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The price of ‘generosity’

THE federal government has started to feel the pinch of the tilt in the 7th National Finance Commission Award towards the provinces.

While it has enabled the provinces to exercise greater fiscal autonomy, the federal finance ministry feels that the centre has been squeezed of its capacity to meet its necessary requirements of debt servicing, defence and development.

While reviewing the third quarterly report of the current financial year on implementation of the award, the NFC last week noted that the total size of the divisible pool tax during July 2011 to March 2012 was Rs1.211 trillion. After setting aside the federal government’s one per cent collection charges (Rs17bn) and special one per cent allocation for  the ‘war on terror’ (Rs12bn), the net divisible pool taxes stood at Rs1.182 trillion, of which Rs680 billion went to the provinces and Rs503 billion to the federation.

As such, the total share of the provinces out of the divisible pool worked out to be about 57 per cent, while the federal government retained the remaining 43 per cent. The country’s economic managers believe that this limited fiscal space has forced the federation to borrow from banks to meet necessary expenditures, resulting in an increasing debt burden and higher interest payments.

While there are also some other significant reasons behind increase in debt servicing, the fact that debt servicing on additional borrowing over the last five years has gone up by about Rs1.5 trillion gives just an idea of the limitations arising out of the reduced fiscal space and resultant resort to bank borrowing.

The finance ministry officials argue that while the total public debt has increased from little over Rs6 trillion in 2007 to Rs13 trillion a couple of weeks ago, about Rs5 trilliong was due to currency depreciation, debt servicing resulting out of additional borrowing and power sector losses. And the monetisation of these factors in the absence of projected financial inflows and revenue growth has caused higher inflation without economic growth.

According to Finance Minister Dr Abdul Hafeez Shaikh, the federal government has become a sort of beggar after the 7th NFC Award. He said that while the federal government remained under constant watch and was still being criticised for the increasing losses of the public sector, the increasing debt portfolio and higher fiscal deficits, the media and academia seldom looked at the whole picture or questioned the performance of the provincial governments who have control over the higher share of revenues.

In his opinion, the Punjab government has almost similar finances at its disposal as the federal government but without the debt servicing and security expenditures, and yet it did not come under public scrutiny for its fiscal management. The additional fiscal resources have led the provincial governments to adopt an extravagant fiscal stance without being answerable to anybody. Distribution of free laptops, sasti roti, Danish schools and agricultural support prices higher than fixed by the federal government’s are some of the examples.

And instead of providing their cash surplus to the federation for an interim period as agreed, most of the provinces are in fact in deficit.

Punjab with an overdraft of about Rs29 billion, though lower than its annual limit of Rs37 billion, would not be able to provide any cash surplus during the current year.

Moreover, both the federal and Punjab government have entered a competition mode ahead of coming general elections. For example, the federal government announced an increase in wheat support price of about Rs100 per 40 kg two months ago and was bettered by Rs150 per 40 kg increase by the Punjab government.

Officials from Punjab attending the NFC meeting are reported to have indicated that whatever increase the federal government allows in the salaries of its employees, the Punjab government would surpass it. “If the federal government gives 100 per cent increase in salaries to government employees, the Punjab government would allow 105 per cent increase (in salaries),” a Punjab representative was reported to have said.

Likewise, the finance minister thinks the media and independent analysts have not questioned how the Balochistan government was utilising the huge additional transfers granted by the NFC. The same goes for the fiscal management in the two other provinces – KP and Sindh.

The higher receipts form the federal government has also made the provinces lethargic in mobilising their own taxes, particularly agricultural income tax and real estate, that they had promised under the 7th NFC Award and which were considered key to increasing the overall revenues to 15 per cent of GDP by 2014.

But then, the federal government has also played a passive role in pursuing the provincial governments to move ahead with these taxes. In view of political limitations, the provinces had requested the federal government to play an enabling role by creating common goals and strategies and tax rates to avoid a political backlash on a single party.

In fact, the NFC, soon after the announcement of budgets in July last year, had constituted a committee of all the federal and provincial finance minister and secretaries to work out a uniform agricultural income tax rate. The committee failed to meet even once since then.

With the general elections so close, no progress could be expected now given  that the taxes already imposed by the federal government have been on reverse gear.

The total divisible pool taxes of Rs1.182 trillion included an overall income tax collection of Rs445 billion that came down to Rs436 billion after adjustment of collection charges. Of this Rs248 billion were paid out to the provinces in first nine months of the current year and Rs184 billion to the centre. Likewise, the total sales tax collection in the same period stood at Rs558 billion, with net divisible share at Rs547 billion. Of sales tax, the provinces got a share of Rs315 billion and the federal government Rs233 billion.

The comparatively smaller taxes like federal excise, custom duties etc also followed the same trend. After transfer of one per cent (Rs12 billion) ‘war on terror’ expenses to KP and special additional transfers to Balochistan (Rs8 billion), the provincial share in the federal divisible pool increased to Rs700 billion in first three quarters of the current financial year.

Of the total provincial share of Rs680 billion in divisible pool, Punjab got the lion’s share of Rs352 billion – only Rs150 billion less than the federal government’s share. Sindh received Rs167 billion in first nine months of the current year while Khyber Pakhtunkhwa and Balochistan ended up with Rs99 billion and Rs62 billion respectively. The share of KP and Balochistan ultimately increased to Rs111 billion and Rs70 billion respectively after having been compensated for anti-terror expenses and backwardness grants.

In addition, another Rs39 billion were paid out to the provinces as special grants. For example, Sindh received Rs4.5 billion in first nine months against withdrawal of Octroi-Zila Tax (0.66 per cent), Balochistan received Rs13.2 billion additional grants. This included Rs9.5 billion for arrears of gas development surcharge under Aghaze Haqooq Balochistan Package. On top of that, KP was paid Rs19 billion on account of arrears of net hydro profit payable by Wapda and Rs3.4 billion to Punjab on the same account.