Fiscal policies of the federation have been at the root of economic crisis in Pakistan and there has been simmering conflict between the federal government and provinces over the distribution of tax revenue. As 8th NFC is being constituted, it’s important to analyse the fiscal resources of the federal government and provinces.
Although the 18th amendment did not touch the issue of fiscal devolution at all, an impression has been created that after the 18th amendment provinces received more resources and the federal government has been left with a meager share.
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No doubt, the seventh NFC award was given in view of the 18th amendment but Article 160 was amended only to the extent that the shares of provinces shall not be less than the previous NFC award. This was the only amendment to the Constitution on the fiscal level.
The 18th amendment was brought in view of the Charter of Democracy signed by two major parties in May 2006 and its various provisions were not adhered to which haunts both the political parties today such as establishment of the National Accountability Commission in place of the National Accountability Bureau and creating the Federal Constitutional Court with equal representation of the four provinces.
The 18th amendment transferred presidential powers to prime minster and abolished much sought after concurrent list in the Constitution. It enhanced the executive and legislative domain of the provinces but the federal government’s power to collect all four major taxes, income tax, sale tax on goods, customs and excise duty, remained the same.
Collection of sales tax on goods almost equivalent to income tax was not devolved to the provinces. In fact, in the seventh NFC award, a slight change was brought in NFC distribution to include factors of poverty, area and revenue generation. Population is still more than 82% criterion to distribute tax revenue among the provinces.
General Musharraf government’s NFC conceded around 43% tax revenue to provinces and retained 57% for the federal government. However, it undertook to provide provinces around 3% to 4% tax revenue in lieu of abolition of octrio tax in provinces and 2% to 3% grants to provinces under Article 160(2)(b) of the Constitution. In effect, Musharraf’s fiscal arrangement was almost 50:50 between the federation and the provinces. Same is the case in the seventh NFC award.
If we look at the terms of the seventh NFC, it fails to give provinces a penny in lieu of octroi tax and zero grants so in effect there was no major change in the seventh NFC or the sixth NFC of Musharraf. The federal bureaucracy cleverly exploited the percentage of the provinces which in fact didn’t change. The federation did not surrender any fiscal space to the provinces in the seventh NFC though their responsibilities grew manifold.
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Leaving apart the interpretation of Article 160, which says the distribution of tax revenue has to be between the federal government and each province, fiscal space and the tax revenue between the federal government and provinces have to be shared on logical principles.
Firstly, the overriding principle is to share the tax revenue on the basis of respective responsibilities of the federal government and provinces under the Constitution, and secondly to devolve one of the major taxes to the provinces such as sales tax on goods.
We would see that major responsibilities of social, industrial and development sectors belong to the provinces under the Constitution, including education, health, population growth, law and order, justice, industries, water and irrigation, lands, local government, transport, environment, infrastructure (except strategic roads), etc. The federal government under the Constitution is essentially left with strategic tasks of defence, foreign policy, communications and finance (tax collection).
Had there not been regional conflict and hot borders and heavy debt trap, tax revenue could have been divided by 20-80% ratio between the federation and provinces as the federal government also has the non-tax revenue of more than Rs800 billion. This would boost development manifold but defence and debt retirement eat up more than Rs3,000 billion. The FBR is financed by at-source deduction of one per cent from the NFC. The remaining federal ministries and institutions could not require more than Rs200 billion.
Presently, when the responsibilities of the federal government stand drastically curtailed, 40-60 ratio between the federal government and provinces, respectively, would be ideal and sustainable to boost human, social and industrial development agenda in the provinces. The second alternative is to hand over sales tax on goods to provinces so that the NFC is left with one major tax of income tax and excise and customs duty. This could be done through a constitutional amendment. However, the NFC arrangement could also envisage that sales tax collected from the provinces by the FBR shall be paid back to them.
After the successful experience of provinces to collect sales tax on services (Sindh collecting now more than Rs100 billion), collection of sales tax on goods could be handed over to them in order to give them fiscal space. In this way, the federation and provinces would each have one major tax. They can redouble their efforts to enhance its collection.
Even otherwise, in federations worldwide sales tax on goods is vested in provinces. In the Government of India Act of 1935 the sales tax wholly belonged to provinces, which was taken over by the centre in 1948 and subsequently retained by it. The federal government of Pakistan could easily enhance the income tax being the direct tax by improving the enforcement mechanism under the Income tax Ordinance, 2001. It can double it within no time. The FBR has the capacity to substantially increase the present annual income tax target of Rs1,735 billion. This will give fiscal space to the provinces and would pave the way for harmonious fiscal relations between the federal government and the provinces. Furthermore, both having one major tax, the provinces will be less dependent on handouts of the federal government in order to frame their development agenda.
Published in The Express Tribune, October 3rd, 2018.