Fiscal federalism: Missing link of tax reform Huzaima Bukhari & Dr. Ikramul Haq No discussion of tax reform in Pakistan can be complete without confronting an uncomfortable reality: the country's fiscal crisis is not merely a taxation problem. It is fundamentally a crisis of fiscal federalism. For nearly two decades, policymakers have debated tax rates, targets assigned by International Monetary Fund (IMF), documentation, retailer schemes, withholding taxes and administrative reforms. Very few have addressed the central question: can a federation function efficiently when its fiscal architecture increasingly departs from constitutional design? The answer is becoming increasingly obvious. Pakistan's taxation problems are symptoms of a deeper constitutional imbalance that emerged gradually after the Constitution (Eighteenth Amendment) Act, 2010 [Eighteenthth Amendment] and intensified under successive IMF programmes. The federation today faces a paradox. It bears responsibility for debt servicing, defence, foreign affairs and many national obligations, bulk of these are due to lack of devolution as envisaged in the Eighteenth Amendment. The substantial portion of tax revenues that is 57.5% under the Seventh National Finance Commission (NFC) Award flows to provinces as a matter of right and not charity. The Centre's insatiable need for more and more funds has resulted in over-taxation of the economy and citizens. It is largely due to bad governance, wastage of funds, ambitious overrun projects and monstrous size of government. After getting their constitutional shares, provinces are forced to accumulate large cash surpluses while the federal government increasingly borrows merely to finance current expenditure. This arrangement has never intended under the Eighteenth Amendment to produce perpetual fiscal confrontation between federation and provinces. The way forward to come out of this mess is available in a two-part series, Pakistan: Case for fiscal equalization-I, Minute Mirror, January 20, 2026 and Pakistan: Case for fiscal equalization-II, Minute Mirror, January 21, 2026. The constitutional scheme embodied in Articles 160, 161 and 162 sought cooperative federalism rather than institutional rivalry. The objective of Eighteenth Amendment was equitable sharing of national resources, preservation of provincial autonomy and promotion of balanced development across the federation. Unfortunately, political actors gradually transformed fiscal federalism into a contest over resource distribution rather than a framework for coordinated national development. The result is visible in virtually every major fiscal indicator. Pakistan today faces a peculiar situation where the federal government struggles to finance debt servicing from its net revenues after NFC transfers. Meanwhile, provinces frequently report substantial cash balances parked in the banking system rather than deployed productively for education, healthcare, local government development or infrastructure. This contradiction exposes a serious structural weakness. The debate should not focus on reducing provincial rights and shares in taxes. Provincial autonomy is a constitutional achievement that deserves protection along with strict implementation of Article 140A of the Constitution. The real issue is how to make federalism functional rather than merely distributive and ensure welfare of all the citizens no matter where they reside. Earlier writings on NFC, fiscal federalism, petroleum levy, sales tax fragmentation and constitutional political economy repeatedly highlighted this challenge. The question is not whether provinces should receive their constitutional share. The question is whether existing arrangements create incentives for efficient utilisation of public resources and coordinated national planning. The evidence increasingly suggests otherwise. One illustration is the petroleum levy regime. For years, the federal government increasingly relied upon petroleum levy collections outside the divisible pool while simultaneously maintaining zero-rating or reduced taxation arrangements affecting provincial shares. This enabled the federation to generate revenues unavailable for distribution under NFC mechanisms while provinces became increasingly dependent upon transfers rather than development of their own revenue capacity. The result was fiscal centralisation through non-divisible revenues combined with political decentralisation through expenditure responsibilities. This contradiction remains unresolved. Provincial revenue mobilisation presents another challenge. The Eighteenth Amendment transferred substantial responsibilities to provinces, including areas directly affecting economic development and social welfare. However, provincial tax efforts remain disproportionately weak compared to available constitutional authority as elaborated in detail in Tapping the tax potential, The News, January 31, 2010. Agricultural income taxation remains largely symbolic. Urban immovable property taxation remains grossly underdeveloped. Large segments of services remain inadequately documented despite provincial jurisdiction. Instead of strengthening their own tax systems, provinces