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Articles and Letters

Fiscal decentralisation

By: HUZAIMA BUKHARI AND DR IKRAMUL HAQ   Published on August 09, 2013
Fiscal decentralisation involves the transfer of taxing and spending powers to sub-national levels of government-in our context, local governments that are non-existent despite clear constitutional command contained in Article 140A. Developing countries are in general, more centralised than most industrialised countries were at a similar stage of development. As a consequence of much dissatisfaction with the results of centralised economic planning, reformers have turned to decentralisation to break the grip of central government and induce broader participation in democratic governance. Thus, fiscal decentralisation has become an important theme of governance in many developing countries over the past three decades.

On an average, for developing countries, the share of public sector expenditure allocated at the sub-national level increased from less than 13% in 1980 to about 20% in the late 1990s-from 2000 to 2010, this ratio has further improved in many countries, but situation in Pakistan has deteriorated as this figure decreased to below 10%. While, in the same period, there has been a modest increase in the share of local taxes in total revenue collection in the developing countries, Pakistan witnessed a reverse trend.

Pakistan is in dire need of fiscal decentralisation-presently major fiscal powers are concentrated in the hands of federal government. On the one hand, federal government has usurped the right of provinces to levy sales tax on goods within their respective territories. On the other, the provinces have shown apathy to devolve administrative and fiscal powers to local governments. Resultantly democratic polity has failed to take roots in Pakistan. Since all broad-based and buoyant sources of revenue are with the federal government, contribution of provinces in total tax revenues is less than five per cent and in overall national revenue base (tax and non-tax revenue) just around eight percent. This has made them totally dependent on Centre for transfers from divisible pool.

We can learn a lot from countries that have successfully achieved the goal of fiscal decentralisation. For example, municipalities in Finland enjoy complete fiscal independence through their elected residents. These municipalities have the right to levy municipal tax in accordance with the Local Government Act 1995. Local authorities perform the functions that they are responsible for by virtue of their autonomy and as required by law. This type of governance is totally missing in our democracy.

In Finland, extensive functions that fall within the specific sphere of authority include education, healthcare and social welfare services. Furthermore, the municipalities are responsible for matters related to the residents' free-time, recreation, housing, and management and maintenance of their living environment (ie roads, streets, water supply and sewerage), as well as land-use planning and functional municipal structures. Tax revenues have a critical role in municipal finances. The power to levy and collect taxes is one of the cornerstones of municipal self-governance as it ensures that the municipalities can manage the functions that they have undertaken to execute or which they are responsible for by law. The most important is municipal tax, which amounts to almost 16 billion Euros. Corporate income tax amounts to a little over 4 billion Euros, and real estate tax also raises almost 3 billion Euros. This is more than Pakistan's total tax revenues collected by the Federal Board of Revenue (FBR) during any fiscal year!

One of the central constitutional principles regarding municipal self-governance in Finland is that, when allocating new functions to municipalities, the State has also to ensure that they have the necessary resources to carry them out. Finland has a well-functioning relationship between the State and the local authorities, as well as a state-subsidy system which ensures municipal resources and residents' equal access to services. We can learn from this great innovation. It can change the fate of Pakistan in a short span of time. We have resources but system for self-governance as in vogue in Finland and elsewhere is non-existent. Resultantly, power vests with the privileged classes instead of the people. Like Finland, we must move to welfare state model, largely based on the idea of the municipalities being the producers and providers of services.

In Pakistan, unfortunately, The Federal Government has been encroaching upon the rights of the provinces by levying presumptive taxes on services camouflaged under the Income Tax Ordinance, 2001, sales tax on gas, electricity and telephone services and excise duty on a number of services-'Centre-provincial harmony: Equitable distribution of fiscal rights needed, Business Recorder, March 13, 2006.





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Table: Position under 7th NFC Award

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Salient features

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* Final share of provinces: Punjab

51.74 percent, Sindh 24.55 percent,

Khyber Pakhtunkhwa (KPK) 14.62

percent and Balochistan 9.09

percent.

* Federal collection charges to be

reduced from 5% to 1%

Sindh to receive additional transfer

of Rs 6 billion from federal

government

* Provinces in agreement on multiple

indicators and respective weights

* Sales tax acknowledged as

provincial subject

* KPK to be given additional 1%

from federal divisible pool

Vertical distribution

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Who will get what?

