The intergovernmental level of fiscal relationship varies in almost all countries. A good transfer system should distribute funds on the basis of explicit formula. The arrangement is called fiscal federalism. The bases of good formula are needs, capacity and efforts. In Pakistan, only population and to some extent location of natural resources forms the basis of fiscal transfers. The federation has to collect almost 96 per cent of revenue and provinces virtually make no effort to mobilize resources, rather they depend on the federation for their fiscal needs. The fiscal federalism in Pakistan has always remained a thorny issue.
The prevalent NFC award was approved in 1997 and made the federal government responsible to constitute a divisible pool consisting of gross receipts of (a) taxes on income, (b) wealth tax, (c) capital value tax, (d) taxes on sales and purchase, (e) export duties on cotton, (f) custom duties, (g) federal excise duties excluding excise duty on gas charged at well-head and, (h) any other tax which may be levied by the federal government. The award was for five years and expired in 2001-02.A new award was due before June 30, 2002 and resources were to be distributed in 2002-03 under the new award.But the provinces could not agree on a formula and the resources had to be distributed according to the old formula.
The shares as recommended by the NFC are distributed as follows. The federal government deducts 5 per cent of such receipts mentioned in (a) to (h) as collection charges. Of the balance, 62.5 per cent goes to the federal government and remaining 37.5 per cent are distributed among the four provinces according to their population, based on 1981 census under the Distribution of Revenue and Grants-in-Aid Order, 1997. The province-wise share in the divisible pool, worked out is: Punjab (57.88 per cent), Sindh (23.28 per cent) NWFP (13.54 per cent) and Balochistan (5.3 per cent).
All the four provinces have asked the federal government to direct more resources towards provinces. An initial agreement had been reached in an NFC meeting in Peshawar and later on in Islamabad that the federal government will retain 60 per cent share while 40 per cent will be offered to the provinces. However, Sindh demands more weight be given to fiscal efforts while Balochistan wants more consideration to its geographical size. NWFP wants royalty for its hydroelectric potential.
Punjab is not ready to loose ground on its stand which has made the task of declaration of award more difficult, although after the inclusion of subvention grant of Rs20 billion and 2.5 per cent share in GST, the federating units may get roughly 44 per cent of the tax revenue but still they want more to be done.
Pakistan is not the only country where distribution of resources among federating units is practised. But unlike Pakistan, federating units have explicit formulas based on explicit criterion. Indonesia in this regard is referred as a success story of fiscal federalism because its formula of distribution is valid since 1965 without serious complaints from federating units. This is also helped by the fact that Indonesia has a reliable system of collection and distribution of fiscal resources.
In industrialized countries like the United States, gradual devolution or decentralization of fiscal authority is in progress and different states have their own set of fiscal laws. In Germany, Landerfinanzauleich, is a system of horizontal transfers among the states of the federal republic designed to reduce differences in the annual per capita revenues from the main taxes of the states by granting more to the economically backward states. The Unites States has very complicated formula but still the focus of priority in distribution is development and less developed states get more resources.
The provinces in Pakistan make no fiscal efforts as they know that they will be bailed out by the centre in the hour of need, and that, somehow the costs of excessive deficits will be spread out over the entire country. In addition, the federal government may have a comparative advantage in tax collection and tax administration, because provinces have very inefficient local administrative structure. The situation in the district governments is even more precarious. It may be noted that every province complains against the federal government for not releasing the budgeted amount during the fiscal year.
However, for example, the estimated Rs193.5 billion of provincial share is consistent with Rs460.6 billion of tax collection in 2002-03. If there is a shortfall (and most likely there will be) in tax collection, the provincial share will also decline. The provinces are normally asked to keep their budget below the estimated allocations because of likely shortfall. The year 2001-02 was an exceptional year when provinces were collectively made to cut expenditure as much as by Rs15 billion (See Table-1). On the other hand federal expenditure exceeded the prescribed limits by a fair margin. Federation should set an example by economizing the expenditure. It is very hard for provinces to bridle the rising expenditure needs at the eleventh hour. The resultant overdraft adds to the already high debt of the provincial government.
The precarious budget position of the provinces is evident from the fact that they have hardly enough resources to finance unavoidable non-development expenditure and they are impotent to finance development needs of the provinces. The so-called devolution plan has exerted extra burden on provincial exchequers. The current NFC award fails to allocate enough resources for provinces for onward distribution to district governments. The district governments will suffer funds starvation like provincial governments. The devolution of powers or finances to grass root level is corruption prone and the district government setup is likely to create more wastage of funds than provincial governments. The provincial governments always complain about high rate of interest on federal government’s loans. The debt servicing liability of the provincial governments is therefore unsustainable.
The abolition of octroi tax is widely appreciated by the general public at large but it was the only source of revenue generation in the local councils. On the other hand roads all over the country are encroached with toll tax collection points and their revenues directly go to the centre. Only a fraction of this collection goes to the national exchequer while major portion goes to bank accounts of contractors. New tax levies by the local councils or provincial governments would be unbearable for poor people while the government will get a small amount.
The country needs judicious levy of taxes at all levels of governments including local councils, district councils, provinces and the centre. The provincial governments also needs to break the begging bowl and instead made serious tax collection efforts. All provincial governments are accustomed to keep un-necessary army of employees. Therefore, they also need rationalization of expenditure, especially, on salaries head. The element of waste in provincial governments’ expenditure is enormous and to be curtailed at once.
The cost structure attached to the revenue collection also needs to be reviewed. The cost of collecting provincial land revenue is probably one of the highest in the world. The federal government should collect taxes but collection as well as distribution should be equitable. The explicit formula for the distribution should consider backwardness as the key factor. The idea of inclusion of subvention grant is important but more important is autonomous body to distribute resources.
The NFC should have an autonomous structure and be responsible to arbitrate all matters relating to inter-provincial and federal-provincial relations. The distribution of development expenditure among federating units should be included in the jurisdiction of the NFC body. The federation should ask the federating units to submit blue print of their development needs and then prioritize them. Moreover, the federal government can inform provinces about priority areas and invite projects in these areas from provinces. This will create harmony among provincial units.