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February 6, 2019

NFC starts discussing division of resources today

Top Story

February 6, 2019

ISLAMABAD: At a time when the Sindh government is expressing fears of rollback of the 18th Constitutional Amendment and the NFC Award, the re-constituted National Finance Commission (NFC) is all set to kick-start its deliberations here today (Wednesday) to finalise resource distribution formula among the Centre and the provinces.

The Centre is demanding to slash down the share of provinces upfront by 7 percent for meeting the requirements of security and Fata development but the federating units are reluctant to accept this demand. It is yet to be seen how the lingering stalemate will be resolved for moving towards a consensus-based settlement under the ambit of constitutional body, the NFC, comprising members from the federal government and all the four provinces.

The Centre has taken the stance that there is a need to improve fiscal coordination between the federal and provincial governments. After the 7th NFC Award, the weight of provinces in the overall fiscal affairs of the government has sharply increased.

In addition, the NFC Award also opened up the possibility for the provinces to borrow from the domestic and international financial markets and donors. While these provisions help the provinces to focus more intently on local development, they also raise certain fiscal and macroeconomic risks. For example, the escalation of fiscal deficit during the last two years was partly because of spending spree by the provinces. The government plans to use the Fiscal Coordination Board (FCB) – which comprises the federal and all the four provincial finance better coordinate federal and provincial fiscal activities so as to ensure greater fiscal discipline and that all governments to move toward attainment of common macroeconomic goals.

Renowned economist and former member of NFC Dr Kaiser Bengali proposed to make the NFC target equity goals, rather than just distributing tax revenues between the federation and between provinces and stated that the current 42.5 : 57.5 vertical distribution ratio among Center and Provinces respectively creates equal incentive/disincentive to raise revenues from direct and indirect taxes.

Thus, the federal government has tended to rely heavily on indirect taxes, as it is easier to collect. Indirect taxes are regressive, i.e., it places a greater burden of taxes on the lower income groups and upper income groups bear a lower burden of taxes.

It is thus proposed to remove direct taxes (net of Withholding Taxes, which constitutes about 80% of direct tax collection) from the Federal Divisible Pool (FDP) and allow the federal government to retain 100% of direct tax (net of WHT) collection. This will enhance the incentive to target direct taxes as opposed to indirect taxes. Resultantly, it can be expected that the tax structure will become more equitable.

He referred to an analysis on the basis of 2014-15 budget which shows that the change will lead to a gain of Rs181 billion for the federal government and corresponding loss of Rs181 billion for the provinces.

The provinces may agree to absorb all or part of the losses or ask for full compensation. In the last event, the federal-provincial vertical share will need to change from 42.5 : 57.5 to 35.0 : 65.0.

On horizontal equity, he said that the 7th NFC Award transferred GST Services to the provinces and thereby strengthened provincial fiscal autonomy. However, fiscal autonomy is only relevant if the provinces possess a strong economic base. Punjab and Sindh do have a strong agricultural and industrial base, but Khyber-Pakhtunkhwa and Balochistan do not.

It is thus proposed to add fifth criteria to the horizontal distribution formula: inverse of cultivable area. This will tilt the distribution balance somewhat towards the two economically weaker provinces.

The federal government’s contention that the 7th NFC Award weakened federal finance by transferring excessive amount of resources to the provinces is factually incorrect. Federal fiscal problems are on account of two factors, for both of which the federal government is responsible. The Award required the federal government to raise its tax-GDP ratio, which it has failed to do.

The 18th Amendment required the federal government to abolish Concurrent List ministries/division, which it has failed to do. Resultantly, current expenditure has increased over 2010-2017 at 9.8% per annum against the inflation rate of 8%. Thus, current expenditure has grown at a rate that is nearly 2% higher than inflation rate.

He said that there are about 16 federal Administrative Divisions that are clearly questionable in the light of the 18th Amendment and in the context of economizing on non-development expenditure. In this context, there are between 15-20 federal Divisions that need to be abolished and which will reduce federal current expenditure.

He said that the Sindh case offers an insight in the potential dangers of any attempt to dilute or roll back the 7th NFC Award or the 18th Amendment enacted in 2010. Post-independence and post-One Unit, demographic and political events gave birth to a nationalist movement that carried elements of secessionism and was largely rooted in anti-Punjab sentiment.

The 2010 devolution has served to demolish this aspect of Sindh’s politics. He said that evidence for this change emerges from the fact that post-2010, almost all nationalist parties and groups in Sindh aligned themselves with the Punjab-based PML-N and one of them even merged with it. Clearly, the 18th Amendment and the 7th NFC Award both achieved with rare unanimity across all political parties and across all provinces, has served to bond the federating units and strengthen national unity.

The implications of any roll back are clear. Any undermining of the 18th Amendment or the 7th NFC Award is almost certainly likely to provide oxygen to nationalist politics, he concluded.

When contacted, former finance minister Punjab Ayesha Ghous Pasha on Tuesday night said that there was no justification on part of the federal government to slash down the share of provinces on the pretext of security or Fata development because the tribal areas had been merged into KP province, so the share of the province would be increased subsequently. She said that she would sternly oppose any move aimed at centralisation instead of strengthening the federating units. She cited example of Punjab and stated that the FBR used to provide Rs25 billion share to the provinces out of its collection in GST on services in 2010 as that time the FBR was collecting taxes from 7 to 8 services only. But when the GST on services was transferred to the provinces then the Punjab collection went up to Rs113 billion whereas the tax net was expanded to almost 4,000 services.

She said that the revenue mobilisation efforts should be made part of the criteria for distribution of resources through divisible pool. She also suggested to make efforts for evolving consensus among all provinces to go ahead with agriculture income tax simultaneously in order to avoid political backlash for any political party of province.

When one top official of Finance Division was contacted, he said on the condition of anonymity that all issues related to fiscal front would come under discussion in Wednesday’s meeting whereby the Center would listen to all provinces in order to firm up its strategy for achieving breakthrough for evolving consensus within the current fiscal year.

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