Make NFC work

The recent demands by multilateral institutions such as the IMF and the World Bank to review the National Finance Commission (NFC) Award have ignited a new debate on the distribution of resources in the country.

Our political trajectory has been characterized by continuous disputes between the center and the constituent units over the decentralization of political and fiscal powers. The Hamood-ur-Rehman Commission, established after the Bangladesh crisis, highlighted the unequal and unfair distribution of financial resources as a fundamental factor contributing to East Pakistan's alienation.

The 1973 constitution was an effort by political leaders to accommodate the concerns of the provinces. The latest NFC Award and the 18th Amendment passed in 2010 were sequels to such efforts to alleviate the concerns of the provinces and meet their demands for more political authority and fiscal space. However, despite these efforts, controversies between the center and the federated units persist, underscoring the need for a more harmonized and inclusive political framework.

The NFC's seventh award was overwhelmingly skewed in favor of the provinces. The main features of the award, which make it pro-provincial, included increasing the participation of the provinces in the vertical distribution between the center and the federative units. The federal share was reduced to 42.5%, while the provincial share was increased to 57.5%. In horizontal distribution, the award was designed to address the disparity between provinces by taking a more inclusive approach to resource allocation.

Instead of considering population size alone, the award incorporated several indices to ensure a fairer distribution of resources between provinces. This adjustment was intended to address long-standing complaints from smaller provinces and promote a more equitable distribution of resources. Given the larger population, in previous awards Punjab would get the lion's share of resources, leaving smaller provinces dissatisfied.

The VII NFC Award addressed this demand from the provinces by including other factors for the distribution of resources. The indicators and the weighting attributed to them are reflected below: population (82%); poverty/Backwardness (10.5%); revenue collection/generation (5.0%); and inverse population density (2.7%).

Another essential feature of the award, widely praised by Khyber Pakhtunkhwa and Balochistan, was the recognition of its specific considerations. In the case of KP, the award, while recognizing KP's role as a frontline province in the “war on terrorism”, allocated 1.0% of the divisible fund to the province. Similarly, while recognizing the special development needs of Balochistan, the award increased the province's share to 9.01% and also protected the minimum share of Rs 83 billion.

KP and Balochistan further benefited from the recognition of their claims for arrears in Hydel Electric profits and arrears in Gas Development Surcharge. For these items, KP would receive Rs 119 billion in five years, while Rs 10 billion would be transferred to Balochistan in the same period. Additionally, to maximize the size of the divisible fund, the award reduced the federal government's collection charges from 5.0% to 1.0%; this amount was further added to the divisible fund.

The aforementioned measures adopted in the seventh NFC award drastically reduced the size of the federal government's available finances. As a result of this award, not only was the federal share of the divisible fund reduced, but some taxes that until then had been collected and used by the federal government now became part of the divisible fund. In addition, the service sales tax was also given to the provinces to collect and improve their tax base. This has greatly reduced the size of the national fund, making it difficult for the center to meet its commitment to repay its debt and finance defense and development expenditure.

There is a strong need at the federal level to review the award. Critics of the award think the distribution formula was finalized without taking into account the center's future financial needs, especially debt service, defense needs and other exigency-based expenses. Due to the limited fiscal space that the 7th NFC Award has left for the centre, the federal government has no option but to resort to internal and external borrowing to pay off outstanding debts.

Similarly, the federal government finds itself in a difficult situation when the need arises for unforeseen expenditures. Natural disasters such as the 2022 floods, previous locust attacks and the Covid-19 pandemic posed challenges that required colossal funding. The federal government was too financially weak to deal with these crises without seeking foreign help.

Over the years, a number of proposals have been discussed to meet the federal government's spending requirements. One such proposal is to shift the financial burden of energy subsidies and the Benazir Income Support Scheme (Ehsas) to the provinces. For national security reasons, the federal government wants the provinces to give up at least 7.0% of their share to the federal government. However, this is easier said than done.

First, any such change to the resource distribution formula would require a constitutional amendment, which is not easy. The amended Article 160 (3A) now prohibits the successive National Finance Commission from reducing the allocated share of the provinces allowed by the previous finance commission.

The 18th Amendment enhanced the taxing powers of the provincial government by transferring certain taxes to the provinces: taxes on sales of services and taxes on real estate. Without an amendment to the constitution, these powers cannot be removed from the provinces. Any such move would inevitably encounter resistance from smaller provinces and some large political parties such as the PPP, which has been the strongest supporter of the 18th Amendment and the 7th NFC Award.

In such a scenario, one might wonder what options are left for the federal government to meet its pressing financial needs. Fortunately, the constitution empowers the president to intervene and favor the federal government without resorting to any constitutional amendment. Article 160 (6) of the Constitution stipulates that: “the President may, by order, make such amendments or modifications as he considers necessary or expedient in the law relating to the distribution of revenue between the federal government and the provincial governments.”

There is a strong likelihood that the President could use his powers to add or eliminate any taxes in the divisible fund, as authorized by Section 160(6), to offset federal revenue losses. In a similar move, in 2018 the federal government invoked this provision and imposed a tax on petroleum products by declaring it non-tax income.

Additionally, the federal government could step up its efforts to improve its tax-to-GDP ratio. The entire edifice of the 7th NFC Award fiscal distribution mechanism was built on the premise that the federal government would achieve a tax-to-GDP ratio of 15%. Unfortunately, instead of achieving a 15% tax-to-GDP ratio, tax revenues have plummeted to 9.0%.

Provincial governments have also failed; its tax-to-GDP ratio has fallen from more than 1.0% of GDP to 0.8% during the 2022-23 fiscal year. As such, there is a great need for tax collection agencies, both federal and provincial, to optimize their tax collection efforts. Once the size of the pie is increased, there will be enough resources for both the provincial and federal governments to meet their spending needs.

The writer is an independent contributor. He tweets/posts @MajidBuhair and can be reached at: [email protected]

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Originally published in The News