increasingly rely upon federal transfers. This dependency weakens fiscal accountability. Citizens often blame the federation for service delivery failures even where constitutional responsibility rests with provinces. Meanwhile, provincial governments face limited political pressure to improve tax administration because NFC transfers continue providing substantial fiscal space. The result is a disconnect between taxation and accountability. A healthy federation requires both revenue autonomy and expenditure responsibility. The present model often delivers neither. The fragmentation of sales tax administration discussed in Part V further illustrates the problem. Provincial autonomy over services taxation should have encouraged innovation and efficiency. Instead, multiple tax authorities emerged with divergent procedures, overlapping jurisdictions and conflicting interpretations. Businesses operating nationally became victims of administrative fragmentation. The costs extend beyond compliance. Fragmented taxation weakens the national market itself. It creates barriers to inter-provincial commerce, discourages investment and increases uncertainty. What should have been cooperative federalism gradually evolved into fiscal compartmentalisation. The Supreme Court's jurisprudence on trans-provincial activities, territorial nexus and constitutional distribution of taxing powers repeatedly demonstrates the need for coherent national frameworks. Economic activity increasingly transcends provincial boundaries, especially in digital commerce, telecommunications, financial services and integrated supply chains. Tax administration, however, remains trapped within fragmented structures. This disconnect will become even more problematic as Pakistan's digital economy expands. The solution lies neither in re-centralisation nor in further fragmentation. Pakistan requires a new federal fiscal compact grounded in constitutional principles and economic realities. First, the NFC mechanism should evolve from a purely distributive formula toward one that also rewards provincial revenue effort, administrative efficiency and development outcomes. Second, provinces must fully utilise their constitutional taxation powers, particularly regarding agricultural income, urban property and services documentation. Third, local governments must become meaningful fiscal entities rather than administrative appendages. Across successful federations, property taxation and local revenue mobilisation constitute the backbone of municipal governance. Pakistan continues neglecting this critical tier. Fourth, harmonisation of tax administration must accompany preservation of constitutional taxing powers. A federalised tax agency, discussed earlier in this series, offers one possible framework. Fifth, provinces and federation should jointly develop integrated databases, harmonised procedures and coordinated compliance systems rather than maintaining isolated bureaucratic silos. Sixth, all extra-budgetary and non-divisible revenue instruments should be subjected to constitutional scrutiny to ensure consistency with the spirit of fiscal federalism. Most importantly, fiscal federalism must be understood as a development framework rather than merely a resource-sharing arrangement. The ultimate objective of the Constitution is not transfer of funds from one level of government to another. It is improvement in the lives of citizens through effective utilisation of public resources. Taxation, federalism and development are therefore inseparable. A country where provinces accumulate surpluses while schools deteriorate, hospitals remain underfunded, local governments remain dysfunctional, and the federation borrows for debt servicing cannot claim that its fiscal architecture is operating optimally. The challenge before Budget 2027 is larger than revenue targets. Pakistan requires a national conversation on rebuilding fiscal federalism itself. Without coordinated reform, higher taxes will continue producing lower outcomes, administrative fragmentation will continue weakening economic integration and constitutional disputes will continue replacing cooperative governance. The lesson is simple. A federation cannot achieve fiscal stability when each tier of government operates as an isolated fiscal island. Sustainable tax reform requires a functioning federal system where revenue authority, expenditure responsibility and accountability move together. Until that balance is restored, Pakistan's fiscal crisis will remain as much constitutional as economic. _____________________________________________ Huzaima Bukhari, lawyer and author, is an Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Senior Visiting Fellow of Pakistan Institute of Development Economics (PIDE) 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.
The Tax Proposals Budget 2027 series: Tax Proposals Budget 2027-I · Tax Proposals Budget 2027-II · Tax Proposals Budget 2027-III · Tax Proposals Budget 2027-IV · Tax Proposals Budget 2027-V · Tax Proposals Budget 2027-VII · Tax Proposals Budget 2027-VIII · Tax Proposals Budget 2027-IX · Tax Proposals Budget 2027-X · Tax Proposals Budget 2027-XI · Tax Proposals Budget 2027-XII
