Pakistan’s federal fiscal system faces acute challenges as it negotiates the distribution of resources between the centre and provinces. On August 22, President Asif Ali Zardari constituted the 11th National Finance Commission (NFC), tasked with recommending the sharing of divisible revenues as per clause (3) of Article 160 of the constitution. The commission’s meetings will likely involve critical and complex negotiations.
Yet, the NFC debate often narrowly centres on revenue-sharing formulas, overlooking a fundamental flaw: without empowering local governments, Pakistan’s fiscal federalism remains dysfunctional and distant from its citizens’ needs.
Other reasons compound dysfunction. The 2010 NFC Award excluded key joint federal-provincial responsibilities – such as public debt and the electricity sector – which impose major fiscal costs and remain fully funded by the federal government. Fiscal resource devolution was also not aligned with devolved expenditure responsibilities.
A glaring symptom is the reporting of tax expenditures – revenues forgone through exemptions and concessions to select sectors and groups. The Ministry of Finance initially reported tax expenditures at a record Rs5.84 trillion ($21 billion), or 5.1 per cent of GDP, for the prior fiscal year. This figure was quietly revised down by Rs3.4 trillion to Rs2.43 trillion shortly afterwards, with the correction buried in an annexure of the Economic Survey of 2024-25 and no clear explanation provided. This inexplicable change, with a fiscal impact twice that of the Petroleum Development Levy (PDL), has attracted little public attention.
Mere adjustments to revenue shares cannot fix the deep fiscal dysfunction. As Dr Nadeem Ul Haque recently argued, Pakistan needs a comprehensive fiscal decentralisation programme that extends beyond federal-to-province transfers to address the critical gap: provincial-to-local devolution. True fiscal federalism requires all levels of government to have clear responsibilities, adequate resources and real authority.
Traditionally, federal tax revenues' divisible pool allocations have prioritised population, with some adjustments for poverty and regional development. These formulas, however, have failed to drive better public services. The current NFC deliberations may explore reducing population weight and linking provincial shares to indicators like education, health and tax effort.
In FY2024-25, gross NFC transfers approached Rs7 trillion, while transfers net of provincial surpluses sent back to the centre were closer to Rs6 trillion – about 50.3 per cent of federal tax revenues – compared to the 57.5 per cent provincial share agreed under the 10th NFC Award. The 7th NFC Award increased the provincial share in the divisible tax pool from about 47.5 per cent in FY2009-10 to 56 per cent in FY2010-11, and further to 57.5 per cent from FY2011-12 onwards.
The federal divisible pool excludes significant non-tax revenues like the PDL, which reached Rs1.16 trillion in 2024-25 and is projected to hit Rs1.47 trillion in 2025-26. Since federal tax revenues of Rs11.9 trillion account for approximately 70 per cent of total federal revenues (Rs16.8 trillion), NFC transfers represent just 35.6 per cent of overall federal revenues – contrary to claims that they leave very little for the federation. Although the PDL functions like a tax, it has been excluded from the divisible pool for over two decades.
The bigger challenge is debt servicing, which rose from 33 per cent of total federal revenues in 2013-14 to 66 per cent in 2023-24, before easing to 53.2 per cent in 2024-25. This left little room for defence, civilian governance, social safety nets, or infrastructure – let alone to prepare for the potentially catastrophic challenges posed by climate change.
After debt servicing and NFC transfers, the federal government’s resources are perilously stretched. As federal resources shrink, borrowing grows; domestic debt climbed by Rs6 trillion (5.1 per cent of GDP) in the first 11 months of the last fiscal year, equating to nearly $2 billion monthly.
The 18th Amendment devolved key sectors, such as education and health, to the provinces. However, provincial power has concentrated at the chief minister level, with local governments sidelined through frequent dissolution of councils, delayed elections, and strict financial control. Starved of autonomous revenues and reliant on arbitrary provincial grants, local governments struggle to reliably provide water, sanitation and infrastructure.
