NFC Award: some positive development

The News
21-12-2009


The basis of horizontal distribution is made more complicated after the inclusion of vague concepts like poverty and backwardness. The population factor remained the most dominant basis for distribution of resources

By Zafar-ul-Hassan Almas

The government has finally resolved the thorny issue of NFC (National Finance Commission) in its Lahore meeting by accepting the provincial governments' demand for a greater share in the national resources.

The government has finally resolved the thorny issue of NFC (National Finance Commission) in its Lahore meeting by accepting the provincial governments' demand for a greater share in the national resources. The federation has sacrificed its chunk of share along with reduction in collection charges from five to one per cent. The horizontal and vertical issues are almost done as well. The basis of horizontal distribution is made more complicated after the inclusion of vague concepts like poverty and backwardness. The population factor remained the most dominant basis for distribution of resources with 82 per cent of them being distributed on this basis. The sympathy towards war torn province of NWFP is yet another positive development besides Punjab’s all out support for the NFC.

The fact that the federal government and the four provinces have come to an agreement in the current round of NFC negotiations is very encouraging and has been hailed as a victory for democracy. However, the worrying thing about the arrangement is that it has not taken into account the ground realities of the budgetary dynamics. The federation has surrendered portion of its 52.5 per cent stake to 44 per cent in this award and if we include four per cent point reduction in collection charges, the sacrifice is even greater. But without transferring expenditure assignments to provincial governments, the federation will face dire resource shortages. Federal government is already responsible for creating major portion of the fiscal deficit, when we are committed to abide by fiscal discipline through restricting ourselves to fiscal deficit target assigned in the SBA package. Now the federation has indulged itself into a situation where attaining fiscal deficit target has become a gigantic task.

With the current revenue short-fall and growing expenditure needs in the wake of security needs compounded by ever increasing debt servicing liabilities, the center needs more resources. In this situation, the provincial share has to be increased at the expense of the federal government. The poor resource mobilization effort on the part of the provinces is likely to remain a hallmark of this NFC. There is a huge untapped potential in the provincial revenue account. Even the local government could amass a huge chunk of revenue from the structure of the local resources. The own revenue concept has to be given more weight without enhancing multiplicity of the taxes.

The right of provincial governments on sales tax of services is also accepted. However, a million dollar question is whether GST on services will remain non-starter like the agriculture income tax. The ability of the provincial governments to collect this tax with efficiency is also doubtful and to devise a mechanism for tax collection will take time.

The last formal NFC award was promulgated in 1997 for a period of five years by a caretaker set up and it generated a lot of controversy. The award after its expiry in 2002 remained formally operative until 2009. The politics of the NFC got messier and no consensus was reached among the federating units for many years. All provinces had taken positions and nobody was ready to compromise even a slight fraction of their position in the larger interest of the country. The deadlock forced the last government to prevail upon the provincial chief ministers to authorize the then president to announce an award by using his powers under Article 160(6) of the Constitution. Subsequently, then president of Pakistan amended the “Distribution of Revenues and Grants in Aid Order, 1997” and announced the NFC award which took effect on July 1, 2006. Then president gave the formula which promised more resources to the provinces. The resources are being distributed on the basis of this formula since the last three years.

Since 1997, the share of the government in the divisible pool had been fixed at 62.5 per cent while the share of the provincial governments was fixed at 37.5 per cent. However, in the provisional award of 2005, the share was enhanced and beginning 2006-07 it was decided the share of the provincial governments in the divisible pool will rise annually to 41.5, 42.5, 43.75, 45.0 and 46.25 per cent thereafter in coming years. This arrangement is going to expire in the end of 2010-11.

The provincial share has already reached 45 per cent in the current year. In the negotiation process of the current NFC, provincial governments demanded 60 per cent share in the revenues. More importantly, they were not demanding expenditure assignments equal to this additional revenue. The dichotomy is that expenditure assignments have continued to perform by the federation with reduced resources.

This is the most trying time for Pakistan when expenditure needs are growing but the revenue base is shrinking with imports contracting, negative growth in industrial output and deteriorating governance. Pakistan has already earned a distinction of having low tax-to-GDP ratio, even in the South Asian region. In this environment we are replicating the performance of the 1990s when additional tax measures were taken more frequently but tax-to-GDP ratio persistently fell. If we are transferring more resources to provincial governments then we have to redefine expenditure assignments because going forward, there is a likelihood of a rising expenditure burden on the federal government.

There is always a question mark on the provinces’ ability to spend because whenever enormous growth in allocations to provinces is witnessed, the provincial governments were not able to consume despite the spendthrift and profligate attitude of the government. The NFC award has badly ignored the most pressing demand of value for money assessment of spending.

The lower tiers of the government are bestowed with new assignments under the decentralization program without any guaranteed resource inflows from provincial governments. We should learn from the experience of our next door neighbor India where distribution of resources is a normal function of the government without any controversy. Indian resource distribution also makes it obligatory on the part of the states to further specify the share of local governments in their resources. In Pakistan’s case, lower tiers of the government are ignored in the process and discretion of the provincial government is adding to their woes. Resource shortage is hampering their simple development needs in many cases while resource abundance is feeding fat cows in pro-government district governments.

Another lesson from India is professionalism because their resource distribution is professional in approach. The composition of the NFC is again political rather than professional. The NFC award should be manned by professionals from different federating units. The countries which have centralized government structures with diversity, the distribution and burden sharing among federating units is always cumbersome. It is natural that resource generating abilities and resource consumption requirements of different regions is different and some sort of burden sharing is a must for the federation to run efficiently. The amicable agreement between the stakeholders requires intricate, professionally designed and unbiased formula based on sacrifices and tolerance. This needs a permanent structure and professionally managed independent body.

Political backing and commitment is a must but if a political solution is tried in an emotional environment like Pakistan’s, the result would be disastrous. Pakistan has a long history of NFC awards’ failure.

Punjab has been generous with respect to smaller provinces and its attitude has remained accommodative with three provincial governments having acknowledged the contribution of Punjab. Every province should have been generous and take into account growing expenditure needs generated in the center. The NFC should also devise a mechanism for equitable distribution of resources to the lowest tiers of the government.

With Musharraf’s devolution system, significant responsibilities have been transferred to lower tiers of the government. The federal government is obliged to share its revenue with provincial governments, but the provincial governments are not bound to share any amount with local governments. The centralized revenue generation to the extent of almost 95 per cent and subsequent transfer of resources among different tiers of the government creates problems and frictions.

We need more professional debates on inter-governmental relationship and consensus building. The provinces should be given some sort of fiscal autonomy by allowing them to generate more revenues. The local taxes like property taxes should be made into important vehicles of revenue mobilization by local governments. True, is the fact that waste and corruption increases with the downward movement of tiers but this is because of weaker monitoring and accountability. Once rule of the law is established and an accountability process is at place, the effectiveness of public spending at the lowest tier of the government would be increased.