Increasing the size of cake

A heated debate on bringing changes into 18th constitutional amendments and much trumpeted 7th National Finance Commission (NFC) Award, has flared up once again. It is a long-standing wish-list of powerful quarters and when Pakistan Tehreek-e-Insaf came into power the first official document prepared by Ministry of Finance envisioned changes into 18th constitutional amendments and NFC Award.

This wish-list was perceived on wrong premises that the last NFC Award had deprived the center of major resource by transferring major the chunk of 57.5 percent share to provinces out of Federal Divisible Pool (FDP). However, no one bothered to read out the NFC Award that had outlined that the tax-to-GDP ratio would be jacked up by 1 percent every year and in five-year period it would go up from 10 percent to 15 percent. But this objective could not be materialised. By end of the current fiscal year 2020, the tax-to-GDP ratio would fall below 10 percent keeping in view the dismal performance of Federal Board of Revenue (FBR) for collection of revenues especially in post COVID-19 scenario. The FBR’s performance was not up to the mark even in pre-corona situation as the revenue collection was expected to touch Rs4,803 billion maximum in accordance with second-time revised target by the International Monetary Fund (IMF) against originally envisaged target of Rs5,555 billion on the eve of last budget.

Any effort of tinkering with the NFC and 18th constitutional amendments will have far-reaching negative impact on federalism. Instead of cutting others shares, why the center and provinces do not sit together to increase the size of the (pieces) of resources, because without increasing the size of the cake, this country cannot grow and bring prosperity into lives of downtrodden citizens. The increasing population is now all set to be doubled till 2050 so there is no other way but to increase the size of the cake with short-, medium-, and long-term strategies.

Pakistani authorities have informed the IMF that in order to rebalance inter-governmental relationships, in the context of the ongoing NFC, they have engaged with provinces with a view to make progress on the following measures such as passing on additional spending responsibilities from the federal to provincial governments, including additional contributions for higher education, health, social protection, agricultural subsidies, and regional public infrastructure investment. There is need for creation of a jointly funded contingency fund for economic shocks and natural disasters, to reduce federal/ provincial structural fiscal imbalances.

The provinces will take steps to increase own tax-collection efforts in sales tax on services, property tax, and agricultural income tax, and harmonise their tax system to eliminate fragmentation.

For reducing the scope of the divisible pool in the context of the ongoing NFC award, the reforming of the revenue sharing formula to improve inter-provincial equity for better horizontal equity is important. Pakistan is a Federal democracy. In order to maintain inter-governmental fiscal relationship, Article 160 of the Constitution provides for setting up a National Finance Commission with intervals not exceeding five years. The mandate of

NFC is to make recommendations to the President for the distribution of resources between the federal and provincial governments. The recommendations of the NFC are given legal cover through a Presidential Order.

Presently, 7th National Finance Commission Award is in practice. Through this Award, the financial autonomy of the provinces has been ensured by increasing their share in the Federal Divisible Pool from 46.5 percent to 57.5 percent from 2011-12 onwards. Earlier, the resource distribution formula provided the center 62.5 percent, while remaining 37.5 percent were meant for provinces. During the tenure of Pakistan People’s Party led regime, for the first time, the provinces’ share was jacked up phenomenally to 62.5 percent of total FDP.

With this lingering fiscal crisis, there is a need to adopt two-pronged strategy, whereby the center must transfer all ministries/divisions that were devolved under 18th Constitutional amendments. The duplications of ministries and departments will serve no purpose so restructuring will have to be done at federal levels. What are the justifications to keep devolved ministries/divisions at federal levels? The center will have to reduce its footprint where it is required to undertake real austerity, otherwise the fiscal imbalance will continue to persist. Secondly the provinces are also bound to raise their tax-to-GDP ratio on war-footing as a contribution of just one percent in the GDP is just peanuts at a time when agriculture income tax and GST on services are in the domain of the provinces.

Renowned economist Dr Kaiser Bengali in his research paper said, “There is a view that the 7th NFC Award transferred excessive resources to the provinces, creating a fiscal imbalance, and shrinking federal fiscal space”. “Concern arises also from the fact that the road to reducing the 7th NFC specified provincial (vertical) share has been blocked by a constitutional provision.”

In this context, Dr Bengali says a demand has been placed for the NFC to pre-allocate 7 percent of the Federal Divisible Pool for the federal government –3 percent for meeting security needs and 4 percent for meeting development needs of federal territories: Azad Kashmir, Gilgit-Baltistan, and FATA. The demand is based on a precedent created by the 7th NFC in pre-allocating one percent of the Divisible Pool for Khyber-Pakhtunkhwa (then NWFP).

“The other view is that federal interpretation of the fiscal impact of the 7th NFC is flawed and its demands untenable. It is held that federal fiscal gap has been created on account of its failure to (1) raise the tax-to-GDP ratio, as stipulated in the 7th NFC Award and (2) to follow up on the 18th Constitutional Amendment, which divested the federation of a wide range of functions and which, had it been carried out accordingly, would have served to reduce federal expenditures,” Dr Bengali said. Instead, he adds, the federal current expenditure growth over 2010-2017 has averaged 9.8 percent – nearly two percentage points above the average rate of inflation.

He said decomposition of current expenditure showed the civil administration expenditures had been contained with average growth restricted to 5.9 percent – two percentage points below the average rate of inflation. “The responsibility for fiscal profligacy lies with debt service and defence, which have averaged growth at above 12 percent each – four percentage points above the average rate of inflation. Herein lies the onus for fiscal imbalance,” he said.

It confirmed the above findings, showing that the share of debt servicing in total current expenditure had risen from 38 percent in 2010 to 46 percent in 2017 and the share of defence expenditure from 18 percent to 21 percent over the same period, while the share of civil administration declined from 44 percent to 33 percent, Dr Bengali concluded.

The writer is a staff member