The 11th National Finance Commission (NFC) was constituted some time ago, but its first meeting has yet to take place. The Commission comes after three earlier NFCs – the 8th, 9th and 10th – failed to arrive at a consensus on a new award after the 7th NFC Award.
The 7th NFC Award was initially valid for five years, from 2010-11 to 2014-15. However, it has continued to be in operation already for an additional ten years. This reflects poorly on the state of fiscal federalism in Pakistan. Clearly, the 11th NFC has a major task of taking forward the process of sharing vertically the divisible pool of federal tax revenues between the federal and provincial governments combined and the sharing horizontally among the provincial governments.
An earlier article by this author has revealed that while the vertical share of the provincial governments is 57.5 percent from the divisible pool, the actual share is significantly smaller. This is because, first, the divisible pool has been reduced by the conversion of the sales tax on POL products partly into the petroleum levy. This levy is outside the divisible pool and has been classified as a non-tax source of revenue.
Second, the provincial governments have not been fully utilizing the NFC transfers and generating sizeable provincial cash surpluses to contain the consolidated budget deficit. Therefore, these two measures have de facto reduced the combined provincial share in the federal tax divisible pool to almost 45 percent.
The 11th NFC may legitimize these two practices and thereby effectively continue them. Consequently, there ought not to be much deliberation on the vertical sharing arrangements, which ought to continue as per the present practice.
However, the divisible pool should be clearly identified, leaving no scope for any further reduction in its size. A target may be set for the size of the combined provincial cash surplus at say close to 1 percent of the GDP.
The focus next has to be on the horizontal sharing formula of the divisible pool transfers among the provincial governments. The 7th NFC developed an elaborate sharing formula of multiple indicators with respective weights. These are as follows:
a. Population 82.0 percent
b. Poverty/backwardness 10.3 percent
c. Revenue collection/ generation 5.0 percent
d. Inverse Population Density (IPD) 2.7 percent
Based on these indicators and their respective weights, the final percentage share of the provinces was decided as follows:
• Punjab 51.74 percent
• Sindh 24.55 percent
• NWFP 14.62 percent
• Balochistan 9.09 percent
The merit of the horizontal sharing formula was that it implied a larger per capita transfer to the two smaller and less developed provinces of Balochistan and Khyber-Pakhtunkhwa. Consequently, there is need for recognizing the achievement by the 7th NFC in implementing an equitable sharing formula, with the expectation that it would help in reducing regional disparities in Pakistan over the years.
There is need for focus on the implications of the horizontal sharing formula shown above. The first task is to see what would be the implications if the 11th NFC decided to continue with the formula, but with updated magnitudes of the indicators.
The first indicator is population. Fortunately, the 2023 Population and Housing Census has provided up-to-date information on the population distribution at the provincial level in Pakistan. However, there is one change. The Federally Administered Tribal Areas (FATA) have been merged with the province of Khyber-Pakhtunkhwa.
Further, there are significant differences in the population growth rate of the provinces. As such, the change in population shares of the provinces is as follows as per table:
======================================================================== Population Share of Provinces ( percent)======================================================================== 7th NFC Award Population Census 2023========================================================================Punjab 57.36 53.40Sindh 23.71 23.29Khyber-Pakhtunkhwa 13.82 17.08Balochistan 5.11 6.23Pakistan (excluding Islamabad) 100.00 100.00========================================================================The change also reflects the faster growth in population in Balochistan and Khyber-Pakhtunkhwa, as well as the increase in the share of the latter province due to the merger of FATA with this province.
The second indicator for deriving the horizontal share is poverty/backwardness. Two sources of data are available. The incidence of multidimensional poverty in each province was derived by the UNDP/Oxford Poverty and Human Development Initiative for 2014-15.
The level of backwardness is estimated by the Human Development Index (HDI). The latest estimate of the HDI at the provincial level is for 2018-19 in the UNDP country Human Development Report for Pakistan of 2020.
Combined these two sets of indicators reveal that the shares of the three provinces—Punjab, Sindh and Khyber-Pakhtunkhwa—are likely to fall; while that of Balochistan increases. The latter province has fallen further behind.
The third indicator is revenue collection/generation as defined by the 7th NFC. Here, in relation to the shares of the provinces taken by the 7th NFC, there are some changes. The share of Punjab goes up while that of Sindh falls. There are marginal increases in the share of Khyber-Pakhtunkhwa and Balochistan.
The last indicator is inverse population density. Here, there is a small decline in relation to the 7th NFC share of Balochistan due to faster population growth.
Overall, the first estimates of application of the horizontal sharing formula as per the 7th NFC Award are that the share of Punjab could fall by up to 4 percentage points and Sindh’s share may decline by 1 percentage point, largely due to the decline in population shares. The share of Khyber-Pakhtunkhwa could go up by almost 3 percentage points, while that of Balochistan could rise by 2 percentage points.
Overall, the change in horizontal shares is likely to be in the desired direction and promote the process of reduction of regional disparities in Pakistan.
There are other possible indicators, which could be included as follows:
(i) Per capita expenditure on education and health, to reward higher expenditure as demonstrating the right priority of development of the social sectors;
(ii) Indicator of poverty to be changed to the share of the provinces respectively in the number of poor and not the incidence rate;
(iii) The indicator of revenue collection/generation should also include the share of revenues generated from the personal income tax and not the withholding tax on electricity.
(iv) The measure of fiscal effort in raising tax revenues annually, as was done in the 1996 Award.
The 11th NFC ought to take on its task of giving a new award with the highest degree of commitment. This will enable the move towards the next stage of fiscal federalism. The Provincial Finance Commissions can then take on the task of developing the sharing formula between the provincial and local governments and among local governments.
Copyright Business Recorder, 2025
The writer is Professor Emeritus at BNU and former Federal Minister