Mumbai, with 20 million residents, exemplifies effective local governance: its municipal budget of $3.2 billion – almost equal to Pakistan’s federal civilian government budget – is funded nearly 76 per cent by locally raised revenue from taxes and fees. Citizens trust and pay because local government delivers. In Pakistan, by contrast, this essential social contract is broken.
Indonesia’s post-Suharto decentralisation in the early 2000s devolved significant fiscal and administrative powers to 38 provinces and 514 districts and municipalities, offering a clear example of effective fiscal federalism in a diverse and populous country with a population of approximately 285 million in 2025.
Post-18th Amendment, provinces received larger budgets, yet outcomes remain poor. Education, a key devolved sector, illustrates this failure. Pakistan’s literacy rate for those aged 10 and above rose from 26.2 per cent in 1981 to 60.65 per cent in 2023, according to the 2023 census; however, progress has stagnated since 2010.
In Khyber Pakhtunkhwa, literacy fell from 52 per cent in 2013 to 51 per cent by 2023. In Sindh, the rate dropped from 58 per cent in 2008 to 57.54 per cent in 2024-25, according to the Pakistan Economic Survey. Provinces allocate 15-20 per cent of budgets to education, but mismanagement, corruption and lack of accountability have yielded poor results.
Pakistan’s central challenge is not just raising tax revenues but overcoming chronic export stagnation. Overburdening the federal government with boosting the tax-to-GDP ratio has resulted in a punitive tax load on the salaried class and formal sector, severely discouraging investment, innovation, and expansion within the formal economy; thereby stifling broader economic growth.
Pakistan’s tax-to-GDP ratio languishes at 9-10 per cent. India’s federal system, while imperfect, sees states contributing 6.0 per cent to a national tax-to-GDP ratio of 18 per cent in 2024. In contrast, Pakistan’s provinces contribute less than 1.0 per cent to the tax base.
The agriculture sector remains largely untaxed due to the domination of legislatures by feudal interests. Rising debt servicing crowds out development spending, while provinces’ failure to generate own-source revenues entrenches reliance on NFC transfers, perpetuating an entitlement culture rife with corruption and incompetence.
To achieve genuine federalism, Pakistan needs fiscal decentralisation that goes beyond simply transferring funds from the federal government to the provinces. A new constitutional amendment should devolve fiscal and administrative powers to local bodies, granting them the authority to raise revenues, such as maintenance fees, and make autonomous spending decisions. Provinces must be required to share at least 30 per cent of the cost of servicing public debt. Provinces should also generate 3.0 per cent of GDP in own-source revenues by 2029, tied to NFC distributions, to reduce dependency on federal transfers.
Agricultural income tax should be reassigned to the federal government, as was the case under the now-defunct January 1977 law repealed by Ziaul Haq, to broaden the tax base. Federal operating expenses should be capped to inflation-indexed growth, with a 20 per cent reduction in civilian government costs achieved by closing redundant ministries. Finally, local governance must be protected through constitutional guarantees of political and financial autonomy, ensuring timely elections and continuity of tenures for elected representatives even in cases of election delays.
Pakistan must address its fiscal crisis through tax base expansion and fiscal discipline. Provinces should tax underutilised sectors, such as real estate, to reduce their reliance on federal transfers. Federal reforms should streamline bureaucracy and cut wasteful expenditure to free up resources.
Federalism is not merely a matter of fiscal arithmetic; one of its core objectives is to bring governance closer to citizens and improve their living standards. While the 18th Amendment and NFC awards have been significant milestones, they remain largely symbolic without genuine grassroots devolution. Without empowering local governments, broadening the tax base and enforcing fiscal discipline, Pakistan’s federalism remains an illusion – masking centralisation, elite capture and dysfunction. Failure to undertake meaningful reforms risks exacerbating socio-economic stagnation and deepening regional disparities, further eroding public trust.
The writer is former head of Citigroup’s emerging markets investments and author of ‘The Gathering Storm’.
