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Thursday April 18, 2024

NFC: call for fiscal reforms

By Dr Miftah Ismail
April 03, 2024
A representational image showing people at a busy market in Pakistan. — AFP/File
A representational image showing people at a busy market in Pakistan. — AFP/File

In an analysis of the 7th NFC Award (‘Fiscal realities: A case for NFC reform’, March 20), published on these pages, I showed that provincial governments collect a small fraction in taxes compared to what they spend; their payroll and development expenditures have increased at a very fast clip; and that even if we somehow double the federal tax intake, we would still be left with a huge deficit.

Now four intellectuals, whose credentials and opinions I respect, have disagreed with me in their own columns. But none, dare I say, has told us how the federation can be brought back from the brink of financial disaster and how the entire country’s fiscal situation can be grounded in sound footing absent a reduction in the NFC Award. In these pro-NFC columns, examples have been given of particular areas where federal expenditures are increasing fast, such as pensions. But pensions are rising fast in the provinces also and unless pension reforms are undertaken across Pakistan, as Khyber Pakhtunkhwa has tried to do, in eight years pensions will overtake all other expenditure heads, including defence.

A point has been made of provincial sales tax on services growing faster than the federal sales tax on goods. But the reason for that particular growth is the explosion of mobile telephony in Pakistan and mobile companies being self-compliant. We see that all other provincial taxes show no such progress. It has also been said that property or agriculture taxes have very limited potential, for instance arguing that half of Karachi is katchi abadis. Perhaps it is, but what about the other half?

My overall thesis that provincial taxes cover only 13 per cent of provincial expenditures and the federal government provides the overwhelming bulk of provincial resources remains valid. Equally valid are the facts that since the NFC, federal deficits have become unsustainable and that provinces have been relatively profligate in spending for political and other purposes.

My dear friend Khurram Husain wrote that reducing the NFC’s 57.5 per cent share “is a little like how a bear will chew off one of its own limbs in order to get out of a trap”. What else would he have the bear do? Die of hunger while in the trap? When the federal government is running ever-increasing deficits (that cause inflation and force people into poverty) and the provinces are flush with funds, isn’t the sensible thing reducing the provincial share? In any case, hopefully our leaders are smarter than bears and will unlock this trap so that we can come out of it without hurting the federation or the provinces.

A red herring has also been raised that those of us who want a reduction in the NFC Award also want a weakening in the 18th Amendment and doing away with federalism. This is simply not true. There is no intellectual defence in a country as big and varied as Pakistan to not devolve every appropriate power and responsibility from the federal government down to the provinces and from the provinces to localities.

Interestingly, some of those vehemently raising voices against even a small change in the NFC Award remain conspicuously silent when it comes to provinces not devolving powers or resources to localities. In fact, while our political leaders took power and resources away from the federation in 2010, they simultaneously stripped the local government of powers accorded to them by General Musharraf’s government.

From 2007 to 2010, the federal government’s share in federal taxes had already been reduced from 58.5 per cent to 55 per cent. After the latest restoration of democracy, our newly empowered political leaders agreed on a formula to reduce the federal government’s share further, from 55 per cent to 41.1 per cent, and also left the federal government with the responsibility to run Fata, Gilgit-Baltistan and AJK.

Perhaps the idea was to have the maximum possible funds for the provinces where they can carry out socially beneficial programmes, thinking that the federal government for now can run deficits and rely on borrowed funds. However, after 13 years of this NFC Award, the federal government cannot borrow from abroad without the IMF umbrella and within Pakistan takes away more than 80 per cent of liquidity from the banking sector and causes money supply growth and inflation. There is a tendency in Pakistani governance to leave problems unsettled till tomorrow. Unfortunately for us, tomorrow is here. As for socially beneficial activities from the provinces, the less said the better. The proportion of stunted children hasn’t improved in two decades, the proportion of wasted children has deteriorated, overall literacy or school enrolment hasn’t much improved, and neither has the number of deaths of women during childbirth.

