Fiscal Federalism in Pakistan: Need for a Revisit

Abstract

This Policy Brief outlines a reform package to streamline the fiscal arrangement among federating units and the centre. The 18th Constitutional Amendment and 7^th National Finance Commission (NFC) award reshaped the fiscal landscape of Pakistan. The provinces enjoy more autonomy in performing various functions within their jurisdictions. These developments have resulted in a fundamental shift in the division of powers between the centre and the provinces. Based on the 7^th NFC Award, 57.5 percent of resources collected by the centre through FBR are transferred to the provinces using four criteria (Box 1).

Time for Revisit: Why? However, the question remains that how these weights were assigned and whether we can achieve higher efficiency by experimenting with the given NFC formula. It is noteworthy that the 18^th constitutional amendment has made the Award inflexible by requiring that the provinces’ share shall not be less than what is decided in the 2009 NFC Award (i.e., 57.5 percent of the divisible pool). The non-flexibility clause added to the complexity and distorted the dynamic nature of the Award. Higher transfers and increased spending needs have placed an enormous burden on the federal government, which resorts to borrowing to finance the budget deficit. Further, it becomes difficult for the federal government to meet development financing needs, defense, pension, salaries, and debt-servicing from the remaining 42.5 percent of the divisible pool.

Being a federal country, there is a need to assess whether the existing state of affairs can continue indefinitely, or it would be important that all the federating units assume the joint responsibility of anchoring sustainability and progress. Debt servicing, development, defense, and natural calamities (like Covid-19 and floods) necessitate better coordination and  joint efforts.

Hence, joint coordinated efforts and a mechanism that can ensure it as a dynamic NFC formula. The resource distribution formula should contain the right set of incentives so that every federating unit puts in its best effort without externalising its expenditures upon others. Additionally, the mounting public debt and rising fiscal needs to finance defense had led to underfinance the social spending needs, thus resulting in miserable progress in social indicators. As a signatory to SDGs framework, financing needs require better coordination. This calls for a revisit of fiscal arrangements between the federal government and provinces to take into account these federational contexts also.