A well functioning federal system needs coherent, functioning and vibrant interactions between the centre and the federating units. Once the constitutional prerequisites are accomplished, the next most important condition to make a federation work is functioning financial arrangements. An efficient resource distribution mechanism calls for the ideal Pareto efficient point. At such a point no further improvement is possible without imposing a cost on the other party. A dynamic resource distribution formula can achieve this.
Historically, Pakistan has persistently remained a centralized federation, with the federal government having vast powers to collect revenues. This leaves provinces with exhausted avenues for revenue generation. This implies two important policy gaps. First, the provinces are always in need of financial help. The federal government provides this out of the excessive funds collected at the centre. Second, and more importantly, this erodes the capacity of provinces to raise revenues from potential indigenous resources. Till the 7th NFC Award, the situation continued as the federal government distributed a manageable portion of additional resources among the federating units. However, in 2010 it was decided that 57.5% of the total proceeds would be horizontally distributed among the provinces. The centre would keep the remaining 42.5% of the total divisible pool.
We should applaud this state of affairs from the perspective of provincial autonomy. However, this tilted arrangement of NFC Awards has created financial problems that are unsustainable in the long run (NFC report, 2009). The NFC Report states that “Under the options proposed, the overall fiscal deficit would neither be consistent with the one agreed with International Monetary Fund (IMF) nor desirable for a stable economy”. The desired proposed options, given to the stakeholders: i) provincial share at 52.5%; and ii) provincial share at 55%. Here it is important to note that both these proposed shares are below the actual 57.5% that took effect in the NFC award.
Besides vertical distribution, they also arbitrarily decided the weights for horizontal distribution without sufficient evidence and analysis of the implications. Certain assumptions made while awarding the 7th NFC Award have yet to be realized e.g. raising tax to GDP ratio to 15% by 2014/15 (and onwards) and a low inflation rate. Similarly, the historic lethargy in generating own revenues still continues. They pursued only the low hanging fruits like property taxes or taxes on services. This practice has resulted in the incidence of double taxation. Taxes on professions (doctors, engineers, retailers etc) along with agricultural income tax are yet to reach their full potential in the provinces. Similar is the case with incentivising local taxes through PFC awards.
Moreover, the award also turned a blind eye to the requirements of the centre; especially related to debt servicing and defence. The current fiscal resource distribution mechanism has left the centre handicapped to take any policy initiative which is of immediate nature but having financial implications (like natural calamity in the form of Covid-19 pandemic, merger of FATA, floods, and agricultural catastrophes like locust attack etc.). In addition, after fulfilling the obligations of interest payments on debt (domestic and international) and defence expenditures, the federal government needs to resort to borrowing (from internal and external resources) to bridge the budget deficits. This represents an unsustainable situation for the country, which cannot go unchecked for long.
The 18th constitutional amendment has also played an important role in further complicating the situation as the federal government is in a compromised situation to get into or fulfil international agreements as a number of ministries (including the environment) have been devolved to the provinces. This by no means imply that resources be centralized again but in fact a workable solution is necessary which can take care of the urgent national responsibilities as well as reward fiscal effort and discipline. Similarly, spending appropriations as per constitutional mandate (debt limitation law) and avoidance of duplication of effort needs to be checked through prudent fiscal discipline. These can only be achieved if we do away with discretionary spending and resort to evidence-based systematic transfers.
Certain provisions of the 18th Amendment have also made the award inflexible in certain ways. The 18th constitutional amendment required that the provinces’ share shall not be less than what they decided in the 2009 NFC Award (i.e. 57.5% of the divisible pool). The non-flexibility clause has added to the complexity of the award and distorted its dynamic nature. This is reflected in the deadlocks experienced in the following years (after the 2009 NFC Award). There were no NFC Awards because the provinces had no incentive to revisit the existing mechanism as the centre had nothing more to offer. No revisiting means no reconsideration, hence, no re-evaluation; an inbuilt inefficiency introduced through the 18th Amendment which is against the spirit of the entire process.
To conclude, the 7th NFC award was a bold step in Pakistan’s resource distribution history, however, the situation demands further analysis. Pakistan still needs to strive for an optimal resource distribution mechanism where no one can externalize their inefficiencies upon the other members of the federation. We need a new formula which can induce the centre and provinces to put in their maximum effort for optimal resource generation. This will also ensure spending efficiency in order to achieve the highest possible shared prosperity. The required mechanism would need analysis to assess the needs of the population and the potential of the jurisdiction so that no one gets a free lunch.
We require a new NFC formula to not only to satisfy our expenditure needs (in wake of population needs or cost disabilities) but also to have sufficient incentives to reward efficiency and efforts. There is also need to shed some light on the political economy of NFC as well. The unanimity rule being adopted for approval of the NFC also has led to recurrent deadlocks that need to be resolved. In short, we need to look for out of box solutions for future allocations and have research-backed deliberations at a nonpartisan academic forum for NFC to further the debate.