A fair award

May 10, 2015

There are issues still to be resolved between the centre and the provinces even after the 7th NFC Award

A fair award

Two months before the expiry of the existing award, the finance ministry notified the 9th National Finance Commission (NFC) on April 24, 2015 which would constitute the 8th Award -- to determine the vertical distribution of tax resources between the centre and the provinces and the horizontal redistribution of combined provincial share among the provinces.

There is a likelihood that reaching a consensus would be difficult this time, as the federal government looks for more resources and sharing fiscal responsibilities of certain subjects with provinces. The federating units, on the other hand, are looking for a bigger share in the divisible pool and want to renegotiate the formula for horizontal distribution of combined provincial share. The first meeting of the 9th (the ministry renamed the commission as 9th) commission, on April 28, ended on a dissenting note with the federation and the provinces unable to agree on whether to extend the 7th NFC Award for one year or push for a new one before the expiry of the current award on June 30, 2015.

Except the 7th NFC Award, which resolved several issues related to intergovernmental fiscal relations, the fiscal federalism remains difficult to reach a consensus.

In fact, it took the federation and the provinces 14 years to reach a consensus award in 2010.

Reaching a consensus on vertical distribution is not the only issue. Horizontal distribution is as much of an issue. Only four out of seven commissions constituted after the 1973 Constitution came up with additional parameters to distribute resources among the federating units.

Under the 7th NFC Award, the share of the provinces from the federal tax revenues increased to 57.5 from 46.5 per cent. The formula for horizontal distribution among the provinces changed -- population which used to be the sole parametre got 82 per cent weight, 10.3 per cent was given to backwardness and lack of infrastructure, 5 per cent to revenue collection and 2.7 per cent on the basis of inverse population density.

The resources in absolute term increased for all the provinces. Punjab’s share from combined provincial pool decreased from 53.01 per cent to 51.74 per cent, Sindh lost 0.39 per cent of its share and KP 0.26 per cent - but Balochistan’s share increased from 7.17 to 9.09 per cent.

One of the major areas of negotiations for the 9th commission was the timing of the last commission, constituted prior to the 18th constitutional amendment, which delegated several ministries, departments and responsibilities to the provinces.

Therefore, the discussions for the 8th NFC Award will resolve issues related to the costs of devolved functions. "All provinces have been demanding an increase in the share of the federating units in the divisible pool as well as their share in the combined provincial pool," says Nasir Jamal, senior journalist based in Lahore, who has been closely watching the process of the next NFC award.

Also read: Provinces’ share of the pie

"The discussions on the horizontal distribution of funds is most likely to generate demand from the smaller provinces to further cut the weight assigned to population to increase the weight of other indicators in the formula," he says.

The Sindh province wants its share to be increased on the basis of revenue collection. KP is expected to push for a heavier weight for backwardness and demand more compensation for losses to its economy because of terrorism while Balochistan would seek greater weight for inverse population density and backwardness, besides demanding the province’s share on the basis of revenue projections made in the award rather than on the actual revenue generated by the federal government.

Jamal says all increases made in the 7th NFC Award were on the assumption that tax-to-GDP ratio, which was 9 per cent in 2009 would be increased to 15 per cent before the next award. "The federal government has failed to increase its tax net and our tax-to-GDP ratio is still less than 10 per cent. So, it has become difficult for the federal government to control the budget deficit," he says.

"Last time, it was Punjab that conceded a major share. It did it for federation but, as a result, the development of Punjab’s social and economic sectors suffered a lot," says a senior official of the provincial finance ministry on condition of anonymity. "Punjab cannot afford further cuts in its share in the combined resources of provinces."

The PPP’s federal government had also significantly increased salaries and pensions of the government employees after the 7th NFC which, to a great extent, neutralised the increased share of provinces as their non-development budget increased significantly. The example of Balochistan best explains the situation. The non-development expenditure of the province was Rs42 billion in 2008 which increased to Rs155 billion in 2013. "I do not see this award to be decided in less than one year. It can take even more time if the provincial governments of opposition parties in KP and Sindh start creating problems," the official adds.

The provinces claim they need more money in the next award as they have been given more responsibilities in the last award.

Related article: Landmark for greater federalism

Officials at the federal finance ministry concede that because of the timing of the 7th NFC Award and the 18th amendment the federal government has suffered more than the provinces.

"The resources for the provinces increased significantly in the 7th award in anticipation of the autonomy granted to the provinces by the 18th amendment. But the provinces took extra resources and refused to take fiscal responsibilities," says a senior official of the finance ministry who does not want to be named.

"At present, the federal government has spent more than Rs100 billion annually on social protection through BISP, between Rs200-250 billion on tariff difference subsidy on electricity, and about Rs100 billion on other subsidies along with running vertical health and population programmes, including immunisation programmes," he says.

The official says higher share of provinces in the 7th NFC Award is the biggest cause of fiscal problems for the federal government, including massive increase in the federal budget deficit.

Seemingly, the provinces will request the federation to give them powers to collect all types of taxes if the federation asks them to share more responsibilities.

Don’t miss: Economic and political experts review the NFC award

Another recent development which has implications for the 8th NFC Award is the federal government’s commitment with the IMF regarding budget deficit of the provinces. "The government will seek a new agreement that will ensure that the terms of the fiscal de-centralisation find a balance between devolution of revenue and expenditure responsibilities," reads the Memorandum of Economic and Financial Policies (MEFP) that Islamabad submitted to the IMF in late 2013.

Even Punjab may raise this issue with the federal government, which requires the provinces to create surplus budget. "This has been affecting our capacity to spend on development schemes," says the senior official of Punjab’s finance ministry.

"The terms of references (ToRs) of the 9th commission reveal that the federal government wants to share some of its financial responsibilities, including expenditures for special territories like Gilgit-Baltistan and Kashmir, with the provinces," says Muhammad Sabir, principal economist at the Social Policy and Development Centre.

"Vertical resource distribution under the 7th NFC Award is secured constitutionally in the 18th amendment. It will not be easy for the federal government to cut the share of provinces but it can play with the divisible pool. It seems the federal government will not include excise duty in the divisible pool," Sabir says.

"The 7th NFC Award introduced multiple criteria for horizontal distribution among the provinces. There is a possibility that the share of one or more criteria can change in the next award," he adds.

Sabir does not see the federal government allocating more funds for provinces this time. "It was expected that the federal government would make serious efforts to expand its tax net as it lost a significant share in the federal taxes under the 7th NFC Award. But the reverse has happened. The FBR was never able to achieve the tax targets projected by the 7th NFC Award. The deviation ranged from Rs160 billion in 2010-11 to Rs625 billion in 2013-14," he says.

The federal government has also failed to curtail its current expenditures despite devolution of basic social services to provincial governments. "The current expenditure of the federal government overshot by more than Rs300 billion compared to the projected amount. In 2013-14, the deviation was close to Rs700 billion," Sabir adds.

Professor Ibrahim, member of the 8th NFC Award from KP says the federal government has failed to transfer funds for the responsibilities it transferred to provinces after 18th amendment. "Federal finance minister, Ishaq Dar, during the first meeting talked more about difficulties which means the federal government is in no mood to share more funds with the provinces," he says. "The provinces want their share to be increased in the divisible pool to 80 per cent."

He points out that before the 5th NFC Award of 1996, the share of provinces used to be 80 per cent. "We also want backwardness and implications of terrorism to be given due share during the distribution of resources among the provinces," he says.

A fair award