This in no way means that the federal government is a paragon of virtue. It has followed disastrous foreign exchange policies, never met an elite or state-owned enterprise it doesn’t want to subsidize, and hasn’t broadened the tax base to include the service sector. But NFC has made our problems much deeper. Even if we were to shut down the entire civil government and national defence, renege on all pension obligations, and stop paying all subsidies, including for BISP and providing cheaper electricity to the poor, we would still have a deficit of over Rs3000 billion. Nothing can bring us back from the brink until the NFC is addressed.

After the NFC Award was approved, our public debt in June 2010 was Rs9010 billion. In the three remaining years of the PPP government, we added 59 per cent to the debt we had accumulated in the previous 63 years and took our debt to Rs14,292 billion by June 2013. In the next five years of the PMLN government, we added another 75 per cent to the total debt added in the previous 66 years and took our public debt to Rs24953 billion.

Then came the PTI and in four years it added 97 per cent of the debt added in the previous 71 years and our debt became Rs49,242 billion. And finally, the PDM government in just the last fiscal year added 28 per cent of the debt added in the previous 75 years, taking total debt to Rs62,881 billion. At this speed, we are now doubling our national debt in three years and unless this is addressed, financial ruin is staring us in the face.

Politics always trumps economics and politics is why we are hollowing ourselves out financially. Since the NFC Award, the PPP has kept its power intact in Sindh, the PTI has tightened its grip on KP and the PML-N has emerged as the largest party in every provincial election in Punjab. Political parties have consolidated their political fortresses with the relatively huge resources at their disposal by doling out jobs and material favours to their voters and supporters. For instance, between 2018 and 2022, the KP government increased employment in ex-Fata, paid for by the federal government, from 33,000 to 84,000 employees.

There is nothing wrong and everything right with governments helping out the poor through better schools, health facilities or cash transfers. But when the federal government has to tax soap and toothpaste bought by the poor and provinces have the money to give away motorcycles to middle-class students, there is something wrong with the incentive structure of our governance. Then there is also the economic cost of collecting taxes.

When a government imposes taxes, it reduces commercial activity causing economic loss to society. Think of the 18 per cent sales tax on motorcycles. Because the price has been raised by 18 per cent, fewer bikes will be sold, the companies making them will hire fewer workers and many consumers will not be able to afford them. This results in economic loss. It is estimated that the loss to the economy can easily be Rs30 for every Rs100 raised in taxes. So when our governments raise taxes to subsidise the non-poor, they are not only distributing income from have-nots to the haves for political gain, but they are also causing significant economic loss.

The root issue with our NFC Award is the fact that the federal government gets to keep less than Rs40 for every Rs100 of additional tax revenue. So no matter how much taxes it raises, 60 per cent goes to the provinces. Last year our tax collection was Rs7169 billion. But to achieve a balanced federal budget, we should have collected more than three times as much, – Rs23,859. That’s 28 per cent of GDP and a higher tax-to-GDP ratio than America and Australia. Surely, we cannot realistically expect the federal government to collect tax revenues at 28 per cent of GDP when the provinces altogether are collecting merely 0.77 per cent of GDP in taxes.

The only way out of our fiscal predicament is for the federal government to ‘do more’, as the provinces want, but also for the provinces to take more responsibilities. Surely the provinces can do better than collect only Rs8 billion in property taxes combined. Dr Hafeez Pasha has given some interesting ideas towards a solution. Adding to that, given that the provinces aren’t able to collect property or agriculture taxes, perhaps they can be transferred to the federation. Maybe the 57.5 per cent allocation can be limited to the first Rs9000 billion of the divisible pool and the provincial share reduced substantially beyond that. But the time has come for us to address this deepening crisis.


The writer is the former finance minister of Pakistan.He tweets/posts @MiftahIsmail