Time to revisit the NFC Award

Notwithstanding the recent IMF demand to amend the existing NFC award, there is a longstanding need to address the serious fiscal issues created by the last award.

The 7th NFC Award and the subsequent 18th Constitutional Amendment resulted in a significant fiscal and administrative decentralization which left the ensuing fiscal federal structure unbalanced, unmanageable and posed macroeconomic and political challenges.

The 7th NFC Award transferred an unprecedentedly large share of the divisible pool and other resources to the provinces from the federation without the re-assignment of additional expenditure responsibilities to the provinces.

Thus the 7th NFC Award contributed to a substantial vertical fiscal asymmetry, creating a significant structural deficit at the federal level with a number of policy challenges discussed below. The biggest political challenge comes from the 18th Amendment which followed, stipulating that the revenue share of the provinces in any subsequent NFC Award cannot be less than the share given in the previous Award.

Main features of the 7th NFC Award were: (i) increasing the provincial share in the divisible tax pool from about 47.5 percent in FY2009/10 to 56 percent in FY 2010–11 and to 57.5 percent from FY 2011–12; (ii) expanding the divisible pool of federally collected taxes by reducing the federal government’s collection charge from 5 to 1 percent; and (iii) moving the General Sales Tax (GST) on services from the divisible pool to the exclusive domain of the provinces.

In addition, the 7th NFC Award altered the formula for horizontal distribution of resources among provinces from population base to multiple parameters, including population, poverty, inverse population density and revenue collection.

The justification for first three parameters is consistent with Constitution’s Articles 160 to 164 read with Articles 37 and 38 encouraging equitable distribution of resources. But the last parameter, Revenue Generation/Collection is a de-equaliser and contributes to increasing disparities between provinces.

There are several important imbalances that resulted in the implementation of the 7th NFC Award both vertically between the federation and provinces and horizontally between provinces:

i- As a result of the 7th Award, the federal government’s ability to respond to unexpected expenditure needs of national importance as well as its ability to assist provinces (e.g., in times of natural disasters) has become limited. This has contributed to the budget deficit and rising debt burden reducing available resources for infrastructure development in subsequent years.

ii- With more than half of tax revenue going to the provinces, federal efforts to raise revenue need to be substantially larger for the federal government, resulting in increased tax burden on existing taxpayers and businesses with adverse consequences for tax compliance and loss of competitiveness contributing to a severe balance of payments crisis.

iii- The devolution of resources was not associated with the devolution of service responsibility to the provinces.

iv- The Award does not address the issue of sharing the burden of financing joint responsibilities that are critical functions of national importance, which fall under the jurisdiction of the CCI (Council of Common Interest) — and hence joint responsibility of the federal and provincial governments after the 18th Amendment that by default, continue to be financed by the federal government; in particular, public debt service of loans taken for national projects.

v- The award does not assign responsibility to provinces for line losses and circular debt of electricity sector despite the unbundling of distribution companies into regional companies (DISCOs), which pose considerable claims on federal public finances.

vi- ‘The NFC Commission’s recommendation that the federal and provincial governments develop and enforce a mechanism for maintaining fiscal discipline at both levels remains difficult although the Fiscal Coordination Committee (FCC), helps to synchronize policy coordination and budget implementation.

vii- Apart from 57.9% share in the divisible pool, the provinces now have exclusive tax jurisdiction over agriculture and services (both potentially buoyant sectors), and which account for 80 percent of Pakistan’s GDP.

This will further skew the resource allocation vis-à-vis the federation as tax collection in these sectors grows in the coming years. ‘Despite significant taxing powers, provinces have collected only a small percent of the national fiscal revenue.

viii- Devolution of fiscal resources to the provinces has not been accompanied with strengthening public financial management (PFM) frameworks at the provincial level resulting in significant wastage and pilferage of resources in the provinces.

ix- By removing GST on services from the divisible pool, provinces will receive varied amounts from this source due to differences in their revenue capacity thus contributing further to disparity between provinces.

x- As a result of the inclusion of revenue collection in the multi-indicator formula, the 7th Award gives more resources to provinces that collected more revenue, rewarding richer provinces with additional resources thus accentuating disparities in development between provinces.

xi- The demand for a larger share in divisible pool resources in the NFC by the provinces was rooted in the acute shortage of resources for running of local governments yet fiscal decentralization did not trickle down to local governments notwithstanding some progress in some provinces.

xii- Progress in improving basic social service delivery-one of the key economic justifications for fiscal decentralization- has been mixed with the exception of KP.

xiii- Revenue mobilization from agriculture and real estate has not shown much improvement relative to GDP.

Fiscal experience post NFC award

Despite fiscal consolidation and increased tax collection fiscal outcomes were much worse than projected in part linked to the imbalances of 7th NFC decentralisation. In its attempt to raise revenue, the federal government embarked on taxation without assessing its impact on competitiveness of the economy with adverse consequences for the balance of payments.

Lack of resources with the federal government may have also contributed to a number of related fiscal imbalances in the power sector manifest in the circular debt and pending refunds to exporters, both of which further eroded competitiveness, restricted growth of the manufacturing sector with consequences for unemployment. Thus the imbalances triggered by the 7th NFC Award directly and indirectly contributed to a range of macroeconomic problems.

Copyright Business Recorder, 2024