March Issue 2019

An uncertain future: The 9th NFC’s inaugural meeting in Islamabad.

One of the steps taken by the Pakistan Tehreek-e-Insaf (PTI) government after coming to power was to initiate the process of reconstituting the 9th National Finance Commission (NFC) to devise a new formula for the distribution of resources between the centre and the provinces.

In September, Finance Minister Asad Umar asked the provincial governments to suggest names for the non-statutory members of the NFC. After these were received, President Arif Alvi was requested, through a reference on January 1, 2019, to reconstitute the commission and this was done through a notification issued on January 12.

According to the notification, the members of the reconstituted NFC comprise the incumbent federal minister of finance and his provincial counterparts from Sindh, Balochistan, Khyber Pakhtunkhwa (KP) and Punjab. The non-statutory members, who represent the provinces, meanwhile, include Asad Sayed from Sindh, Mehfooz Ali Khan from Balochistan, Dr. Musharraf Rasool Cyan from KP, and Dr. Salman Shah from Punjab. A 10th member – the federal finance secretary, Arif Ahmed Khan – has also been added.

The first meeting of the 9th NFC was held in the first week of February. It was headed by the finance minister, while the secretary finance and the statutory and non-statutory members from the four provinces were present. The commission was briefed on the financial situation in the country and its provinces by the secretary of the finance division and the respective provincial finance ministers. 

The commission decided to hold meetings every six weeks, established an NFC secretariat at the ministry of finance, and assigned tasks to the federal ministry and the provinces to come up with proposals and recommendations by setting up six groups. Each group has been assigned a particular area of research. 

The federal ministry will provide recommendations on the vertical distribution of the divisible pool of taxes between the federation and the provinces, including the needs of Azad Jammu and Kashmir (AJK) and Gilgit Baltistan (GB). Punjab, meanwhile, will provide recommendations on the macroeconomic framework and benchmarking, Balochistan on the horizontal distribution of the divisible pool of taxes among the provinces and straight transfers to the provinces, Sindh on the measures required to simplify tax procedures and payment systems to facilitate the coordination of businesses, and KP on its integration with FATA.

The NFC is constituted every five years, as stipulated in Article 160 of the Constitution of Pakistan. The constitutional term of the 9th NFC started in July 2015 and will end in June 2020. Three-and-a half years of its tenure have already passed. The previous Pakistan Muslim League-Nawaz (PML-N)-led government constituted the 9th NFC, but was unable to announce an award in its five-year-term and kept extending the 7th NFC award. 

After the Pakistan People’s Party (PPP) government announced the landmark 7th NFC award in 2010, it started working on the 8th NFC in July 2010. The then president, Asif Ali Zardari, constituted a commission to work on the 8th award, but when the PML-N came into office in 2013, it did little to follow up on this. The term of the 8th NFC ended inconclusively without the announcement of an award, and the PML-N government constituted the 9th NFC on April 24, 2015. Its first meeting was held on April 28. 

Spirits were high as the commission began its work, and four groups were set up to make recommendations on various issues. Each province was assigned the responsibility to prepare a report. Punjab had to come up with recommendations on resource mobilisation at the federal and provincial levels, Sindh on a devolved vs integrated tax structure, KP on allocation efficiency and expenditure analysis at the federal and provincial levels, and Balochistan on the rationalisation of subsidies and grants.

What is the NFC?

In Pakistan, the taxes collected at the federal level are distributed through the National Finance Commission (NFC), which is constituted by the president every five years. It comprises five parties – the federal government and four provincial governments – who are represented by their finance ministers, and assisted by four non-statutory members, one from each province. 

The commission devises criteria for the transparent and judicious distribution of resources between the centre and the provinces (referred to as vertical distribution), and among the provinces (horizontal distribution). Once a consensus is reached, the award is announced and remains valid for five years. This has, however, always been a onerous task, as all the stakeholders contest for their respective shares. Inability to reach a consensus has, on several occasions, left the NFC inconclusive and failed to produce an award. 

A meeting was held after a gap of a year-and-a half, in September 2016, followed by two more meetings – in November and December 2016 – but the proceedings reached a dead-end when the federal government came up with the proposal of a six per cent reduction in the size of the net federal divisible pool before it was shared with the provinces. The government was asking for a three per cent allocation to set up a national security fund and another three per cent for socio-economic development of the tribal region that was to merge with KP. The move was resisted, and the PML-N could not come up with a new award. It kept on extending the period of the 7th NFC award from 2015/16 until the end of its term. 

The NFC deals with inter-governmental fiscal transfers between the centre and provinces. The members of the NFC advise the president on the distribution of financial resources from the divisible pool. Apart from the divisible pool under Article 163 of the Constitution, the NFC recognises the rights of the provinces on their indigenous resources which are transferred to them through straight transfers by the centre.

The reconstituted 9th NFC is left with only a year-and-a half to reach a consensus on a new award. It has a long way to go, since both the federal government and the provinces are hell-bent on demanding an increase in their respective shares, and each has its own set of arguments. 

The federal government has to deal with deficits, debt servicing, the defence budget, the administrative and development expenditures of the newly merged Federally Administered Tribal Areas (FATA) and KP, and the governments of Gilgit Baltistan (GB) and Azad Jammu and Kashmir. Meanwhile, the International Monetary Fund (IMF) has proposed a cut in the divisible pool of the provinces to help the centre deal with fiscal deficits, but this proposition was opposed in unison by all the provinces. The centre’s proposal for an allocation from the divisible pool for FATA was also opposed, as the Chief Minister of Sindh, Murad Ali Shah, said that allocations for FATA were part of the centre’s share in the vertical allocation, and now that FATA is merged with KP, the centre should give a portion of its vertical share to the merged territory.

