The NFC heat

The talks of 9th NFC have started; by no means is it going to be conclusive anytime soon. The need is to rethink the whole process of unfair revenue collection, skewed burden sharing, and wrong resource distribution where the spirit of devolution is simply missing.
The federal budget after the 7th NFC award has increasingly become unsustainable - over 90 percent of country's revenue is generated by federal sources while its share in revenue is around 50 percent. The sticky and growing expenses like defence and debt servicing at federal level have diluted the impact of marginal increase in tax to GDP ratio in the past few years. According to ministry of finance, the debt servicing and defence expenditure would be 121 percent of net federal revenues in FY19 - the ratio was 83 percent in FY10, prior to the 7th NFC award.
The federal fiscal system is becoming unmanageable, and at this rate, without any change, time is not far when debt servicing exceeds net federal revenues. In simple words, debt trap is looming fast. The skewed burden sharing has to come to an end by passing on of provincial debt liabilities. Apart from that, energy-related accumulation of circular debt has to be passed to provinces along with management of discos, if these are not privatized.
The pressure is on the federal government to increase its taxation while the provinces have formed their own collection bodies. The taxation collection system lacks integration, where the existing taxpayers have to pay to multiple agencies with no or little coordination. The tax compliance for SMEs, especially in services, is eating up time and resources of businesses which is increasing the cost of doing business and reducing Pakistan's score on ease of doing business. This has to be corrected by forming an integrated taxation collection system where federal agency collects taxes on behalf of provinces and give them back their due share.
The other problem of unfair tax collection is based on allowing service sales tax collection based on origin. Why financial and many other services originating from Karachi being consumed all over the country are a part of Sindh's collection? The need is to revisit the services sales tax distribution, based on certain realistic formula, with taxes being collected on behalf of provinces, at federal level, and redistributed in accordance to consumption pattern. The future is services economy and sooner the mechanism of collection and distribution is corrected, the better it is.
The other problem of provinces collecting taxes is that they do not tend to tax their own voter base. For instance, virtually all the services GST collected in Sindh is from Karachi and Hyderabad where the ruling party, PPP, does not have any significant presence, and elsewhere, where the vote bank lies, the collection is minimal. Provinces have to go beyond the GST on services (regressive in nature) to agriculture income and real estate taxes. In order to avoid duplicity of taxes and to improve the score on ease of doing business, and to curb the practices of hiding non-agriculture income in agriculture businesses to evade taxes, the collection ideally should move to federal government on behalf of provinces.
That is one side of the problem, the other issue is skewed distribution of taxes. The provincial revenues share in absolute terms multiplied by 3-4 times in the last decade, and the desired outcome was to have equitable distribution of resources by enhanced spending in backward districts. The story in Punjab is entirely opposite, according to Hasaan Khawar calculations, 50 percent of Punjab development budget during FY13-18 was spent alone in Lahore - per capita spending in Lahore was 25-30 times more than southern Punjab cities. The whole objective of devolution is defied - Punjab has given its incremental share to Sindh in 7th NFC award so that backward districts of KP and Balochistan can have higher share in development, but ironically, Punjab's own backward districts suffered in the process.
In case of Sindh, Karachi does not have any political constituency of PPP and it has been pushed into darkness in the past decade with deteriorating infrastructure and poor service delivery. On top, the corruption cases of Sindh government's top leadership are unfolding, demonstrating alleged misuse of additional resources in the past few years.
The spirit of giving higher resources to provinces in 7th NFC award was to have better service delivery across the country, but that is clearly not the case in two big provinces. The natural progression is to have provincial finance commission which is still missing. An effective level of local governments is the need of the hour.
The federal government has done its part by allocating higher resources to provinces in 7th NFC award which is costing the macroeconomic stability in the medium to long-term in isolation. The next step is for provinces to enact the local government law in letter and spirit and to have successful provincial finance commissions; that did not happen as leading political parties have polarized political constituencies.
Had the provinces used the resources optimally by giving due share of Punjab in Southern Punjab districts, and Sindh's in Karachi, the economic potential would have been unleashed to increase the economic growth and in turn federal tax collection. The transmission did not happen and now the boom bust cycles are frequent.
The need is to go back to the drawing board and somehow link the next NFC award or transfers to provinces, by passing on the allocation to neglected districts. Provinces are required to build capacity at local government levels and empower them to impose and collect local and counsel level taxes. The PTI government has this on top of its agenda, and the process should be expedited in PTI's own governments - Punjab and KPK, and its coalition government in Balochistan. The problem is in Sindh where it is hard to negotiate as PPP would not want to lose its grip. Be that as it may; do it in rest of the country and by next elections, people of Sindh may vote for their own rights.