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Federation, taxes & distribution

Huzaima Bukhari & Dr. Ikramul Haq

On April 27, 2020, the 9th National Finance Commission (NFC), like 8th NFC, remained fruitless as the federation and its units failed to reach a consensus for distribution of fiscal resources. The official document [Budget in Brief] of budget 2016-17 says: “The 8th NFC was constituted on July 21, 2010, but it did not give any Award”. Subsequently, the 9th NFC was constituted on April 24, 2015 followed by its demise on April 24, 2020. Now, the 10th NFC Award is reconstituted but till today no meeting has been held. This is a sad reflection on fulfilling a constitutional obligation on the part of the federal and provincial governments. In 2020, our economic managers are relying on 7th NFC Award signed on December 30, 2009, before the Constitution (Eighteenth Amendment) Act, 2010 [commonly called 18th Amendment].

The 9th NFC was the fifth since 1973 that unsuccessfully ended without consensus. So far only four NFCs have given awards. The 10th NFC was constituted on May 12, 2020 but later on reconstituted on July 21, 2020 by President of Pakistan as the earlier was set aside by Balochistan High Court on June 25, 2020. A number of writs petitions were filed in Sindh, Islamabad and Balochistan High Courts challenging its constitution and deviations from mandate under Article 160 of the Constitution of Islamic Republic of Pakistan [“the Constitution”]. In the new notification, Adviser to the Prime Minister on Finance and Secretary Finance have been removed. The terms of reference related to sharing expenditures on Azad Jammu and Kashmir, Gilgit-Baltistan, security, natural disaster, public debt servicing, subsidies and losses of state-owned enterprises have also been deleted. Now, the Prime Minister will chair the meetings of 10th NFC in the capacity of federal finance minister.

In fiscal year 2019-20, debt servicing by federal government was Rs. 2620 billion (domestic Rs. 2313 billion and foreign Rs. 307 billion) against net revenues of Rs. 3278 billion after transfer to the provinces. Debt servicing was 79% of total net revenues of the federal government and 65 % of tax collection of Federal Board of Revenue (FBR). This is the real dilemma and challenge on the fiscal front faced by Federal Government as Article 160(3A) of the Constitution, inserted by 18th Amendment, categorically says:The share of the Provinces, in each Award of National Finance Commission shall not be less than the share given to the Provinces in the previous Award”.

In these columns, it has been repeatedly pleaded that Pakistan needs to review the existing taxation rights under the Constitution between the federation and its units.

Presently, all broad-based and buoyant sources of revenue are with the federal government and contribution of provinces in total tax revenues [Rs. 4748 billion] for the fiscal year 2019-20 [11.4% of GDP] was merely 8 percent and in overall national revenue base (tax and non-tax revenue) of Rs. 6272 billion [15% GDP] it was 9 percent against the total national expenditure of Rs. 9648 billion. All provinces together generated taxes of Rs. 414 billion and non-tax revenues of only Rs. 102 billion.

Extension of the 7th NFC Award, concluded on December 30, 2009 well into 2020 is not according to the Constitution as there exists time limitation of five years under Article 160(1) that says: “within six months of the commencing day and thereafter at intervals not exceeding five years, the President shall constitute a National Finance Commission consisting of the Minister of Finance of the Federal Government, the Ministers of Finance of the Provincial Governments, and such other persons as may be appointed by the President after consultation with the Governors of the Provinces.”

The 7th NFC Award, termed as “landmark consensus”, was announced after a gap of 19 years. The 7th NFC Award was acceded to by accommodating major adjustments in vertical as well as horizontal distributions between the centre and the provinces and between provinces themselves. The shares were worked out on the basis of a formula that covered population, incidence of poverty, collection of revenues, and generation of revenues. Population was given a weight of 82 percent, poverty 10.3 percent, revenue collection 2.5 percent, revenue generation 2.5 percent and inverse population density 2.7 percent.

The Pakistan People Party (PPP) till today takes a great pride in achieving consensus over 7th NFC Award and 18th Constitutional Amendment. Unfortunately, there are clear tensions and tussles between the federation and federating units over distribution of resources under the new NFC Award. Allegedly, the coalition government of Pakistan Tehreek-i-Insaf (PTI) before getting bailout from International Monetary Fund (IMF) assured that it would strike a deal with the provinces “to balance revenue and expenditure responsibilities.” The provinces on the other hand are putting up fresh demands for increasing the divisible pool and compensation for hike in the weightage in the wake of Covid-19 endemic, for lack of infrastructure and challenges of uprooting of people and destruction of property and businesses in the aftermath of torrential rains, which they say is not provincial but national issue.

