Imbalances in NFC award

Asad Umar, the Finance Minister, stated in the Senate Tuesday that he has directed Secretary Finance to initiate the process for the National Finance Commission (NFC) award which, as per the constitution, determines the revenue share of provinces and the federal government from taxes identified in the divisible pool every five years. An NFC award has been the source of much acrimony in the past which accounts for inordinate delays in negotiating a subsequent award. Pakistan is 71 years old, the NFC awards began four years after independence in 1951, and if the next NFC award is agreed this year then that would be the eighth NFC award.
Article 160 of the constitution stipulates that the members of the NFC award include the federal finance minister, the provincial finance ministers, "and such other persons as maybe appointed by the President after consultation with the Governors of the Province." When all members are agreed the resulting recommendations are on-sent to the President who as per the constitution "shall, by Order, specify, in accordance with the recommendations of the Commission."
To reach a consensus on an NFC accord during dictatorships as well civilian governments indicates that distribution of financial resources is a highly politically sensitive issue. This explains why even the carefully selected Musharraf acolytes in the provinces and the centre failed to reach a consensus on the NFC accord after the previous one lapsed in 2002, though in what is now regarded as a usual sycophancy style, they did agree to accept whatever Musharraf deemed appropriate. This implied that the provinces did not agree to accept a binding NFC award for the subsequent five years which would have included as per the constitution's: (i) Article 160 (2) (a) 'the distribution between the Federation and the Provinces of the net proceeds of the taxes'; (ii) Article 160 (2) (b) 'the making of grants-in-aid by the Federal Government to the Provincial Governments; and (iii) Article 160 (20) (c) "the exercise by the Federal Government and the Provincial Governments of the borrowing powers conferred by the Constitution".
However, it was Article 160 (3) (a) that accounted for Dar's refusal to reach a consensus with the provinces from 2015 onwards (when the award was due to be negotiated) till he made himself effectively non-functional after the Panama papers verdict against him on 28 July 2017. The clause states that "the share of the Provinces in each Award of National Finance Commission shall not be less than the share given to the Provinces in the previous Award." The 2010 NFC award so claimed Ishaq Dar after he took over the portfolio of finance, gave too much away to the provinces - an award that he himself reportedly assisted in negotiating on behalf of the Punjab government - an award for which Chief Minister Punjab Shahbaz Sharif was hailed by all parties as he agreed to a change in the criteria from a mainly population based criterion, that benefited Punjab, to a multiple criteria - a long standing demand of the smaller provinces.
The first post-programme monitoring discussions with Pakistan report uploaded on the International Monetary Fund (IMF) website in March this year maintains that "improving efficiency, flexibility and responsiveness of the national federal fiscal federalism framework will be critical to contain medium term risks," which it states led IMF "staff (to) reiterate the need for strengthening the current framework with better alignment of revenue and expenditure responsibilities as well as improved coordination and resource sharing mechanism."
A report dated July 2017 on the IMF website, in the chapter on "fiscal decentralization and macroeconomic challenges in Pakistan" notes that the seventh NFC award contributed to substantial vertical fiscal asymmetry which is explained as follows: "as of fiscal year 2015/16, the provincial share of general government expenditure stood at 35 percent, broadly in line with, for example, average in OECD countries. However, the provinces' share in general government revenue was significantly higher - about 50 percent in FY 2015/16, pointing to a significant structural deficit at the federal level. In this respect, Pakistan's fiscal system is somewhat unique compared to other countries. In all OECD countries, for example, sub-national governments' share in revenue is generally lower than their share in expenditure with the resulting gap covered by various forms of transfers." In 2018-19, the total share of provinces is estimated at 57.5 percent compared to the federal government's 42.5 percent - a share frozen since 2015 when the next award was due.
The IMF report itemizes a number of relevant imbalances in Pakistan's fiscal federalism framework which include: (i) the design of fiscal federalism more than the degree of decentralization affects social and macroeconomic outcomes; missing in the 2010 NFC award but critical are setting clearly defined responsibilities between various tiers of government, securing predictable and stable resources to support increased expenditure responsibilities, and strengthening public finance management systems at the sub-national levels; (ii) devolution of resources was not tied to devolution of responsibilities; (iii) revenue sharing arrangement posed challenges for fiscal policy making and may have changed incentives at the centre and provincial levels by narrowing the range and effectiveness of fiscal policy instruments with the federal government focusing on increasing revenue from non-divisible pool taxes as well as diminishing the need to raise taxes by provinces; this did not happen in Pakistan's case as in the budget 2011-12 total divisible pool taxes (revised) were 1.063 trillion rupees while total taxes collected were 2.024 trillion rupees or around 50 percent. By 2017-18 total divisible pool taxes collected were 2.230 trillion rupees while total taxes collected were 4.147 trillion rupees again around 50 percent; (iv) devolution of resources was not synchronized with strengthening public financial management at provincial levels; (v) no provision was made for unforeseen contingencies including security related or natural catastrophes; (vi) public sector debt and flawed electricity sector management did not form a component of the NFC award and the Council of Common Interest was not strengthened enough to deal with these issues which partly accounts for the massive increase in the country's indebtedness during the past years and the sustained poor performance in managing the electricity sector; (vii) decisions by Fiscal Consolidation Committee (comprising of fiscal and provincial secretaries) are non-binding and have not been implemented; and (viii) decentralization has not trickled down to the local governments yet. These are some useful pointers identified in the report and one would hope that Asad Umar takes the time to familiarize himself with this report before proceeding with negotiations on the next NFC award.