11th NFC: Challenges & Solutions

Dr. Ikramul Haq

HISTORICALLY, the country has been dogged by two intractable problems: civil-military imbalance and unfair distribution of resources between the federation and provinces. The former has bedevilled democracy, the latter, federalism. Yet, no lessons have been learnt from this odyssey of failures. With the induction of the new government, a vociferous campaign has ensued in official circles and the media to review the seventh National Finance Commission (NFC) award—It’s not the NFC Award, Shahab Usto, Dawn, April 6, 2024 

The National Finance Commission (NFC) Award has always been central to Pakistan’s federal structure, reflecting the delicate balance of responsibilities, rights, and resources among the federation and its constituent units. All earlier articles contributed by this scribe on NFC Awards consistently emphasized that any NFC arrangement must be fair, evidence-based, and aligned with constitutional principles to sustain the federation.

As Pakistan now enters the phase of the 11th NFC Award—formally notified on August 22, 2025 by the President of Pakistan after the expiry of 10th NFC on July 21, 2024 —this is an opportune moment to revisit earlier arguments and update them in light of new fiscal realities.

What is new in the 11th NFC?

The 11th NFC Award marks an important institutional milestone after the dissolution of the 10th NFC. The inaugural meeting on December 4, 2025—led by the Federal Finance Minister Muhammad Aurangzeb—established multiple thematic working groups mandated to examine broader needs than population alone.

For the first time, there was a structured conversation on (i) integrating the economic needs of the merged tribal districts into the national fiscal framework; (ii) addressing long-standing grievances of underfunded provinces; and (iii) reconsidering the outdated formula that overwhelmingly emphasizes population rather than need, deprivation, backwardness, or fiscal effort.

This last one is, indeed, a promising shift from earlier NFC cycles where the debate remained restricted to one or two variables.

Most crucial question remains untouched

The most crucial point, however, remains untouched. It is why the provinces remain heavily dependent on the NFC transfers in the wake of Constitution (Eighteenth Amendment) Act, 2010, [18th Amendment], became effective on April 19, 2010.

It may be recalled that Seventh NFC Award [7th NFC Award] concluded in 2009 before the 18th Amendment. The 18th Amendment brought a major shift in Pakistan’s fiscal and administrative architecture.

With principal objective of granting greater autonomy to provinces by devolving critical functions, the 18th Amendment substantially transformed federal-provincial relationship, with re-sharing of taxation powers conforming to fiscal federalism and decentralized governance model. However, even after the lapse of more than 15 years, the provinces have failed to introduce progressive taxes, transferred from centre to them through the 18th Amendment.

The provinces have also miserably failed to implement Article 140A(1) of the Constitution of Islamic Republic of Pakistan [“the Constitution”] to “devolve political, administrative and financial responsibility and authority to the elected representatives of the local governments”.

One of the many maladies in Pakistan’s tax system is cumbersome withholding tax system contained in the Income Tax Ordinance, 2001, Sales Tax Act, 1990 and all provincial laws relating to sales tax on services. This kind of irrational system of withholding of tax at source is operationally inefficient, anti-business, complex, time-consuming and costly. The withholding tax regime must be abolished, except for payroll, dividends, interest income from banks, and taxable payments to non-residents.

The implementation of agenda of simplification of tax codes and rationalization of tax system can improve tax compliance. Provided this agenda is also accompanied by substantial improvement in public perception regarding the efficiency, technical competence, integrity and ability of the tax authorities to collect taxes fairly and justly, using modern technological tools.

The present weak and fragmented structures of the federal and provincial tax agencies have failed to achieve these objectives. Therefore, the fundamental challenge is providing a simple tax but efficient system that is manned by a competent, proficient and service-oriented administration, which is presently non-existent.

Tax administrations, both at federal and provincial levels are outdated and outmoded, besides suffering from inefficiencies, lack of trained manpower and requisite infrastructure and facilities.

