Fiscal performance of provincial govts

The information on fiscal operations by the four provincial governments in the first half of 2024-25 has been released by the Federal Ministry of Finance.

An analysis of the fiscal performance of provincial governments is essential because the IMF Programme focuses more on provincial governments than has hitherto been the case. A number of structural benchmarks and indicative targets have been included relating to the combined performance of the four Provincial governments.

There is clearly a general realization that the provincial governments will not only have to increase their share in national revenues but also accept the devolution of more functions from the federal level in line with the 18th Amendment.

The position in 2023-24 was that only 7.5% of the national tax and non-tax revenues were generated by the four Provincial governments combined. This is despite the constitutional allocation of substantial fiscal powers to these governments, including the agricultural income tax, sales tax on services and property-related taxes.

The provincial tax-to-GDP ratio was also only 0.7 percent of the GDP in 2023-24. A comparison with the revenue mobilization by the states in India reveals the low level of fiscal effort. The 31 states of India generate tax revenues of almost 6 percent of the GDP.

Given the low collection, almost 83.4 percent of provincial expenditures were financed by federal transfers in 2023-24. There is clearly a need for greater self-financing of higher levels of expenditure on social services and social protection.

Given the urgency of these measures, the IMF has included a number of targets relating to the performance of the four provincial governments combined for 2024-25, starting with the targeted levels for December 2024 in the first review, which is currently on-going.

There are three indicative targets relating to the performance of provincial governments. The first is a floor on the combined budget surplus. The second specifies a floor to provincial tax revenues. The third relates to spending on education and health, over 90% of which is incurred by the provincial governments.

Further, the reforms expected include, first, alignment of the agricultural income tax with the federal personal income tax by end-October 2024 and commencement of collection under the new law from the 1st of January 2025. Second, a National Fiscal Pact has to be signed between the federal government and the provincial governments relating to the types of spending to be devolved. Third, the expectation is that the provincial governments will also develop the property-related taxes and the sales tax on services. The latter tax will make a transition from a positive list to a negative list of exempt services only.

The very good news is that the two indicative targets on the consolidated provincial budgetary surplus and tax revenues have been met. The flood on provincial tax revenues as of December 2024 was Rs 376 billion. The actual collection was Rs 442 billion. The provincial cash surplus was targeted at Rs 750 billion. The actual surplus was Rs 775 billion. The achievement of the latter target has been facilitated by a 37 percent growth in federal transfers. This is significantly higher than the 28% increase in the case of the federal divisible pool of tax revenues.

However, there is a significant variation in the performance of the four Provincial governments. The fastest growth rate in own tax revenues has been shown by the Government of Sindh with a growth rate of almost 36%, due partly to enhancement in the tax rate on the sales tax on services from 13 percent to 16 percent. The governments of Punjab and Balochistan have shown only a single-digit growth rate in tax revenues.

The biggest increase in the cash surplus has been shown by the government of Punjab, followed by Sindh’s and Khyber-Pakhtunkhwa’s. The Balochistan government has a shown a decline in the budgetary surplus.

Further, the target level of health and education spending is also likely to have been met. It was set at Rs 1405 billion for up to December 2024. This is 38% of the total provincial spending. In previous years, the four provincial governments combined have devoted almost 40% of their spending to education and health.

The National Fiscal Pact between the Federal and the Provincial governments was finalized, as required, in September 2024. A 19-point agenda has been prepared. There is an agreement on more devolution of spending to provincial governments on higher education, health, social protection and infrastructure development.

However, progress on the design and implementation of tax reforms has not been adequate. The amended Agricultural Income Tax act was delayed, and the four provincial governments have decided to start collection under the new law from the 1st of July 2025. Some Provincial Acts do not specify the tax rates by level of income.

A recent study for PIDE has estimated that the potential tax revenue from the agricultural income tax is significant if the tax rate is in line with the federal personal income tax rate structure at different levels of income. The tax potential is enhanced by the very uneven size distribution of farms.

The estimated revenue from the agricultural income tax is 0.8 percent of the GDP. Effective implementation of this tax will double the provincial tax-to-GDP ratio. However, it is likely to meet stiff resistance from the powerful lobby of the largest farmers.

The provincial governments will need to focus also on the development of the urban immoveable property tax and the capital value tax on property in the forthcoming budget of 2025-26. These are highly progressive and revenue-yielding taxes.

There is need to appreciate the performance of the provincial governments in meeting the indicative targets in the IMF programme for December 2024. However, the same degree of fiscal effort will be required to achieve the annual targets for 2024-25. This will also hinge on continued fast growth in revenue transfers by the federal government to the provincial governments.

Copyright Business Recorder, 2025