to relatively adverse 1990 award culminating in an overdraft of over Rs. 6.5 billion when the second PPP government took charge in October 1993.
The demands of the Sindh province that the revenue sharing should not be based on population alone, and that other factors such as collection, specific needs, poverty and extent of economic development be considered in devising the distribution formula were not accepted in the 1990 NFC award. The demand that the sales tax, being universally a provincial tax should be given to the provinces was also rejected and the population remained the sole criteria for distribution. Consequently, the 1990 award was also unjust and detrimental to Sindh and other smaller provinces on an overall basis. However, there were some positive changes that in hindsight reflect that this award, when compared with the past, was a significant improvement. To begin with, the overall share of provinces as a percentage of total federal revenue significantly increased by nearly 18 per cent compared to 1974 award owing to expansion of the divisible pool by inclusion of excise duty on sugar and tobacco. Additionally, for the first time straight transfers in respect of net profit on generation of hydel energy, net proceeds of development surcharge on natural gas and royalty and excise duty on crude oil was allowed to the provinces based on the generation/production in the respective provinces. These transfers greatly benefited NWFP, Sindh and Balochistan and to an extent compensated them for the increased allocation to Punjab on the population formula.
As a result of above positive features together with impressive tax collection performance in the three years of the PPP government, there was substantial increase in the revenue transfers to the smaller provinces including Sindh during the last later three years of this award. This remarkable improvement in fiscal management and revenue collection is illustrated from the figures of tax collections given in Table II:
Similarly, the provincial receipts that had remained pegged at Rs3.8 billion upto 93-94 jumped to over Rs7 billion 95-96 reflecting a magnificent increase of 84 per cent. It is because of such excellent performance that Sindh received matching grant of over Rs500 million subsequently during the Muslim League government. Massive increase in the CBR revenue coupled with substantial increase in the provincial tax revenue and successful implementation of austerity measures enabled Sindh, like other provinces, to enhance its development programme from a paltry Rs.3.5 billion to around Rs 16 billion besides lowering the overdraft balance to less than Rs.1.5 billion. Unfortunately, owing to the excessive and arbitrary at source deductions made by Wapda during this period of approximately Rs12 billion, the financial position remained adverse.
1996 NFC Award: As highlighted in my earlier articles on this subject and the facts and figures given below, there can be no doubt the care-taker regime of 1996 had, in the form of this award, committed a fraud on the provinces. More specifically, the province of Sindh suffered the most as its financial position deteriorated severely. As a result we have seen virtually no development activity during the past five years in this province. Apart from rejecting all other demands of Sindh relating to the transfer of sales tax to the provinces and distribution of revenues on the basis of population alone, there were three most unusual feature in this award as discussed below. Two of them (drastic reduction in the overall share of the provinces and use of highly inflated projections) were adverse to all the provinces, while the third (use of lower benchmark) was more specifically adverse to Sindh.
Deceiving the provinces: Keeping in view the resource shortfall of the federal government owing to escalating fiscal deficits, and more specifically the enhanced requirements for debt servicing and defence, a novel concept of national resource picture (or most high priority expenditure) was introduced. On this pretext, the framers of the 1996 NFC award proposed to revise the formula for distribution of revenues between the federation and the provinces by increasing the share of the federation in the federal divisible pool revenue from 20 per cent in the 1990 award to 62.5 per cent and lowering the provincial share accordingly.
Obviously all the provinces initially expressed their serious objections on such proposal of drastic reduction of provincial share. However, to satisfy the provinces, their representatives were told to prepare the projections of their expenditure requirements for the next five years. When the provinces presented their projections, a crafty technique was used, whereby the projected federal tax revenues were so grossly inflated that they satisfied even the exaggerated expenditure forecasts of the provinces. Through the use of this deceptive technique on the novice care-taker finance ministers mostly chosen by the President himself, the wizards at the Planning Commission assisting the federal government were able to get a consensus from all the provinces to the above extremely adverse distribution formula. No one in the provinces realised at that time that the projections of revenue made by the federal government were only hypothetical and that the funds would be distributed based on the proceeds of the tax revenue actually collected in the proportion of the revenue-sharing formula adopted by the NFC. The extent to which the figures of projected revenue have been inflated in the 1996 award can be gauged from the comparison between the projected revenues and actual revenue receipts during the five-year period as shown in Table III:
As can be seen from the above table, in a period of five years, the shortfall in the revenue collection compared to NFC projections is Rs1137 billion. There can be no doubt that such colossal shortfall could only be due to highly inflated projections. As a result of such shortfall in the revenue projections, there has been a drastic reduction of Rs 425 billion in revenue transfers to the provinces. The shortfall in the of revenues to the province of Sindh when compared with the NFC projections is estimated at Rs102 billion. Also, if the 1990 award continued, the province of Sindh would have received Rs350 billion, 84 billion more than the actual receipts under the 1996 award.
Discrimination against Sindh: The most blatant injustice to Sindh in this award, in addition to the above deception, was that its benchmark figures that were to form the basis for the expenditure projections,were rejected,forcing it to lower its current expenditure for 1996-97 by Rs 5 billion, from Rs41 billion to Rs36 billion. Consequently, Sindh, the most financially distressed province, did not qualify for the special annual grants similar to NWFP and Balochistan of Rs3.3 billion and Rs 4 billion as their resource fell short of their projected expenditure. Ironically, Sindh’s projections reflected that during the five-year period it would have a surplus of Rs13.4 billion. This was totally unrealistic and unfair to Sindh as its current expenditure of that year, despite unprecedented resource crunch, turned out to be Rs 39.8 billion as reported in the accounts prepared by the Accountant General of Sindh (which comes under the administrative control of the federal government).
The actual expenditure was in fact much larger than what had been reported because a large amount of expenses and liabilities had been deferred, not eliminated, due to the province’s inability to pay. Therefore, even if this amount of Rs. 39.8 billion was kept as a benchmark, Sindh would have received an annual inflation adjustable grant of Rs.4.5 billion like Balochistan and NWFP, with a total of around Rs.30 billion in the five-year period.
Another important issue, though not directly connected with the revenue distribution, is the exorbitant rate of interest charged by the federal government on the provinces’ borrowings (cash development loans) from the federal government. The provinces must be provided adequate relief considering that excessive and arbitrary interest has been charged that is substantially above the cost of funds and the prevailing market rates.
Based on the above historic perspective, it is hoped that the members of the new NFC will come up with more equitable and balanced award that is free from distortions and imbalances that had permeated the past awards. To this end, I propose four recommendations. First, the new award must ensure larger share for the provinces that enables them to play their role in the nation building.
The share must be on the pattern of 1990 award and should be adequately increased in view of the scheme of devolution. Second, they should evolve more equitable formula of allocation of resources between the provinces moving away from population as the sole criterion and in a manner that different taxes are shared on different appropriate bases as per the international best practices. Third, the sales tax should be devolved to the provinces consistent with this government’s policy of devolution and decentralization. Fourth, they must develop an overall resource allocation framework based on realistic and conservative financial projections unlike highly inflated projections of 1996 award.