The absence of requisite level of digitization, professionalism and human skills is their major malady. Tax reforms certainly do not mean mere alteration of tax laws or making cosmetic changes here. There is no effort till today to first restructure the entire tax administration on modern lines.

The failure to tap real tax potential of Rs. 34 trillion is the real dilemma of both the federal and provincial governments and not the mere NFC Award. Poor performance of Federal Board of Revenue (FBR) adversely affects the provinces as they are overwhelmingly dependent on the transfers under the NFC Award—commonly called Divisible Pool.

Provinces are not ready to collect taxes wherever due e.g. agricultural income tax from rich absentee landowners and rationalized property tax from occupant of palatial houses/bungalows/farm houses etc.

Structural causes of fiscal imbalances

To illustrate the present structural imbalance in Pakistan’s fiscal federalism, below is a summary of federal and provincial revenues and expenditures for fiscal year (FY) 2025:

Table – I

Federal Fiscal Profile – FY 2024–25

(Rs. in million)

Table – II

Provincial Fiscal Profile – FY 2024–25

(Rs. in million)

Source: Summary of Consolidated Federal & Provincial Fiscal Operations 2024-25

Look at the above figures, how little provinces collect as taxes at their own and the quantum of fiscal deficit suffered by the federation! While the federal government is accumulating debts, the provinces are heavily dependent on transfer from NFC Award.

What makes the situation more disturbing is the fact that right of provinces to levy sales tax on services is encroached by federal government through levy of presumptive/minimum taxes on services under the Income Tax Ordinance, 2001, sales tax on gas, electricity and telephone services and excise duty on a number of services. In 2025, the provinces encroached upon the right of Parliament by imposing sales tax on rent!

The federal government after imposing all kinds of oppressive taxes has miserably failed to reduce the burgeoning fiscal deficit. The reason being that FBR has been persistently failing to achieve the assigned targets, what to speak of tapping the actual tax potential that at federal level is not less than Rs. 30 trillion at federal level and Rs. 4 billion at provincial levels.

The Centre is unwilling to grant provinces their legitimate taxation right of sales tax on goods, while it collects too little to meet overall needs of the federation and federating units. Sales tax on goods at time of independence was a provincial subject. The subject of sales tax was on the Provincial Legislative List at Serial No.48 in the Government of India Act, 1935 and was described as “Taxes on sales of goods and on advertising”.

In the Constitution, 1956, “tax on sales and purchases” was mentioned at Serial No.26 of the Federal Legislative List, and therefore, for the first time it became a federal subject. The position was maintained in 1962 Constitution, which mentioned “tax on sales and purchases” on the Federal Legislative List as clause (j) at Serial No.43 in the Third Schedule.

In 1973 Constitution as originally adopted ‘tax on sales and purchases’ was kept on Federal Legislative List at Serial No.49 of Part I of the Federal Legislative List given in the Fourth Schedule to the Constitution. The item was, however, completely substituted by Constitution Fifth Amendment Act, 1976 with effect from September 13, 1976, to read “Taxes on sales and purchases of goods imported, exported, produced, manufactured or consumed”.

The second half of the amended entry appears to have been taken from the amendment made in Sales Tax Act, 1951 by Finance Ordinance, 1960. Through that amendment the words “consumption of goods” in the preamble were substituted by “importation, exportation, production, manufacture or consumption” [see details in WAPDA v. Collector of Central Excise and Sales Tax (2002 PTD 2077 and in Pakistan through Chairman FBR and others v Hazrat Hussain and others (2018) 118 Tax 260 (S.C. Pak)].

The size of the cake is so small that it cannot help the country to come out of debt trap and spend adequately for the welfare of the masses, no matter which part of the country they belong to. Under the given scenario, Pakistan will remain in debt prison, and more and more people will be pushed below the poverty line, especially due to oppressive indirect taxes. If we want to overcome it, the Parliament will have to reconsider the prevailing social contract between federation and the provinces.

