NFC and fiscal equity

Initiated by the centre and fiercely contested by the provinces, the reallocation of the NFC comes under debate each time the annual budget is due or when a new federal government takes charge. Now it has surfaced in the wake of ongoing negotiations between Pakistan and the IMF.

Provided for by the 1973 constitution under Article 160(1), the NFC, while providing the basic framework for resource distribution between the federation and its units, embodies the principles of fiscal federalism, aiming to allocate resources fairly among the provinces.

The 7th NFC Award, declared in 2010, increased the share of provinces in vertical distribution from 49 per cent to 56 per cent during 2010-11 and later 57.5 per cent– adding the 10.3 per cent criteria on poverty and backwardness, 5.0 per cent on revenue collection/generation and 2.7 per cent on inverse population density – and played a pivotal role in addressing regional disparities and strengthening provincial autonomy. The increase in share of resources was only rational given the devolution of power in the 18th Amendment that increased the fiscal burden of the federating units.

While the 7th NFC Award has been instrumental in empowering provincial governments, the continued mishandling of fiscal matters with the approach of fiscal adhocism by the succeeding federal governments has worsened matters, leading the country to a near-default situation today.

According to the latest consolidated report released by the Ministry of Finance, titled ‘Federal Footprint SOEs Report FY2020-22’, commercial entities under the control of the centre incurred losses amounting to a staggering Rs1.395 trillion over FY2021 and FY2022 only. Twenty-five entities made a cumulative loss of Rs665 billion in FY2021 and 31 entities made a cumulative loss of Rs730.26 billion in FY2022 –more than twice the size of the Public Sector Development Programme.

As per the UN’s National Human Development Report for Pakistan released in 2021, the economic privileges accorded to Pakistan’s elite groups “add up to an estimated $17.4 billion or roughly 6.0 per cent of the country’s economy” that is driven by the country’s tax and subsidy policies mainly benefiting the corporate sector and the feudal class.

Currently, Pakistan’s total expenditure stands at 19 per cent to GDP with federal expenditure amounting to 12.9 per cent and provincial expenditure at around 6.1 per cent, while total revenues stand around 11.4 per cent to GDP – a gap amounting to 7.6 per cent of GDP. The country faces a whopping tax-evasion of around Rs5.8 trillion annually – 6.9 per cent of GDP. Most of the tax evasion is reported from sectors mainly under federal control including: annual evasion on POL products estimated to be Rs996 billion and caused by smuggling, retail sector evasion estimated at Rs888 billion, transport sector Rs562 billion, IPPs Rs498 billion, smuggling-prone items Rs355 billion, exports Rs342 billion and customs-related tax evasion at Rs600 billion. This tax compliance alone could plug leakages, injecting 5.8 per cent of GDP into the national kitty on an annual basis.

In the 7th NFC, it was decided that the tax-to-GDP ratio would be increased up to 15 per cent of GDP – to be achieved till 2014-15. Nine years later and despite different wild experiments aimed at reforming the FBR, tax collection has remained stagnant whereas the provincial tax collection has increased from 0.3 per cent to over 1.0 per cent of GDP. The flawed taxation policies of centre, which rely overwhelmingly on indirect taxation, have driven inflation overwhelmingly higher.

The fiscal gap borne out of the centre’s inefficient policies is then bridged from the share of the provinces whose resources seem much easier to encroach upon than any effort at adopting reformative actions that require long-term and not-so-popular approaches. As a result, the centralization of financial resources has remained a bone of contention. The federal government’s tendency to withhold funds and interfere in provincial affairs has impeded the progress of regional development initiatives. In contrast, the provinces have shown commendable diligence in utilizing their share of resources for the welfare of their people.

One of the primary virtues of the 7th NFC Award is its ability to decentralize resources – empowering provinces to address local needs effectively. By directly allocating funds to the provinces, the NFC Award eliminates not just federal bureaucratic hurdles but also the monopoly of the centre while ensuring efficient utilization of resources at the grassroots level. This devolution of financial authority has led to a surge in local development projects, improved service delivery and enhanced governance standards across some provinces.

Since the NFC is a constitutional body, any revision requires a constitutional amendment with the consensus of all federating units. Blame games by the centre will not provide any solutions to the fiscal problems of the country. Instead of taking a reactive stance and unfairly laying the blame for consistently flawed fiscal mismanagement upon the provinces, it is essential that the centre works with the provinces in addressing fiscal challenges and tax reforms.

In the intricate web of Pakistan’s federal structure, the 7th/ last NFC award stands as a cornerstone of fiscal justice – granting equitable distribution of resources among the federating units by providing each province a fair share of financial resources for equitable distribution of resources. As the saying goes, the budget of a country and its tax systems are not neutral but deeply political – which is why fiscal justice is imperative to ensure socio-economic parity.

The writer is a member of the human rights committee of the Sindh Human Rights Commission. He tweets/posts @SukhdevHemnani_