ISLAMABAD: The World Bank (WB) has warned that devolution remains an incomplete agenda in Pakistan and there is a mismatch in revenues and expenditures among the federal and provincial governments.
According to the Pakistan Development Update released by the WB the 18th Constitutional Amendment promulgated in 2010 and the 7th NFC Award that preceded it established the framework for fiscal decentralisation in Pakistan.
Considered to be the most far-reaching reform in the country’s constitutional history, it significantly increased the overall share of sub-national governments in the country’s revenues and re-established the fiscal autonomy of the provinces in taxing and spending decisions.
The 18th Amendment abolished the Concurrent Legislative List (CLL), devolving nearly all 47 responsibilities of the CLL to the provinces. It also strengthened the role of key constitutional bodies, including the Council of Common Interests (CCI) and the National Economic Council (NEC) to coordinate intergovernmental relations.
The 7th NFC Award was approved before the 18th Amendment, with financing arrangements therefore not informed by service delivery responsibilities. As a result, the revenue mobilisation and expenditure responsibilities at the federal and provincial levels are not aligned and lead to recurrent budget shortfalls.
Progress with implementing the devolution agenda has stalled since the 18th Amendment, with current arrangements distorting incentives and accountabilities and impeding performance, both at the federal and provincial levels.
Because formal responsibility for delivering most services resides with the provinces, and around one-half of federal revenues are transferred to provinces, the federal government faces weaker incentives to raise revenues. Because provinces receive funds from the federal divisible pool regardless of service delivery performance, they face few incentives to bear the political cost of imposing additional taxes or even collecting existing taxes. Because the federal government continues to devote significant resources to spending in formally devolved areas, there are substantial overlaps and major problems of coordination in service delivery. Public accountability for service delivery and economic development is weakened at both the provincial and federal levels. Provinces have therefore used additional fiscal space from increased transfers to increase recurrent spending, especially on payroll and pensions, leaving development spending unchanged.
In the absence of effective coordination, constitutionally fragmented tax bases have further constrained effective tax policy and administration. The sales tax base is fragmented between tax on goods and on services, the former legislated and administered by the federal government and the latter under the purview of the provinces. Similarly, the income tax base is fragmented between agriculture income (provincial tax base) and non-agriculture tax (federal tax base).
The constitutional division of taxing powers has impacted authorities’ ability to legislate, implement, and reform a coherent tax policy. It has also led to tax arbitrage and tax evasion and an enormous tax compliance challenge for businesses. In addition, the lack of adequate data-sharing protocols between the federal and provincial tax agencies hinders enforcement, creating even more opportunities for tax avoidance, especially in income taxation.
The country’s existing fiscal institutions and intergovernmental coordination arrangements have constrained the effective management of the government’s finances. Fiscal policymaking is fragmented across numerous bodies resulting in institutional gaps that contribute to the lack of focus on achieving sustainable fiscal outcomes at the national level.
Pakistan’s fiscal legislation, the Fiscal Responsibility and Debt Limitation (Amendment) Act 2022 limits country’s public debt GDP ratio below 60 percent of the GDP and makes preparation of a national Medium-Term Fiscal Framework mandatory. However, the law lacks safeguards against the violations of these thresholds. The lack of a consolidated medium-term framework to anchor both federal and provincial budgets and fiscal targets results in incremental budgeting and a lack of coherence between the objectives of the federal and provincial governments, contributing to sizable recurrent fiscal deficits.
Devolution remains an incomplete agenda to resolve constraints arising from current fiscal institutional arrangements, action is needed to:
i) Strengthen coordination and coherence between federal and provincial fiscal policies, including through enhanced cooperation on tax policy and administration, service delivery, and fiscal policy
ii) Amend the revenue sharing arrangement to ensure that resources commensurate with responsibilities. Institutions like the CCI and NEC should play a more active role in shaping a common fiscal framework. Strengthening the fiscal federalism framework is crucial for long-term fiscal sustainability Priority reforms to address the challenges identified above include: a) resurrecting institutions for fiscal coordination, including the CCI; b) implementing legal reforms to support a national fiscal policy; c) limiting federal spending within provincial mandates to reduce federal expenditures and improve accountabilities for service delivery; d) developing a national tax policy and strengthening federal-provincial coordination on tax policy; and e) revisiting the 7th NFC Award in order to ensure that financing is aligned with functions for provincial and federal governments.