Presently, all broad-based and buoyant sources of revenue are with the federal government. The   contribution of Rs. 978.6 billion by all provinces in total tax revenues of the country for fiscal year (FY) 2024-25 at Rs. 12.722 trillion was pathetically low, 0.9 % of GDP. It was merely 5.2% in overall national revenue base (tax and non-tax revenue) of Rs. 17997.45 billion [15.7% GDP] against the total national expenditure of Rs. 24494.3 billion [21.4% of GDP].

The share of provinces in national expenditure was  5.1% of GDP. All provinces together generated non-tax revenues of only Rs. 313.59 billion against the GDP of Rs.114,692 billion.

The federal government in FY 2024-25 spent Rs. 2193 billion on defence and Rs. 8887 billion on debt servicing and after transfer to provinces of Rs. 6854 billion under the 7th National Finance Commission Award (NFC), these two alone were Rs. 1134 billion higher than net revenue collection of the federal government. This is our real and perpetual fiscal dilemma.

Paradigm shift in tax policy and administration

The following measures/steps are necessary to fix the crumbling tax system and create a reliable national socio-economic registry:

• All adult individuals, whatever the level of income may be, should be facilitated to file simple and easy one-page income tax returns made available both in English and Urdu—incentive for filing return should be Rs. 5,000 cash paybacks in the bank account/mobile wallet of the filer. It would enable the process of creating National Registry about households and their earning levels at national level. Individuals earning below Rs. 600,000 should be paid income support (negative tax) till the time the State provides them employment and not keep them beggars for life.
• For individuals, income tax rate exceeding income of Rs. 1.2 million should be 10% with alternate minimum progressive tax 1% to 2.5% of net wealth exceeding Rs. 50 million.
• Corporate income tax rate should be reduced to 20%.
• All citizens should be given a chance to pay any past unpaid liability due to non-reporting or under-reporting by just paying 10% tax latest by June 30, 2026. After the deadline, stringent action including confiscation and imprisonment should be provided.
• For the next three years, under a self-assessment scheme if any taxpayer pays more than 25% tax over the last year’s liability, no audit should be conducted. If definite information for underreporting or non-reporting of any income is received, the retrieval be made with penalty of 100%.
• Simplified and harmonized sales tax on goods and services at a low rate of 10% by making recourse to Article 144 of the Constitution. The collection will be through single national agency but provinces will get shares according to the provisions of the Constitution/NFC Award.
• Simplify Customs tariff with ‘One-Chapter One-rate’. Radiographic scanning of all inbound and outbound containers to plug revenue leakages.
• Effective mechanism to counter unfair practices on the part of tax administrators—subjected to punitive actions and pecuniary damages after the final fact-finding authority adjudges their actions arbitrary, excessive and beyond their assigned powers. The Federal Tax Ombudsman should be given the statutory power of awarding damages in such instances.
• Taxpayers’ rights must be safeguarded and strengthened by giving adequate rights under Taxpayers’ Bill of Rights ensuring quality of treatment, guaranteeing privacy and confidentiality of their declarations, providing right to assistance by the State in tax matters, ensuring unfettered right of appeal through an independent tax appellate system and providing facilities for independent review of disputes with tax authorities.
• In Pakistan under the repealed Income Tax Ordinance, 1979 (until assessment year 1995-1996), three specific characteristics were the hallmarks of advance tax, viz.

1. Advance tax was paid by the taxpayer on the basis of last declared/assessed/estimated income for that assessment year;
2. Credit for any advance tax collected for an assessment year was accounted for in that year and not the year of collection; and
3. 6% mark-up on the amount retained as advance tax was paid to the taxpayer at the time of assessment thereby compensating his cost of funds or opportunity cost for the period his money remained with the government.

The above should be revived by suitably amending section 147 of the Income Tax Ordinance, 2001 that will help in ascertaining collection for the current tax year without accumulation of refunds after abolishing all regressive withholding provisions.

