The finance ministry notified and convened belated meeting of the 8th National Finance Commission (NFC) to develop a mechanism for distribution of resources between federal government and the provinces for the next five years.

Resource distribution in a federation is a complex and often contentious affair. Relations between provinces and centre have never been cordial in Pakistan. The three smaller provinces have a deep-seated discontent, the roots of which can be traced to over-centralised policies adopted since the formative years of the country. A tight-fisted centre has been cavalierly devouring the resources of smaller provinces. Exploitation of resources and a callous repudiation of Bengalis’ political rights culminated into an ignominious debacle.

Sanity did not dawn on the rulers even after the dismemberment of the country in 1971.

Making population the sole criterion for vertical distribution of resources has been disproportionally favoured Punjab being the most populous province. This decision was taken unilaterally without consulting other provinces that sowed the seeds of discontent. India allocates only 20 per cent on population on the basis of the population recorded in 1971.

The 7th NFC award for the first time, recognised other factors for allocation of resources. Although the weightage assigned to these factors was paltry, it was a seminal shift in favour of the remaining provinces. The 7th NFC award redefined the basic structure of the resource distribution formula. In all likelihood, provinces will seek widening of this aperture in the 8th NFC award.

Procrastination in nominating technical members especially by Sindh, caused inordinate delay in notification of the 8th NFC award.

The nine-member commission was constituted hardly two months before the expiry of the current award ending on June 30. The ongoing 7th award will cease to exist from July 1, 2015. Article 160 of the Constitution reads out that within six months of the commencing day and thereafter at intervals not exceeding five years, the President shall constitute a National Finance Commission (NFC). Deliberations on the new award are less likely to be concluded before the expiry of the current award.

Obviously recommendations of the new award cannot be incorporated in the upcoming budget.

The 7th NFC award was formally signed on December 30, 2009, in Gwadar and that is how it was included in the federal and provincial budgets for fiscal year 2010-11 in June 2010. This time the process is delayed by almost a year, making it impossible to reach consensus for the next award before the budget, process for which has already begun. The only option is to extend the award in vogue for another year.

The 7th award introduced some major changes e.g. size of the divisible pool was enlarged by reducing collection charges of the federal government from five to one per cent. Provinces’ share was increased from 46.25 per cent to 57.5 per cent, effectively reducing the federal government’s share to 42.5 per cent. KP received one per cent extra from the divisible pool as a frontline province against the war on terror.

General Sales Tax (GST) on services was made a provincial tax. Discretionary grants-in-aid to provinces were scrapped. Sindh was allocated 0.66 per cent of the pool to offset its loss due to the merger of one-sixth of GST in the divisible pool.

A policy paper of Social Policy and Development Centre (SPDC) on the subject provides a comprehensive analysis of benefits accrued to the provinces through the 7th award. The paper reveals that compared to 6th award, provincial share increased by Rs1228 billion and the federal share reduced by Rs1148 billion during the same period. Punjab and Balochistan gained Rs320 billion and Rs319 billion each whereas Sindh and KP gained Rs290 billion and Rs307 billion respectively through the divisible pool. However, the projections of tax receipts of both federal and provincial governments miserably fell below the projections.

In contrast, the current expenditure of federal government and the provinces dwarfed their projections. As a corollary, provincial development expenditure was slashed by over Rs400 billion to bridge the yawning deficit.

As negotiations for the next award are afoot, provinces are trying to jostle for a larger pie this time. Smaller provinces feel that the current weightage of population i.e. 82 per cent is very high and should be trimmed further by increasing the share of other three indicators. Punjab will have a heavy cross to bear on this account. Balochistan is vying for increased weightage for inverse population density and backwardness.

Punjab is expected to safeguard the current weightage assigned to population. It may also confront the federal government’s requirement from the provinces to create budget surpluses to satisfy the IMF’s demand, and the imposition of excise duty on provincial services. The IMF, under fiscal reforms agenda, is asking the provinces to cut their expenditure to reduce federal deficit. This has caused resentment among provinces, including Punjab.

Provinces have a legitimate grievance that the federal government is not reciprocating by reducing its budgetary deficit. KP, apart from demanding the underpaid hydroelectricity profits, is also mulling over the demand to increase its share of the war on terrorism allocation from 1 to 3 per cent. Similarly, Sindh is contemplating to demand a similar allocation as a massive operation is going on in Karachi which is hemorrhaging the provincial government’s resources. Sindh is also expected to demand that the collection of GST on goods should be transferred to provinces. Additionally, Sindh has indicated to demand compensation for hosting a large number of legal and illegal immigrants from other provinces and countries, which is a burden on the provincial government.

In India, the proposal for 14th Finance Commission recognises this factor. The proposal reads "as the states are subjected to more and more interstate migrant workers and illegal migrants from the neighbouring countries, the finance commission shall give appropriate weightage in distribution of the total taxes to the states based on these criteria."

The federal government would attempt to regain a part of the lost share in the divisible pool. The argument is that higher provincial shares were based on a major assurance that the tax-to-GDP ratio would be raised to 15 per cent from the current ratio of less than 10 per cent. Under the 7th NFC award, the provinces had promised to widen their tax base by effectively taxing real estate, agricultural income and services, which did not happen at the desired level.

However, the federal government’s argument has already lost its steam as the federal government not only failed to meet its own tax collection projections but also could not contain the current expenditure that surpassed the projections.

Better fiscal management is an obvious need at both federal and provincial level. Provinces would demand increased share due to transfer of subjects under the 18th Amendment. With the passage of 18th Amendment, 47 subjects of the erstwhile concurrent list were devolved to the provinces. Transfer of these subjects entails an additional hefty salary and pension bill, development of infrastructure of the devolved departments and expenditure on operation, maintenance and procurements.

After the 7th award, federal public sector development programme does not allocate adequate resources for schemes pertaining to these subjects. Council of Common Interest in its meeting held in April 2011 decided that all projects located in the provinces, except being carried out under the president and prime minister’s directives, would be financed by the provinces. SPDC’s report Devolution and Social Development mentions that the total cost of the projects transferred to the provinces stood at Rs108 billion. Adjusting the expenditure of Rs40 billion incurred on the projects, a throw forward of Rs68 billion was heaped on the provinces.

On the other side, the federal government would also negotiate for a greater share to meet the spiralling debt servicing and defense budgets. Natural disasters and war on terrorism are also stretching the federal government’s kitty. Whereas Article 160 guarantees that the share of the provinces in each award of NFC shall not be less than the share given to the provinces in the previous award, the NFC has to recommend taxes to be made part of the shared basket.

Constitution stipulates certain taxes explicitly and provides discretion to the president to include any other taxes and duties to constitute the divisible pool. Custom duty can be a pertinent example to cite.

Redefining the ingredients of divisible pool can alter the whole equation in favour of the federal government. However, it will be a political upheaval for the federating units. A real thrust is required to contain current expenditure and improve a chronically ill tax collection system. Reckless borrowing is not a sustainable solution.