NFC award: the thorny issues

On November 19, at a press conference, after two days of deliberations with the provincial finance ministers, the federal finance minister could claim no more than a 'consensus' among the participants. Province-wise allocation of federal revenues (vertical distribution) remains the thorny issue.
In the last NFC award, the cumulative share of the provinces in the federal divisible pool was 49, but until the day before Tarin's press conference in Karachi, while Sind and Balochistan were demanding 60 percent share of this pool, NWFP was demanding as much as 80 percent.
Although the profile of the 'consensus' is unclear but if indeed it was the end result, Tarin deserves credit for it. Bringing such widely differing demands within the framework of consencus is a big achievement. One issue on which all provinces did agree was giving a part of their respective shares to NWFP for the huge reconstruction cost to be incurred after the current peace-restoring operation in the NWFP comes to an end.
For this commonly shared cause, a fraction will first be deducted from the federal pool and thereafter the provinces get their share (horizontal distribution). That's when problems will start because provinces have their stock of historic grievances against the federation over allocation of their shares. But to address them the federation has proposed four rational (though tough to measure) yardsticks to determine each province's share.
These bases for 'horizontal' distribution, that according to Tarin were agreed by the provinces, are: a) population, b) backwardness, c) inverse population density and, d) revenue generation and collection; what is yet to be agreed is the distribution formulae, and the weight to be assigned to each of these bases. That's no surprise because assigning weights to these factors must be based on credible province-wise current statistics.
The fact, however, is that the formulae must be devised by experts in macroeconomics and sociology, and the weight for each factor must be based on ground realities; politicians everywhere lack these credentials. Even more important is the fact that these experts must be independent and autonomous in conducting this exercise. To credibly administer the state, politicians can't afford making mistakes; they must rely on expert advice. But even if experts are assigned this tough task, they will confront the mother of all problems - inadequate and out-dated statistics. Experts need to devise indicators of allusive and inadequately defined yardsticks like 'backwardness', and 'inverse population density' to highlight and quantify the problems faced by small populations residing in an area-wise huge province like Balochistan.
Both these yardsticks are subject to differing definitions, depending on what bases are preferred by the provincial governments. There is obviously a world of a difference between, says, Khuzdar and the Defence Housing Societies anywhere in Pakistan. But there are huge similarities between Khuzdar and the slums in every big city of Pakistan. So, how do you define and quantify backwardness credibly and comprehensively?
Defining inverse population density may be a bit easier because in this context what is worth highlighting is its negative impact on people of being virtually cut off from developed towns and cities in terms of mobility, access to employment, child education, healthcare and minimum civic amenities, in short, losing out on all benefits essential for raising the standard of living to the level of the rest of the Pakistanis.
The criteria both relevant and reasonably quantifiable are population, and the generation and collection of revenue. But even if we accept the census figures dating back to, perhaps 2006, and assume that distortions in it, hopefully, impact all provinces equally, it may not be wholly valid because of large population migration from one province to another after 2006, which could benefit one province at the expense of the other.
Including revenue generating capacity among the fund allocation criteria must be lauded because it will highlight to each province the importance of revenue generation. Secondly, differentiating between revenue generation and collection is very important. What this prioritises is the importance of the location of the revenue generating activity over the location where revenue is collected.
Karachi, the capital of Sind, houses the head offices of many businesses (eg financial institutions) with countrywide networks. While these entities pay income tax to the FBR office in Karachi, their income is generated from outlets all over Pakistan. Therefore, tax collection alone can't be a valid basis for allocation of funds to Sind; benefit of generating the revenue must go to the relevant province(s).
This sounds both logical and fair depending on the basis for defining what a nation-wide revenue generating entity is. But, will it be possible to identify all such entities in each province (and devise a fair basis for treatment of taxes collected by the provinces) by December 10, the date when the formula for 'horizontal' distribution of funds is to be finalised? Obviously not, but given time and credible expert advice, this tough exercise can produce the desired results.
The crux of the matter is that Pakistan needs to increase the size of the federal divisible pool. With the tax-GDP ratio falling to 8.8 percent instead of rising from its peak of over 12 percent in the past, and the GDP unlikely to rise at its 2004-08 pace, there is no short-cut to raising tax revenues. The rise of the ratio to 13.9% in the next five years is not enough; the target should be at least 15 percent because that is achievable.
According to Transparency International (TI), as of now, the estimated leak in tax revenue is around Rs 500bn. The TI report also points out that while half of this amount is accounted for by corrupt tax collection practices, the other half owes itself to corrupt 'procurement' practices of the state offices, both federal and provincial. More than seeking a higher share from the federal divisible pool, provinces need to reverse these trends.
At the same time, there is dire need for optimising value generation from each Rupee of revenue; it calls for good governance - strict supervision and accountability - wherein provinces continue to lag behind. Nor do we find much concern for adopting austerity measures in a country that is in a state of war. Remember the fate of the austerity plan recently presented to the Federal Cabinet by the Ministry of Finance?
Finally, taking a higher share in the federal revenue pool will entail taking over more state offices, functions and obligations. Are the provinces gearing themselves to take on this load and carry it in a result-oriented fashion?