Hafeez Pasha
A recent World Bank report on fiscal federalism in Pakistan offers a timely evaluation of the country’s decentralized governance framework. While acknowledging the 7th National Finance Commission (NFC) Award of 2010 as a major step forward, the analysis underscores critical implementation failures and structural deficiencies that hinder effective governance. Addressing these gaps requires examining institutional breakdown, fiscal distortions, and a viable path forward.
The first major failure stems from incomplete devolution. The two-step administrative transfer envisaged under the 18th Amendment failed to fully materialize, as functions outlined in the Federal Legislative List were never completely shifted to provincial control. Furthermore, despite Articles 32 and 140A, devolution stalled entirely at the provincial level, leaving local governments ad hoc, financially constrained, and subservient to provincial discretion. Concurrently, the 7th NFC Award created distorted revenue incentives by allocating 57.5 percent of the federal divisible pool to the provinces. This large guaranteed transfer discouraged provincial governments from developing their own substantial revenue bases and reduced the federal center’s willingness to bear the political cost of broader resource mobilization.
Tax system fragmentation presents another severe structural defect. The division of sales tax powers—federal control over goods and provincial authority over services since 2015—prevents a unified Value-Added Tax (VAT) mechanism. Without offsetting input costs across goods and services seamlessly, the tax system distorts neutral economic activity. Additionally, the horizontal resource-sharing formula among provinces relies disproportionately on population size, failing to achieve proper fiscal equalization by under-representing factors like poverty, backwardness, and inverse population density, which reflect higher service delivery costs.
To counter these structural imbalances, the federal government has increasingly relied on informal fiscal maneuvers. Article 160(3A) dictates that the provinces’ combined share in any new NFC Award cannot fall below the previous benchmark. Unable to lower the nominal 57.5 percent benchmark legally, the center has used back-door methods to curtail net provincial transfers. By converting the sales tax on petroleum into a federal levy, the center excludes an estimated Rs 1,677 billion from the divisible pool. Furthermore, requiring provinces to return roughly Rs 1,794 billion in cash surpluses to offset the consolidated budget deficit and directing them to provide Rs 1,035 billion in direct grants under Article 164 significantly reduces the actual resource flow. These maneuvers effectively drop net provincial transfers down to just 34.3 percent of the true divisible pool.
Rather than creating additional provinces, true administrative efficiency depends on empowering elected local governments as mandated by Article 140A. Localized authority ensures direct service delivery, transparent spending, and grassroots accountability. Concurrently, integrating federal sales taxes on goods with provincial sales taxes on services into a unified VAT framework will remove market distortions. Finally, revising the horizontal distribution formula to reduce population weight while rewarding provincial tax collection efforts will establish a balanced, resilient fiscal federalism in Pakistan.
