The President of Pakistan has constituted the 11th National Finance Commission. The task before the Commission is to come up with a new NFC Award on the sharing vertically of federal tax revenues with the provincial governments and horizontal sharing among the provincial governments.
The award which remains operative today is the award by the 7th National Finance Commission. It became effective in 2010-11 and was expected to be valid for five years, up to 2014-15. However, the 8th, 9th and 10th National Finance Commissions could not agree on a new Award. Consequently, the 7th NFC Award has been valid now for fifteen years. It is interesting that India, which is also a federation, is currently seeing the operation of the five-year award by the 15th Finance Commission.
There is need to review the level of NFC transfers over the last fifteen years. The first quantification is of the trend in transfers since 2010-11. Second, there is need to determine the share of the transfers in total federal tax revenues. Third, it will be useful to see that if the same horizontal sharing formula had continued with updating of the relevant magnitudes what the share of each province would have been in 2023-24.
The trend in total fiscal transfers to the four provincial governments includes the transfers mandated by the 7th NFC plus the straight transfers. The latter are a small component of the total transfers.
Quantification of the trend in transfers since 2003-04 reveals, first, that the 7th NFC Award did lead to a significant increase in transfers. They went up from 3.8 percent of the GDP in 2009-10 to 5.1 percent of the GDP in 2010-11, the first operative year of the 7th NFC Award.
The level of transfers rose with the increase in the federal tax-to-GDP ratio and reached a peak of 6.7 percent of the GDP in 2015-16. Thereafter, with a persistent decline in the federal tax-to-GDP ratio the transfers came down to 5.0 percent of the GDP by 2023-24. Fortunately, with the quantum jump in the federal tax-to-GDP ratio in 2024-25, the transfers to the provincial governments have risen once again and reached the level of 6.0 percent of the GDP.
The issue is the effective transfer to the provincial governments as a percentage of federal tax revenues. This is an important magnitude as there is a perception that the 7th NFC gave too large a share of 57.5 percent of federal tax revenues to the four provincial governments. Inclusive of the straight transfers, the proposed share was somewhat larger than 57.5 percent.
There is need to adjust this share by two factors. The first is the conversion of the sales tax on POL products into partly a non-tax revenue in the form of the petroleum levy. This has effectively reduced the size of the divisible pool.
Second, the provincial governments have been persuaded to generate cash surpluses to reduce the consolidated budget deficit of the federal and provincial governments combined. These cash surpluses have been significant at close to 0.8 percent of the GDP and tantamount to a de facto reduction in transfers.
Therefore, the true share of the provincial governments is as follows:
There is a visible drop in the share of the provincial governments. It was 55.7 percent in 2010-11, close to the mandatory 57.5 percent. However, it has been declining sharply with the increased pressure for larger provincial cash surpluses, especially during the tenure of IMF programme, and diversion of federal tax revenues to the petroleum levy. In 2024-25, the provincial cash surplus was large at Rs 921 billion, while the non-tax revenues from the petroleum levy were relatively large at Rs 1,220 billion, equivalent to over 10 percent of the FBR revenues.
The share of the provincial governments as per the above formula was 52.3 percent in 2022-23, 45.9 percent in 2023-24 and 45.8 percent in 2024-25. Therefore, there has effectively been a large-scale deviation and reduction from the provincial share of 57.5 percent, mandated by the 7th NFC Award.
We turn now to examination of the horizontal shares of the four provinces as per the 7th NFC Award, as follows:
These shares were based on the following indicators and weights:
The issue is that if the horizontal sharing formula remains unchanged but the magnitudes of the indicators are up-dated to 2023-24, then what will be the provincial shares. The resulting estimates are as follows:
Therefore, the application of the same horizontal sharing formula with up-dated magnitudes of the indicators leads to an equitable outcome. The shares of the two developed provinces, Punjab and Sindh, somewhat fall while those of the two less-developed provinces, Khyber-Pakhtunkhwa and Balochistan, increase. This is the consequence of the declining share in population of Punjab and Sindh and a big increase in poverty in Balochistan. Merger of FATA with Khyber-Pakhtunkhwa increases the share of the province.
Therefore, the 11th NFC ought to estimate the share of provinces after allowing for generation of provincial cash surpluses and for diversion of petroleum levy to non-tax revenue sources. Further, at the minimum in the absence of a consensus the 7th NFC revenue-sharing formula among the four provinces should remain unchanged, with incorporation of the latest data on the sharing indicators.
Copyright Business Recorder, 2025
The writer is Professor Emeritus at BNU and former Federal Minister