In defence of NFC

THE federal fiscal crisis has, it appears, reached breaking point, causing panic attacks and forcing apologists for Islamabad and partisans for centralization to scramble for scapegoats.

One such attempt is an article in The News International on March 20, 2024, with the writer singling out the provinces and their share in the NFC formula as the principal culprit in the worsening of federal fiscal health. The article in question has presented a roster of numbers to support his thesis. They need to be addressed one by one.

To begin with, the fiscal distribution formula arrived at by the 7th NFC Award needs to be placed in perspective. The decision to raise the provincial share to 57.5 per cent was not without adequate thought and deliberation. Two factors were at play. One, the change in the intra-provincial distribution criteria from single to multiple criteria effected a loss for Punjab on account of a reduction in the weightage assigned to population in the NFC formula from 100 per cent to 82 per cent; which needed to be compensated by raising the provincial share. Two, the NFC was aware of the Constitution Committee decision to abolish the Concurrent List and transfer bulk of the subjects to the provinces. This entailed higher expenditure burden for the provinces, which needed to be funded through higher provincial share.

The article has provided a partial account of revenues, which produces a biased view. Herewith, the revenue and expenditure numbers need to be provided in the correct perspective. As of the revised estimates for fiscal year 2022-23, the federal government collected Rs7200 billion in tax revenue and Rs1618 billion in non-taxrevenue; totalling around Rs8188 billion.

The provinces receive share only from tax revenue; which amounted to Rs4129 billion – or 57.5 per cent of total federal tax revenue and 50.6 per cent of total federal revenue. The federal government retained Rs4,059 billion, with interest liability at Rs5,700 billion. In other words, Rs140 have to be paid out for interest on past loans out of every Rs100 collected in tax and non-tax revenues. Admittedly, this is a dire situation.

The writer has made an issue of provincial tax revenues and ‘provincial surplus’. He states that the provinces collect Rs650 billion in taxes and spend Rs5,038 billion – nearly eight times more; that provinces collect 9.0 per cent of what the federal government collects, but that they themselves collect 12.9 per cent of what they spend. The context is totally fallacious. The fact is that tax collection is a function of the tax base. The tax base for federally levied sales tax, import duty and income and corporation tax is huge – the entire country’s corporate and manufacturing base and import requirements. By comparison, the tax bases for the provinces are pitifully small.

Much has been made of taxes on property and agricultural incomes. These statements make for good, but irresponsible, slogan-mongering. Honest opinions should, however, be formed on the basis of facts and data. The fact is that the tax base for property tax and for income tax on agricultural income is very small; meaning that the potential for tax collection therein is low.

Except for the federal capital, cities in Pakistan are in a state of decay. Property tax is charged on housing. However, more than half of buildings in Karachi are in ‘katchi abadis’; three-quarters of buildings in Hyderabad city are derelict; and Quetta – the only city in Balochistan worth the name – cannot account for 10 per cent of buildings that are taxable. Punjab and Khyber Pakhtunkhwa are in a similar situation and Punjab is only somewhat better. Admittedly, the well-off houses are highly under-taxed; however, even if property tax rates are doubled, total revenue impact is not likely to be significant.

Taxing agricultural incomes is a long-term demand. Here too, a perusal of numbers does not provide much hope. The fact is that income tax is applicable to individuals above a certain income threshold -- those below the threshold are (legally) exempt. The agriculture sector does account for the single largest share – over one-fifth – of national income; yet, its share in aggregate provincial tax revenue is miniscule. Admittedly, the large landowners are highly undertaxed; however, more than 80 per cent of farms are small landholdings and, by the tax laws of the country, are exempt from taxation. Thus, even if all large farms are taxed to the full extent, total revenue impact is not likely to be significant.

It would appear, therefore, that the overall provincial tax potential is low. Those that persist in holding the provinces to account should consider this. Reverse the tax bases and provinces will be seen collecting over 90 per cent of taxes and the federal government less than 10 per cent. Ironically, the Sindh government has been asking for this with respect to the sales tax.

The writer rues the situation that, while the federal budget is in deficit, the provinces ran a surplus of Rs157 billion. And the disparity is used to make the alarming proposition that provinces have “difficulty spending their money”. The fact is that the provinces do not run budget surpluses voluntarily, but under federal government compulsion, which is itself under IMF compulsion.

While the writer berates the provinces for lack of own-resource mobilization, he also mentions the Rs417 billion – 64 per cent of total provincial tax revenue – collected on account of (provincialized) GST on services; which is the flagship achievement of the provinces, reporting record growth. Sindh’s pre-NFC GST services receipts from the FBR were Rs15 billion, which is now Rs285 billion – a 15-fold growth. Balochistan’s pre-NFC receipts from FBR were just over Rs700 million, and are now over Rs3billion – a four-fold increase, despite an extremely weak tax base and so on. The provincial revenue authorities, newly set up post-NFC, have certainly done better than the FBR.

The writer puts forth another preposterous point in holding the allegedly NFC-induced federal fiscal deficits partly responsible for high inflation and thereby helping push 40 million more people below the poverty line. This argument could be held valid if federal fiscal deficits, inflation and poverty levels were lower during the pre-NFC years. Clearly, they were not. The country’s economy was not generating milk and honey prior to 2010.

Given all of the above, the contention of “misaligned incentives” with respect to the provinces holds no water. Rather, the misalignment exists at the federal level. If interest payment is Rs140 for every Rs100 of net revenue received and if the Rs40 deficit is attributed solely to the NFC Award and provinces, the equation is clearly under-specified; given that three other crucial determining variables are expenditures for civil administration, defence and subsidies as well.

The Rs2760 billion deficit that the federal government faces is on these three accounts. The writer would do well to address expenditures on these three heads as well.

(Economist and member of 7th, 8th, 9th and 10th NFCs)