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7th NFC 6th NFC Change

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Centre 44% 52.5% -8.5

Provinces 56% 47.5% +8.5

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Horizontal distribution

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7th NFC 6th NFC Change

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Punjab 51.74% 53.01% -1.27%

Sindh 24.55% 24.94% -0.39%

KPK 14.62% 14.88% -0.26%

Balochistan 9.09% 7.17% +1.92%

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Projected amount (in billions)

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2009 2010 2014

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Punjab 419 471 938

Sindh 197 223 445

KPK 118 133 265

Balochistan 53 83 165

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Federal injustice in tax matters has denied the provinces their constitutional rights besides crippling them financially-even 7th NFC Award (see table) has not solved the issue of dependence on Islamabad as FBR has miserably failed to collect projected taxes. The provinces should have the exclusive right to levy indirect taxes on goods and services within their respective physical boundaries. Right to levy any tax on goods should be restored to the provinces as was the case at the time of independence. Despite federal highhandedness in levying unjust taxes and denying the provinces their legitimate shares, the Centre has miserably failed to reduce the burgeoning fiscal deficit that has reached the horrifying mark of Rs 1.8 trillion. Had provinces been allowed to generate their own resources, the present chaotic situation could have been averted. FBR has the audacity to claim that provinces lack infrastructure to efficiently collect sales tax-an attitude that is reflective of colonial legacy. This is also a blatant lie-Sindh and Punjab by establishing modern tax apparatuses proved it wrong and now Khyber Pakhtunkhwa is following in their footstep from this year.

For fiscal year 2013-2014, FBR is required to collect Rs 2475 billion. The Federal government's total revenues (both tax and non-tax) are estimated at Rs 3420 billion, out of which share of provinces is Rs 1502 billion. The federal expenditure under debt servicing is Rs 1154 billion, defence affairs & services is Rs 627 and running of civil government is Rs 275 billion. After charge of these four items, there is deficit of Rs 138 billion-meaning by more borrowings! While the provinces have not been allowed to levy and collect indirect taxes on goods within their geographical boundaries, the federal government has utterly failed to tap the real revenue potential which is not less than Rs 6 trillion. Failure of FBR to tap real tax potential adversely affects the provinces. In fiscal year 2012-13 due to massive revenue shortfall of Rs 456 billion on the part of FBR, all the four provinces would not get the promised amounts from NFC-eg Punjab shortfall alone is Rs 126 billion. Any shortfall in FBR's revenues jeopardises projection of fiscal deficit. This year the federating units have to show surplus of Rs 117 billion to keep the overall budget deficit at 6% of GDP, as agreed with the IMF. But obviously the provinces have linked the savings with the FBR's ability to generate Rs 2475 billion.

On the one hand, the provinces have been denied autonomy over their resources and on the other money that belonged to them-collected fraudulently as federal taxes eg presumptive taxes and federal excise duty on services-is given to them as act of benevolence under NFC Award. It is adding insult to injury-'NFC, FBR & VAT: usurping provincial rights', Business Recorder, September 5, 2009. This is a considered policy of control by Islamabad for maintaining hegemony over federating units. The provinces should have an exclusive right to levy indirect taxes on goods and services generated within their boundaries and they must devolve fiscal powers to local governments for meeting the universal entitlements of local residents.

We need amendments in Constitution to ensure judicious distribution of taxation rights between the federation and its units. Unless it is done, the provinces will continue to remain hugely dependent upon federal transfers. Transferring of indirect taxes on consumption of goods to the provinces will empower the federating units and raise the tax-to-GDP ratio. FBR's propaganda that provinces do not have the capacity to handle such taxes is just a ploy to maintain hegemony. Sindh Revenue Board (SRB) and Punjab Revenue Authority (PRA) have proved FBR wrong. Collection of SRB in two year since its inception at Rs 25 and Rs 33.7 billion was impressive as compared to what Sindh used to get from FBR. PRA in its very first year (2012-13) collected Rs 37 billion compared to Rs 26 billion received in the same head from the FBR in 2011-12.