After the 7th Award, both the federal government and provinces failed to observe strict financial discipline. Monstrous size of governmental departments is causing colossal wastage of resources. The governments are spending recklessly and borrowing ruthlessly, tendencies that continue under civilian and military regimes alike since the last many decades.

The 7th NFC Award authorised the provinces to raise taxes from agriculture, property and services. It granted 57.5 percent of revenues to the provinces with the expectation that the provincial governments would use the resources efficiently to improve the living standards of their people—a promise that remains unfulfilled even after passage of a decade. Another disturbing area has been non-existence of functional local governments and lack of fiscal decentralisation that is non-compliance of Article 140A of the Constitution. Major fiscal powers are concentrated in the hands of the federal government. Even the Constitution denies provinces the right to levy sales tax on goods within their respective territories—a right available to the provinces before independence. The provinces have also shown apathy to devolve administrative and fiscal powers to local governments.

The fundamental issue of judicious and evenhanded distribution of taxation rights amongst federation and its units has never been touched by any party in the NFC’s parleys held in Islamabad on August 27-28, 2009 or during the parleys on 18th Constitutional Amendment. The politicians of all the parties have failed to comprehend the real issue involved and how to empower provinces so that they could enjoy full autonomy in fiscal matters. Resultantly, the provincial governments continue to depend heavily on receivables from the NFC Award—commonly called Divisible Pool. In this scenario, both the federal and provincial governments have failed to reduce budget deficits, let alone achieve prosperity.


Table:  Position under 7th NFC Award

Salient features Shares
  *    Final share of provinces: Punjab 51.74 percent, Sindh 24.55 percent, Khyber Pakhtunkhwa (KPK) 14.62 percent and Balochistan 9.09 percent. *    Federal collection charges to be reduced from 5% to 1% *    Sindh to receive additional transfer of Rs. 6 billion from federal government *    Provinces in agreement on multiple indicators and respective weights *    Sales tax on services acknowledged as provincial subject *    KP to be given additional 1% from federal divisible pool Vertical distribution
  7th NFC6th NFCChange
 Horizontal distribution
  7th NFC6th NFCChange
 Amount (in billions). For FY 2021 as projected

There is something fundamentally wrong with the structure of distribution of taxing powers between the federation and the federating units. Before independence, the provinces had the exclusive right to levy sales tax on goods and services within their respective physical boundaries. 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” in 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. The item was, however, completely substituted by Constitution 5th Amendment Act, 1976 with effect from September 13, 1976 that 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 also in Pakistan through Chairman FBR and others v Hazrat Hussain and others (2018) 118 Tax 260 (S.C. Pak)].

The solution is to move towards harmonised sales tax on goods and services for which there is a need to debate in public and Parliament for reaching a consensus. The total collection by imposing unified sales tax on goods and services can reach Rs. 4000 billion as against collection of around Rs. 1596.6 billion by FBR in 2019-20 through sales tax on goods and provinces cumulatively of Rs. 232 billion through sales tax on services. The additional revenue collection of nearly Rs. 2000 billion will not only give fiscal space to the federal government to narrow down fiscal deficit but will also enhance distribution amount to the provinces. Distribution will be strictly as per Constitution.

The issue of NFC Award vis-à-vis provisions of 18th Amendment relating to decentralisation of fiscal powers cannot be examined in isolation. It is clear that all the federal and provincial governments have never been concerned with the fundamental issue of judicious and evenhanded distribution of taxation rights between federation and its units that can help empowerment of masses and ensure prosperity for all.

The performance of provinces in collecting agricultural income tax is extremely appalling. This is a common issue both at federal and provincial level arising from absence of political will to collect income tax from the rich and mighty—meagre collection of agricultural income tax—less than Rs. 3 billion by all provinces in fiscal year 2019-20—is lamentable. The way forward is that provinces should have the exclusive right to levy sales tax not just on services but also on goods as was the situation in 1947. 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 and it can tax the rich and mighty 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 stabilisation in Pakistan.  


The writers, lawyers and partners of Huzaima, Ikram & Ijaz, are adjunct faculty of Lahore University of Management Sciences (LUMS)

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