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NFC & fiscal consolidation

Huzaima Bukhari & Dr. Ikramul Haq

In these columns, we have been repeatedly pleading for an urgent action to review the existing taxation rights under the Constitution of Islamic Republic of Pakistan [“the Constitution”] as presently, all broad-based and buoyant sources of revenue are with the federal government and contribution of provinces in total tax revenues is hardly 6 percent—in overall national revenue base (tax and non-tax revenue) it is around eight percent.

On March 12, 2020, the Adviser to the Prime Minister on Finance and Revenue, Dr. Abdul Hafeez Shaikh, chaired the meeting of the Monitoring Committee of National Finance Commission that was attended by Provincial Finance Ministers of Khyber Pakhtunkhwa and Balochistan, whereas Punjab and Sindh were represented by their Finance Secretaries.

According to official handout, the purpose of the meeting was “to seek approval of the bi-annual reports on the implementation of the National Finance Commission (NFC) Award for the periods of July–December 2018 and January–June 2019 and the establishment of the National Tax Council (NTC)”. It is the requirement of Article 160(3B) of the Constitution that these reports, after approval, must be presented in the National and Provincial Assemblies. These contain the information on ‘Distribution of Revenues and Grants in Aid’ to the provinces under NFC Award. The last one was announced in 2010 (7th NFC Award). In 2020, we are relying on 7th NFC Award, ignoring the latest census of 2017, in utter violation of the Constitution.

The bi-annual report of July-December (FY 2018-19) shows out that total collection by Federal Board of Revenue (FBR) of distributable taxes (Divisible Pool) was Rs.1949.752 billion. Out of this, share of provinces was Rs.1121.207: Punjab (Rs. 580.061 billion), Sindh (Rs. 275.232 billion), Khyber Pakhtunkhwa (Rs. 163.906 billion) and Balochistan (Rs.101.909 billion). In addition to these, Khyber Pakhtunkhwa received 1% as war on terror (WoT) fund of Rs. 10.079 billion.  Straight transfers of Rs 46.826 were also made to the provinces during the period under four heads of royalty on crude oil, royalty on natural gas, gas development surcharge and excise duty on Natural Gas.

During the meeting, suggestion for sales tax harmonization also came under discussion in pursuant to the decision of Council of Common Interests (CCI) of November 24, 2017. The NFC Monitoring Committee was assigned the task of framing of Terms of Reference (ToRs) of the Fiscal Coordination Committee (FCC) as well as to discuss the fiscal policy issues of the federal and provincial governments and prepare suggestions/solutions for their resolution. It will also monitor current and development expenditures of the federal and provincial governments. The discussion on issues related to enhancing FBR’s receipts shall also fall under the ambit of this committee. It was proposed during the meeting that the NTC shall meet at least once in every quarter and its recommendations shall be expressed in terms of majority and shall be placed before NFC Monitoring Committee.

It is strange that in the meeting, the issue of dependence of provinces on the federal government for transfers from divisible pool—as envisaged in Article 160 of the Constitution—was not discussed in proper historical context. Before independence, the provinces had the exclusive right to levy sales tax on goods and services within their respective physical boundaries. This was snatched from them in 1948 and was never reverted. Federations like Canada and India have already moved towards harmonised sales tax on goods and services. It is high time that this issue is debated in NTC, Parliament, provincial assemblies and in public for reaching a consensus.

It is an established fact that even after levying all kinds of irrational and expropriatory taxes, the federal government has miserably failed to reduce the burgeoning fiscal deficit that reached 8.9% in fiscal year 2018-19 and this year due to corona virus and other factors would be much worse. For the last many decades, every attempt to bring it down to 4 to 5 percent of GDP has miserably failed. 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. 8 trillion—see details in Overcoming fiscal woes, TNS, Political Economy, April 7, 2019 and How to boost tax collection, TNS, Political Economy, May 21, 2017.

Tackling twin menaces of underground economy and tax evasion has always met with failure in Pakistan. Even after giving generous amnesties in 2018 by the Government of Pakistan Muslim League (Nawaz) and 2019 by the coalition Government of Pakistan Tehreek-i-Insaf (PTI), total collection was only Rs. 3828.5 billion in 2017-18 (which was0.4% lesser than the collection of the previous fiscal year) and Rs. 4435 billion in 2018-19 [which was revised downwards twice, first to Rs. 4398 billion and then to Rs. 4150 billion]. The underground economy is driven by many aspects of poor fiscal policy, and as highlighted by Dr. Arthur B. Laffer in Handbook of Tobacco Taxation: Theory and Practice: “it isn’t just high tax rates that indicate whether illicit trade activity will be a problem, but rather high tax rates coupled with other factors such as affordability, level of corruption, effectiveness of enforcement, and cultural and societal reasons.” 

The collection of taxes at federal level is much below the actual potential. The failure to tap real tax potential poses a tough challenge to both the federal and provincial governments. Poor performance of FBR adversely affects the provinces as they are overwhelmingly dependent on Divisible Pool. Provinces are not ready to collect taxes wherever due e.g. agricultural income tax from rich absentee landlords and property tax from owners of palatial houses/bungalows/farm houses etc and not giving fiscal powers to local governments as envisaged under Article 140A of the Constitution. Centre is unwilling to grant the provinces their legitimate taxation right os sales tax on goods, while it collects too little to meet overall needs of the federation and federating units. The size of the cake—divisible pool—is so small that it cannot help the country to come out of debt trap and to spend adequately for the welfare of the masses, no matter which part of the country they belong to. The so-called relief/stimulus package announced on March 24, 2020 by Prime Minister exposes our economic and fiscal vulnerabilities in testing times.

Track record of FBR shows remote possibility of collecting even Rs. 8 trillion in the next three years to give enough fiscal space to both the centre and the provinces to come out of the present economic mess, thus providing some relief to the poor as well as trade and industry. Under the given scenario, Pakistan will remain in debt prison, and more and more people will be pushed below the poverty line, especially after corona crisis. If we want to overcome it, the Parliament will have to reconsider the prevailing social contract between federation and the provinces.

Provincial autonomy and local self-governance without taxation rights and equitable distribution of income and wealth is meaningless. We cannot overcome perpetual economic crises unless the provinces are given true autonomy; ownership of all resources; generation of own revenue and exclusive right to utilise it for the welfare of their residents at grass root level through local governments.

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. This will help both FBR in collecting income tax as per actual potential; and by levying sales tax on goods in addition to services, the provinces will generate sufficient funds for their needs. It will also eliminate/reduce fiscal deficit at the federal level. This is the only way to achieve fiscal stabilisation in Pakistan. However, this can only be successful if we also reform and merge all tax collection agencies at federal and provincial levels, as suggested way back in Too taxing, TNS, Political Economy, June 22, 2014 and Revamping Tax system, TNS, Political Economy, December 7, 2014, but unfortunately ignored by successive governments till today.     

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The writers, lawyers and authors, are Adjunct Faculty at Lahore University of Management Sciences (LUMS)

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