Friday April 19, 2024

Economic reforms: Part-XXXXIII

By Waqar Masood Khan
January 22, 2019

The 1990 NFC made another curious recommendation, which was not part of its original TORs, but based on a reference made by the Council of Common Interests (CCI) in its meeting held on January 12, 1991. This was related to the payment of net hydel profits (NHP) under Article 161(2) of the constitution and inquiring thereof as to who should be responsible for its payment, the federal government or the generating agency.

The commission recommended that this was the responsibility of the generating agency, but the federal government would guarantee such payments to ensure that provincial finances were not affected.

The next NFC was constituted in 1995 by the PPP government. The NFC held only one meeting in December 1995 and constituted working groups for its future work. However, before these reports could be considered, the government was removed and an interim government was established, which constituted a fresh NFC that moved with lightning speed to achieve a consensus award.

The 1995 NFC was assigned TORs that were standard, without any new taxes to be included or a new question of finance to be deliberated by the commission, except for whether the royalty on oil (which the constitution has allocated to federal government) and the gas development surcharge (GDS) should be continued in the future. This was a recognition of the fact that the inclusion of these taxes, which were exclusively federal, was an extraordinary step and needed reconsideration. What’s more, following the TORs of 1974, no excise duty was included for sharing. Evidently, the PPP was committed to a stronger federal government.

In sharp contrast, the NFC constituted by the interim government completely transformed the basis of revenue distribution by adding all taxes to be considered for inclusion in the divisible pool. Customs duties, hitherto the most notable source of revenue that were exclusively reserved for the federal government since 1935, were allowed to be considered for inclusion in the divisible pool along with the entire set of excise duties.

With this, the approach embodied in the 1935 act and largely followed since then was completely jettisoned. In the course of time, the resource distribution would become biased in favour of the provinces, leaving the federal government with a share that was hardly sufficient to meet its current expenditures.

The commission introduced a new concept of a ‘national resource picture’ whereby all resources were pooled and, after imposing a fiscal-deficit constraint, the expenditure requirements of different units were worked out. Revenue distribution was worked out on the basis of this scenario. Generous benchmark expenditures were allowed to the provinces in the base year together with a hefty growth projection over the award period – though a distinction was made between priority and non-priority expenditures, with the former rising at a higher rate than the latter.

The divisible pool was expanded by including additional taxes such as customs duties; wealth tax; excise duties other than those on tea, tobacco, tobacco manufactures, and sugar; and capital value tax and the surcharge on petroleum products. To top it all, it was further provided that there would be “any other tax which may be levied by the federal government”. This was the complete exhaustion of the active taxation authority of the federal government. The inclusion of a petroleum surcharge in the divisible pool was yet again an instance in which a super tax reserved for the federal government since 1935 was made part of the divisible pool.

After deducting five percent as collection costs, the provinces were allocated 37.5 percent of the divisible pool, which was now the entire tax base of the federal government. In the 1990 NFC, this share was 35.3 percent and, therefore, there was only a 2.2 percent in provincial shares. The significance of this award, however, was the transformation of the divisible pool to include all taxes imposed by the federal government.

Regarding borrowing powers, the commission adopted the same recommendation as that of 1990. On the question of the royalty on oil and the GDS, it also retained the recommendation of its predecessor, allowing their continuation as straight transfers. It also recommended the continuation of NHP payments as per the decision of the CCI. A curious recommendation was the provision of matching grants as an incentive for the provinces to increase their own revenues beyond a given percentage.

The interim government was overly enthusiastic in giving an award as well as seeking a new IMF programme. Its term was limited to only 120 days. Yet, it felt appropriate to give an award that had enormous political implications. There were apprehensions whether it would hold elections on time. The political environment at the time was highly divisive as government of Benazir Bhutto was removed for the second time, and this time by a president who was appointed by the PPP government.

The PML-N was keenly awaiting elections and aspiring to form the new government, and wouldn’t want to take exception to the actions of the interim government, whose goodwill was critical for the transfer of power to a new political party.

A number of considerations that had guided the work of previous commissions were missing. First, there was no discussion on how revenue distribution would affect the international credit standing of the federal government and, therefore the country’s ability to raise foreign resources that were so critically needed for economic development. Second, would the centre have the ability to play a decisive role in ensuring balanced regional development across the country? Third, how would the centre play the role of an insurer and authority of last resort in providing contingent support in case of a national calamity, falling in one or more parts of the country, without having a strong financial arm?

The inexorable drift towards larger transfers to the provinces continued to mark the deliberations of the commission. The ground was set for the transfer of an ever larger share of federally-mobilised resources to the provinces to a point where the incentive for resource mobilisation would be diluted as the political cost for raising taxes was borne exclusively by the federal government, while much of the resources would be spent by the provinces.

To be continued

The writer is a former finance secretary.