NationalVOLUME 16 ISSUE # 21

The controversy over NFC award

One of the key challenges faced by the federal government is resource constraint, resulting from low tax collection. In recent months, a lot of debate has taken place on the subject and some economists have pointed to the NFC award as one of the reasons for the lack of enough development funds at the disposal of the federal government.

But, according to experts, this is not the case. They say that instead of blaming the award for the federal government’s growing fiscal trouble and public debt, we should look at the failure of successive governments since 2009 to increase the country’s tax-to-GDP ratio as envisaged in the award for growing the size of the national financial cake. The 7th award had envisaged that the tax-to-GDP ratio would be raised by one per cent every year from less than 9pc to 14pc over its five-year life and the federal government would curtail its non-development spending by abolishing ministries and departments that were to be devolved to the provinces after the passage of the 18th amendment to the constitution.

However, the essential task could not be accomplished, with the result that Pakistan’s tax-to-GDP ratio hovered between 10pc and 13pc during 2011-2018.

It is a sorry fact that Pakistan’s tax-to-GDP ratio is one of the lowest in the world. By comparison, India collects taxes at around 20pc of its GDP. Bangladesh, Maldives and Nepal also fare much better than Pakistan. It means that it is not the NFC award but low tax collection that is responsible for the increasing pressure on federal finances and worsening macroeconomic imbalances, particularly the skyrocketing budget deficit.

It is relevant to point out here that the increase in the combined provincial share from the federal divisible tax pool under the 7th NFC award is only around 1pc of GDP, depending upon the actual tax collection in a given year. The NFC award made significant changes in the way the country’s taxes are shared by the federation and provinces as it cut collection charges from 5pc to 1pc, allocated 1pc of the pool money to Khyber Pakhtunkhwa to make up for the losses on account of the war on terror, and raised the provincial share from 50pc (including 2.75pc in compensation for the abolition of octroi taxes) to 57.5pc. Additionally, the GST (general sales tax) on services was transferred to the provinces and its contribution excluded from the pool.

The PTI government’s Finance Minister Shaukat Tarin, in a TV interview in May 2020, had said that it was not possible to devolve new responsibilities to provinces without increasing their share from the federal divisible pool. At the time of the finalisation of the award, it was noticed that the existing size of the tax revenue would not be enough for the Centre and the provinces. To recall, Tarin had then headed the NFC commission in his capacity as the country’s finance minister.

At the time of finalising the award, it was decided to raise the tax from 8.8pc to 19pc by 2019, to generate sufficient financial resources for the Centre and the provinces. It was also agreed that the loss-making state-owned enterprises would be made profitable and devolved ministries abolished by the Centre.

However, the federal government and the provinces failed to implement the award in letter and spirit.

The upshot of the whole debate is that the tax-to-GDP ratio would have to be increased to 18-20pc to solve the financial problems facing the country. In the meantime, the PTI government has reduced its expenditure and urged provinces to cut back on their expenditure but the latter are unlikely to respond positively to the suggestion, especially Sindh, which is in the habit of locking horns with the Centre on every issue.

Some dissenting voices have also been heard from Punjab that the province will not agree to cut expenditure to help Islamabad contain its fiscal deficit. The argument advanced is that Punjab does not have room for austerity in the next two years if the incumbent government plans to win the next elections. The PTI will face dire political consequences if it does not start spending money from next year.

What is the way out of the dilemma? For one thing, the federal government should abolish all devolved ministries and thus reduce the expenditure it is at present incurring. There are other ways to cut federal expenses, like reducing the size of the cabinet and launching an austerity drive all across the board. The provinces too should follow suit and eliminate all inessential expenditures.

Another way is to increase tax collection, both at the federal and provincial levels. Needless to say, if corruption is eliminated, tax collection can be raised by 50 percent, which will be enough to meet the development needs of the Centre and the provinces.