NFC and fiscal consolidation

The way forward is for the provinces to have the exclusive right to levy sales tax, not just on services but also on goods

In these columns, we have been pleading for urgent action to review the taxation rights under the Constitution of Islamic Republic of Pakistan. Currently, all broad-based and buoyant sources of revenue are with the federal government and the contribution of provinces to total tax revenues is hardly 6 percent. In overall national revenue base (tax and non-tax revenue) it is around eight percent.

On March 12, Adviser to Prime Minister on Finance and Revenue Dr Abdul Hafeez Shaikh chaired the meeting of the Monitoring Committee of the National Finance Commission. The meeting was also attended by Provincial Finance Ministers of Khyber Pakhtunkhwa and Balochistan. The Punjab and Sindh were represented by their finance secretaries.

According to an official handout, the purpose of the meeting was “to seek approval of the bi-annual reports on the implementation of the National Finance Commission Award for the periods of July–December 2018 and January–June 2019 and the establishment of the National Tax Council (NTC)”.

Article 160(3B) of the Constitution requires that these reports, after approval, be presented in the National and Provincial Assemblies. These contain information on Distribution of Revenues and Grants in Aid to the provinces under the NFC Award. The last one was announced in 2010 (7th NFC Award). Thus in 2020, we are relying on the 7thNFC Award, ignoring the census of 2017, in utter violation of the Constitution.

The bi-annual report of July-December (FY 2018-19) shows out that total collection by the Federal Board of Revenue (FBR) of distributable taxes (Divisible Pool) was Rs1,949.752 billion. Out of this, share of the provinces was Rs 1,121.207: Punjab (Rs 580.061 billion), Sindh (Rs 275.232 billion), Khyber Pakhtunkhwa (Rs 163.906 billion) and Balochistan (Rs101.909 billion). In addition to these, Khyber Pakhtunkhwa received an additional 1 per cent as war on terror (WoT) fund of Rs.10.079 billion. Straight transfers of Rs 46.826 were also made to the provinces during the period under four heads of royalty on crude oil, royalty on natural gas, gas development surcharge and excise duty on natural gas.

A proposal for sales tax harmonization also came under discussion during the meeting pursuant to the decision of the Council of Common Interests (CCI)on November 24, 2017. The NFC Monitoring Committee was assigned the task of framing the Terms of Reference (ToRs) for the Fiscal Coordination Committee (FCC) and to discuss the fiscal policy issues and prepare suggestions for their resolution. It will also monitor current and development expenditures of the federal as well as provincial governments. The discussion on issues related to enhancing FBR’s receipts shall also fall under the ambit of this committee. It was proposed during the meeting that the NTC shall meet at least once in every quarter and that its recommendations shall be expressed in terms of majority and shall be placed before the NFC Monitoring Committee.

It is strange the issue of dependence of provinces on the federal government for transfers from the divisible pool—as envisaged in Article 160 of the Constitution—was not discussed in the proper historical context.

Before independence, the provinces had the exclusive right to levy sales tax on goods and services. This was taken away from them in 1948 and never reverted. Federations like Canada and India have already moved towards harmonised sales tax on goods and services. It is high time that this issue is debated in the NTC, Parliament, Provincial Assemblies and in public and a consensus reached.

Even after levying all kinds of irrational and expropriatory taxes, the federal government has failed to reduce the burgeoning fiscal deficit. It reached 8.9 per cent in 2018-19 and is likely to be worse this year. Every attempt over decades to bring it down to 4 to 5 percent of the GDP has failed.

The reason is that the FBR has been persistently failing to achieve the assigned targets, what to speak of tapping the actual tax potential that at federal level is no less than Rs 8 trillion—see details in Overcoming fiscal woes, TNS, Political Economy, April 7, 2019 and How to boost tax collection, TNS, Political Economy, May 21, 2017.

Attempts to tackle the twin menace of underground economy and tax evasion have met with failure in Pakistan. Even after generous amnesties in 2018 by the PML-N government and in 2019 by the PTI-led government, total collection was only Rs 3,828.5 billion in 2017-18 (which was0.4 percent lesser than the collection of the previous fiscal year) and Rs 4,435 billion in 2018-19 [which was twice revised downwards, first to Rs 4,398 billion and then to Rs 4,150 billion].

The underground economy is driven by many aspects of poor fiscal policy, and as highlighted by Dr Arthur B Laffer in Handbook of Tobacco Taxation: Theory and Practice: “it isn’t just high tax rates that indicate whether illicit trade activity will be a problem, but rather high tax rates coupled with other factors such as affordability, level of corruption, effectiveness of enforcement, and cultural and societal reasons.”

The collection of taxes at federal level is much below the actual potential. The failure to tap real tax potential poses a tough challenge to both the federal and provincial governments. Poor performance of the FBR adversely affects the provinces as they are overwhelmingly dependent on the divisible pool.

The provinces are not ready to collect taxes wherever due e.g. agricultural income tax from rich absentee landlords and property tax from owners of palatial houses/bungalows/farm houses etc and not giving fiscal powers to local governments as envisaged under Article 140A of the Constitution. The Centre is unwilling to grant the provinces their legitimate taxation right to collect sales tax on goods while it collects too little to meet the needs of the federation and the federating units.

The size of the pie — the divisible pool — is so small that it cannot help the country come out of the debt trap and to spend adequately on the welfare of the masses, no matter which part of the country they belong to. The so-called relief/stimulus package announced on March 24 by the prime minister has only exposed our economic and fiscal vulnerabilities in testing times.

The size of the pie —the divisible pool—is so small that it cannot help the country come out of the debt trap and spend adequately on the welfare of the masses, no matter which part of the country they belong to.

Given the track record of the FBR, the possibility of collecting even Rs 8 trillion over the next three years to give enough fiscal space to both the Centre and the provinces to come out of the present economic mess, thus providing some relief to the poor as well as trade and industry is remote. Under the given scenario, Pakistan will remain in debt prison, and more and more people will find themselves below the poverty line. To overcome the predicament, the Parliament will have to reconsider the prevailing social contract.

Provincial autonomy and local self-governance are meaningless without taxation rights and equitable distribution of income and wealth. We cannot overcome perpetual economic crises unless the provinces are given true autonomy; ownership of all resources; generation of own revenue and exclusive right to utilise it for the welfare of their residents at grassroots level through local governments.

The way forward is for provinces to have the exclusive right to levy sales tax, not just on services but also on goods. Amendments should be made in the Constitution after debate and consensus to assign the right to levy tax on all kinds of income, including agricultural income, to the federal government. This will help the FBR collect income tax as per actual potential. By levying sales tax on goods in addition to services, the provinces will generate sufficient funds for their needs. This will also eliminate/reduce fiscal deficit at the federal level.

This is the only way to achieve fiscal stabilisation in Pakistan. However, this can only happen if we also reform and merge all tax collection agencies at federal and provincial levels, as suggested in Too taxing, TNS, Political Economy, June 22, 2014 and Revamping Tax system, TNS, Political Economy, December 7, 2014, but ignored by successive governments.

The writers, lawyers and authors, are Adjunct Faculty at Lahore University of Management Sciences (LUMS)

NFC and fiscal consolidation