The provincial performance in the case of sales tax on services completely belies the impression that provinces do not have the capacity to generate taxes. If sales tax on goods is given back to provinces, as was the case at the time of independence, they will perform much better as experience of handling sales tax on services shows. However, the performance of provinces in collecting agricultural income tax is extremely poor. This is a common issue both at federal and provincial level arising from absence of will to collect income tax from the rich and mighty-the meagre collection of agricultural income tax despite the existence of relevant provincial statutes should be a serious cause of concern. It is imperative that right to levy tax on income, including agricultural income, should be with the Centre. In return, the Centre should hand over sales tax on goods to the provinces-Taxing "agricultural income: qua Constitution, Business Recorder, April 09, 2010

The federal government has miserably failed to tap the real revenue potential, which is not less than Rs 6 trillion-'FBR: new chairman, old challenges', Business Recorder, August 2, 2013. FBR even failed to collect Rs 2000 billion last year and this year target is less than Rs 2500 billion. The failure of FBR to tap the real tax potential is the real dilemma of Pakistan. Poor performance of FBR adversely affects the provinces as they are wholly dependent on what the Centre collects and transfers to them from the divisible pool. Centre is unwilling to grant the provinces their legitimate taxation rights while it collects too little to meet their overall financial demands. The size of the cake-divisible pool-is so small that nothing substantial can be done to come out of debt enslavement and to spend adequately for the welfare of the people, no matter in which part of the country they live.

Track record of FBR shows remote possibility of collecting Rs 6 trillion in the next three years to give enough fiscal space both to 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. Under the given scenario, federation-provinces tax tangle will continue unchecked and further taxation through local governments, when elected, would not serve any useful purpose-there will be no relief to the people, rather tax burden will increase manifold.

Pakistan will remain in debt enslavement and more and more people will be pushed below the poverty line. If we want to come out of this crisis, the parliament will have to reconsider the prevailing social contract between federation and the provinces. Provincial autonomy and local self-governance without taxation rights and equitable distribution of income and wealth is meaningless. We cannot overcome perpetual economic and political crises unless provinces are given true autonomy; ownership of all resources; generation of own revenue and exclusive right to utilise it for the welfare of their denizens.

Fiscal decentralisation and municipal self rule should essentially be linked with a social policy based on the principle of universal entitlements for all residents in terms of access to social benefits and social services. Taxation without representation also means denial of spending for the essential entitlements guaranteed in the Constitution-'Municipal self-governance', Business Recorder, July 19, 2013.

The principle of universal entitlements, as practised in Finland through municipalities, is worth studying. "It seeks to prevent the formation of inequalities and the foundation of the poor as a separate social group, whereas residualism/marginalism takes the form assisting the poor and the needy, and thus implicitly defining them as certain types of social groups. However, in practice the system of universal entitlements is not the only one in place in Finland: Some social benefits, such as income support and housing allowance, are allocated on the basis of certain threshold criteria to those most in need, and therefore selective positive discrimination is being practised. Similarly in terms of social services, the national Social Insurance Institution remits some of the costs from service fees which nevertheless first have to be purchased by the patient. Therefore, in practice the principle of universalism means that a relatively larger share of social benefits and services function according to this principle when compared with the situation in other countries"-'The Local Government System in Finland' (http://www.localfinland.fi/en/authorities/local-self-government/Pages/default.aspx)

The provincial parliaments in Pakistan should be pressurised by civil society to enact laws for establishment of local governments as ordained under Article 140A of the Constitution on the basis of social policy discussed above-they have so far just copied the previous outdated ones with patch work here and there. The ruling classes do not want to empower people through self-governance. They want to enjoy total control over resources. The local governments will not be meaningful unless entitled, within national economic policy, to have adequate financial resources of their own, of which they may dispose of freely within the framework of their powers and for public welfare.

In a nutshell, for achieving the goal of fiscal decentralisation, local governments' financial resources must commensurate with the responsibilities provided for by the constitution and the law to ensure the welfare of the people and ensure sustainable growth at grass root level. Part of the financial resources of local authorities shall derive from local taxes and spend for providing universal entitlements and development. Pakistan must follow the model of welfare states like Finland where resources available to local governments are based on a sufficiently diversified and buoyant nature to enable them to keep pace with the real evolution of the cost of carrying out their tasks.

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

Copyright Business Recorder, 2013