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Tuesday March 19, 2024

Economic reforms: Part - XXXIV

By Waqar Masood Khan
November 13, 2018

Fiscal federalism in Pakistan was conditioned on the pattern of the Government of India Act 1935 as the act was adopted as the country’s interim constitution. A considerable delay and a host of factors played a role in establishing the first formal award of revenues between and among the centre and the provinces.

The approach adopted was to divide revenues into four categories. First, taxes levied and retained by the centre (customs, taxes on income and capital of corporations) and receipts from public undertakings (railways, posts and telegraphs). Second taxes levied by the centre but divided between the centre and the provinces (export duties, excise duties and taxes on individual incomes). Curiously, no other tax except for income tax and export duties qualified under this list because a federal legislation was not in place that provided for such division at the time of Partition.

Third, taxes levied by the provinces (land revenue, irrigation charges, taxes on sales, succession duties on agricultural property, taxes on agricultural incomes. etc). Fourth, taxes levied by the centre but distributed to the provinces, such as stamp duties in respect of various instruments of credit, terminal taxes on the movement of goods and passengers by rail or air, and succession duties (except on agricultural property). These taxes were, in fact, provincial sources of revenue but levied by the centre in the interest of uniformity.

In their remarkable work titled ‘The Economy of Pakistan’, J Russell Andrus and Azizali F Muhammad (1958) have deliberated on the factors that initially led to some major deviations in the distribution of revenues, both vertically and horizontally relative to those envisaged under the 1935 act.

“The terms of the act relating to income taxes and the jute export duty were elaborated by the ‘Niemeyer Award’ of 1937 which also incorporated provisions for additional assistance to certain provinces. Provincial shares were prescribed out of the divisible pool of income tax collections, and the province of Bengal alone was allotted a share in the export duty on jute, at 62.5 percent, of collections from the basic duty. NWFP was given a central subvention of Rs10 million in view of its meagre revenue resources and Sind [sic] received a subvention of Rs10.5 million under the award together with certain readjustments in public debt and debt owing to the centre”.

The above scheme wasn’t considered viable due to mounting central government responsibilities and inherited burdens: the refugee influx, the setting up of a new central government, the war over Kashmir, a massive decline in railways income due to ticket-less passengers (all refugees), rising coal costs, the now needless strategic lines linking the then NWFP, and the defence of the highly vulnerable and explosive Durand Line dividing the tribal areas from Afghanistan.

However, the central incomes were incommensurate with the resources needed to discharge these responsibilities. “The more fundamental cause lay in the undeveloped character of the Pakistan economy; in a vast, poverty-stricken agricultural population, there were few assessable under the direct taxes. The position regarding central excise duties was, if anything, more difficult since these were collected at points of manufacture, many of which remained in India, although part of their consumption markets were located in Pakistan”.

It was under such circumstances that the central budget for 1948-9 introduced a series of new taxes designed to raise an additional Rs100 million at least. Furthermore, after due consultations, extraordinary constitutional measures were adopted. The sharing provision of income tax under the 1935 act was suspended. More significantly, the sales tax, a provincial subject, was given to the centre for two years, and after a one-year extension, permanently allocated to the centre in 1951. Development grants of the provinces were also suspended, though subventions continued along with the transfer of export duty on jute to Bengal. Debts were to be raised by the central government, which would give loans to the provinces if needed.

The Korean War brought significant improvements in central finances, which were also improved because of an increase in the international prices of cotton and jute. Collections from trade taxes became a major source of revenues. The demands from provinces to transfer windfall gains were initially responded by ad-hoc transfers. It was in this backdrop that Sir Jeremy Raisman, former finance minister in Undivided India, was invited to examine the existing allocation of revenues between the centre and the provinces. It was agreed that any recommendations made by Raisman would be accepted as an award.

The basic recommendation of the Raisman Award was to revert, as closely as possible, to a general scheme of the division of revenues as envisaged in the Government of India Act, 1935. This was the keynote of the award.

First, it provided that 50 percent of the net proceeds of taxes on income would be assigned to the provinces (as in pre-Partition times) after deducting the proceeds of corporation tax, taxes on federal emoluments, taxes collected in the federal capital, and the proceeds of any central surcharges. The share of the provinces in the divisible pool were determined as follows: 45 percent for East Bengal; 27 percent for Punjab; 12 percent for Sindh; eight percent for NWFP; and four percent for Bahawalpur. The remainder was four percent.

Second, the levy of the sales tax would vest with the centre and the provinces would continue to share 50 percent, of the collections, with slight modifications in the shares received by the provinces in West Pakistan. Third, 50 percent of the net proceeds of the central excise duties on tobacco, betel-nuts, and tea would be paid to the provinces on the same percentage basis as prescribed for income tax (this was to compensate the provinces partially for the loss sustained by transfer of 50 percent of sales tax collections to the centre).

Fourth, an existing additional duty on raw jute (Rs1 per bale) would be amalgamated with the basic duty (Rs3) and 62.5 percent of the net proceeds paid to the province of East Bengal, and any additional duty imposed would be assigned to East Bengal to the extent of 10 percent of net proceeds thereof, the existing upper limit of Rs35 million being lifted. Fifth, the central subvention to the then NWFP was raised from Rs10 million per annum to Rs12.5 million and a subvention was provided for the province of Balochistan, when formed.

To be continued

The writer is a former finance secretary. Email: waqarmkn@gmail.com