• Recovery of tax demand should be made only after decision of National Tax Court as suggested in a column.
• An efficient tax judiciary to help in removing impediments in the way of collection of genuine tax demands by the State and settling tax dispute within 12 months. After merging Appellate Tribunal Inland Revenue and Customs Tribunal, the new entity should be renamed as National Tax Court (NTC). It should be placed directly under the Supreme Court, as is the case with Service Tribunal.
• After one intra-court right of appeal with the NTC, only the substantial questions of law should go to the Supreme Court by way of leave to appeal as provided in Article 185(3) of the Constitution. Members for NTC should be recruited in the same manner as judges of High Court. The pay, perquisites and salary structure of NTC members and staff should be at par with that of High Courts.

The way forward to sustain fiscal consolidation is that centre and provinces should have shared right to levy sales tax on goods and services, as is the case in many federations like us, under a Unified Sales Tax on Goods & Services Act.

Unified sales tax on goods and services should be collected under federalized National Tax Authority, having representation of both federation and the federating units—this is the need of the hour, see details in A new Tax Model For Pakistan: Fair Rates, Unified Collection, And Exclusive Growth, Friday Times, May 3, 2025.

It is also imperative that further amendments should be made in the Constitution after debate and consensus to assign right to levy tax on all kinds of income, including agricultural income, to the federal government so that it can tax the rich absentee landowner to improve infrastructure, retire debts and bridge fiscal deficit without sharing proceeds with provinces. This alone can eliminate/reduce fiscal deficit at the federal level and achieve fiscal stabilization in Pakistan.

Punjab receives the largest share under the population-based formula. However, a truly equitable federation requires that deprivation, revenue effort, need, and geographic constraints should be weighted more heavily, that provinces strengthen internal resource mobilization, and that distributive equity be treated as a constitutional obligation, not political charity.

Local governments—constitutionally recognised under Articles 7, 32, and 140A—remain fiscally starved. They lack meaningful taxation powers, cannot impose effective local taxes, depend entirely on provincial transfers, and fail to deliver essential municipal services. No modern federation can function when its grassroots tier remains financially crippled.

Balochistan should have exclusive right to levy indirect taxes on natural gas and Khyber Pakhtunkhwa on electricity, just to mention two for illustration. This can make them rich. Their present share in sales tax from Divisible Pool is as low as 9% and 14% respectively. They have rich natural resources and wealth of oil, gas and electricity but due to low population get a small share for goods they produce. The same is the case for Sindh.

The Centre has been brazenly encroaching upon the rights of the provinces by levying presumptive taxes on services under the Income Tax Ordinance, 2001, sales tax on gas, electricity and telephone services and Federal Excise Duty (FED) on a number of services. Had provinces been allowed to generate their own resources, the present chaotic situation on fiscal front could have been averted.

As Pakistan moves toward debating and finalizing the 11th NFC Award, policymakers must recognize that transfers from Divisible Pool to provinces alone cannot sustain fiscal federalism. Provinces must enhance their revenue mobilization, rationalize expenditures, and build credible fiscal discipline. At the same time, the federation must broaden the tax base, reduce reliance on indirect taxation, and address structural debt vulnerabilities. Only then can Pakistan’s fiscal federalism evolve into a system that is equitable, sustainable, and true to constitutional federalism.

Only an equitable, transparent, and reform-oriented NFC Award can reinforce provincial autonomy while safeguarding national stability. The numbers presented above—based on the government’s own fiscal data—illustrate both the scale of the challenge and the urgency of genuine reform. The 11th NFC Award must become a turning point, not another missed opportunity.

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Dr. Ikramul Haq, Advocate Supreme Court, Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE), holds LLD in tax laws. He was full-time journalist from 1979 to 1984 with Viewpoint and Dawn. He also served Civil Services of Pakistan from 1984 to 1996.