In recent news the federal cabinet decided that FATA will get three percent share under the National Finance Commission (NFC) Award. However, that announcement seems to be more like a political statement than an actual economic decision on the anvil.
For one, with FATA being merged with Khyber Pakhtunkhwa (KP), does the federal government plan to give that 3 percent to the KP, or is it so that the centre has decided to delay the merger and allocate 3 percent specifically to FATA. In case of the former, under what law can the centre direct a province to spend such and such amount on a particular region or on particular public service delivery. In the case of latter, well that’s another political can of worms of altogether.
Second, has the federal cabinet decided to give 3 percent share from the divisible pool or its own resources? The former cannot be done without a unanimous nod from all the provinces, which is difficult considering that at least Sindh will not agree to such proposal. The latter is just too difficult, given the tight budget constraints that the centre has continued to face since Tarin’s (NFC) Award.
But this debate is not new. Recall that in the previous regime, the centre had demanded a 7 percent cut from the divisible pool before that cake is shared between the provinces. That amount was to be allocated on federal territories and security spending. However, the provinces, including Punjab governed by the party ruling Islamabad, were very clear that it was not to happen because both federal territories and security spending are federal subjects.
In a recent consultative dialogue on the NFC by the Islamabad-based think tank Prime Institute, participants agreed that at the heart of ongoing ‘deadlock’ or ‘delay’ in the NFC, howsoever one would like to put it, lies taxation.
In the NFC agreement, the five parties – centre and the four provinces – had decided to increase the country’s total (federal and provincial combined) tax-to-GDP ratio to 15 percent by the terminal year of the award, and there was implicit agreement that that ratio was to be raised to 19 percent in the four years hence. There was no other way that a huge reduction in federal share in the 7th NFC in vertical distribution could have worked for the centre.
Expanding the size of the cake was the only way the centre’s finances could be stable. But tax-to-GDP was not raised in the manner that was planned and agreed upon in the NFC agreement. The result: an increasing pressure on federal fiscal deficits, based on which the IMF and other centralists demand a roll back in the NFC or 18th amendment or both.
Considering that the major tax bases lie with the centre, the centre was to lead this campaign to raise tax to the GDP. For instance, there is plenty of hype that agriculture income tax (AIT) is not being collected properly by the provinces. But the actual potential of country-wide AIT estimated by various reputable economists is no more than Rs150-Rs250 billion. Given weak farm productivity, environmental fluctuations, small land holding sizes in north and central Punjab – the country’s heartland – the AIT estimates cannot be expected to keep pace with the growth in overall GDP.
Of course, there is an argument of equity, and there is indeed no denying that AIT should be paid, as is income taxes are expected from other economic sectors. Even more so, for the sake of doing away with the shadows that current AIT system provides under which many people hide their non-farm income. However, it must be kept in mind that there is as such no publicly available reliable study that shows that ‘X’ amount of income is being hidden in the shadows provided by the existing AIT system.
There are certain quarters that suggest some adjustments to be made in the NFC to reduce the pressure of tight budget constraints on federal finances. That cannot be done unless the PTI changes the constitutional amendment which guarantees that combined provincial share shall not be less than what was agreed at the time of Tarin Award.
Some demand that the cost of debt servicing should be transferred to the provinces. First of all, this cannot happen unless all the provinces agree. Second, why would provinces share the liabilities without sharing the assets? The assets in this ‘may’ be – and it’s big ‘may’ – infrastructure spending by the centre in the provinces.
The only way that the centre can crawl out of its problems is by increasing taxation and pushing a country wide tax reforms agenda. It should coordinate with the provinces in rolling out income-based AIT – as against land-based AIT - as well as reforms in other taxes such excise duty and urban property taxes. In turn, all of these reforms should be aimed towards sharing databases and triangulating information for increasing both the number of filers as well as the amount collected.
On a related note, the centre should study how it can govern better with lower expenses. These days there is a lot of criticism that there are about 41 divisions in the federal government that are ‘unnecessary’ after the devolution. But how much do they actually cost to the federal kitty and whether indeed they are ‘unnecessary’ or whether do they have some coordinating role to play. Matters like these are little researched.
Soon after taking office, one of the good things that Finance Minister Asad Umar did was to write to the provinces to notify their non-statutory members for the NFC. Later, the information ministry said “PM Khan has directed to speed up the process of NFC Award”. With the budgetary work behind us, and the soon-to-be-finalised macroeconomic stabilisation plans (of which Saudi card has already been played), the NFC negotiations can be expected to begin around end of December. It is hoped the PTI would not fall prey to the demands of the IMF and other centralists.
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