The provinces demand an increase in their share on the basis of multiple indicators: population (82 per cent), poverty and backwardness (10.3 per cent), revenue collection and generation (5 per cent), and inverse population density (2.7 per cent). These indicators were held as the basis for distribution of the vertical share among the provinces in the 7th NFC award. It was in sharp contrast to all previous awards, which were based on the sole criterion of population. 

A Brief History of the NFC Award

Resources were first distributed in 1951 through the Raisman Award, during Liaquat Ali Khan’s tenure as prime minister. Sir Jeremy Raisman, an economist and finance member of the British Government in India, was tasked with preparing a revenue-sharing formula between the centre and the federating units after Partition. He finalised the Raisman Award by December 1947. 

In December 1961, General Ayub Khan constituted the NFC for the first time and announced an award that was replaced by another award in 1965. General Yahya Khan also formed an NFC, but it remained inconclusive, since East Pakistan was separated in 1971.

The next award came in 1974, during the government of Zulfikar Ali Bhutto, and lasted 16 years. In General Zia-ul-Haq’s reign, the commission was constituted twice – in 1979 and 1983 – but a consensus could not be reached and no award was announced.

 In 1990, a new commission was constituted which announced an award in 1992. The PPP government moved to constitute an NFC in July 1995, which was then reconstituted in December the following year by a caretaker government, and an award was announced in February 1997. Then, General (R) Pervez Musharraf, following in the footsteps of General Zia, constituted a commission twice, but both remained inconclusive, and he had to announce an award through an ordinance in 2006.

The PPP government constituted an NFC in 2009 and announced the 7th NFC award, which was supposed to expire in June 2015, but the PML-N government kept extending it for four consecutive years as it failed to reach a consensus regarding the 8th and 9th NFCs during its term in office. 

Now, the PTI-led government has reconstituted the 9th NFC that has started working on a new award, but it seems unlikely that it will come up with one before the upcoming budget. It seems the 7th NFC will be extended for another year. 

Application of the horizontal criteria in the 7th NFC award led to the following shares for the provinces: Punjab, 51.74 per cent; Sindh, 24.55 per cent; KP, 14.62 per cent, and Balochistan, 9.09 per cent. 

Under the provisional results of the 2017 population census, which is yet to be approved by the Council of Common Interests (CCI), the allocated share of Balochistan and KP would increase, while that of Punjab would decrease by more than 5 per cent. Also, the poverty and backwardness criteria could work to the benefit of the two smaller provinces. A recent study by the United Nations Development Programme (UNDP) estimates that the incidence of poverty (poverty headcount) in Balochistan is more than 70 per cent of the total population of the province, while in KP (including FATA) it is more than 50 per cent, in Sindh approximately 40 per cent, and in Punjab approximately 30 per cent.

The 7th NFC award led to the gradual increase in the provinces’ share in vertical distribution, which reached 57.5 per cent as compared to the centre’s share of 42.5. And the 18th Amendment, by inserting clause 3A in Article 160 of the Constitution, safeguards the provinces’ share, which cannot be decreased from the amount in the previous award. 

Such conditions restrict the federal government from taking any steps against the wishes of the provinces, and so it is left only with the option of increasing the tax-to-GDP ratio to 15-20 per cent (a goal that the 7th NFC award failed to achieve) and massive tax reforms to increase the tax net.

Perhaps the new consultation process will lead to better plans and consensus between the centre and the provinces so that the country can be put on the path of fiscal federalism and equalisation.  

Sindh and the NFC

The Pakistan People’s Party (PPP)-led government in Sindh has been raising the question of the new NFC award since the 7th NFC ended in June 2015. When the previous government of Pakistan Muslim League-Nawaz (PML-N) constituted the 9th NFC, Sindh was the first province to complete its task of giving recommendations on the devolved vs. integrated tax structure and presented it in the second meeting, held in September 2016. Incidentally, the PPP government in Sindh has been vocally opposed to any plans to reduce the provinces’ share in the vertical division between the centre and the provinces. 

Back in 2010, the PPP came up with the 7th NFC award and changed, for the first time, the formula for the vertical distribution of resources between the centre and the provinces , as well as the horizontal distribution among the provinces. While all previous awards were distributed on the single criterion of population, the 7th NFC award added multiple indicators. Sindh benefited from the criteria of revenue generation, thanks to the port and other economic activities in its provincial capital, Karachi.

Murad Ali Shah, the Chief Minister of Sindh, has been participating in the 9th NFC meetings, since he looks after the portfolio of the provincial finance ministry. This time round, in the
reconstituted NFC, he is accompanied by the Karachi-based economist Asad Sayeed, a Senior Research Associate at Collective for Social Science Research (CSSR), as the non-statutory member from Sindh.

Murad has, in a preparatory meeting prior to the inaugural meeting of the 9th NFC in Islamabad, advocated the case for Sindh by changing the ratio of the multiple indicators in the horizontal distribution among the provinces, and insisted that the ratio of NFC linked to performance ought to be increased and revenue generation be given more weightage, while the weightage attributed to population be decreased.

In the first meeting of the 9th NFC, Sindh was asked to come up with recommendations on the measures required to simplify tax procedures and payment systems to facilitate business. Sindh has already made a case for increasing its share of the octro zilla tax (OZT), from 0.66 per cent of the divisible pool, to 2 per cent. It has also asked that the Capital Gains Tax (CGT), which is collected on immovable property and the excise duty on crude oil and natural gas, be devolved to the provinces, and demanded an increased role for the provinces in sales tax collection. 

Shah has insisted that the collection of sales tax on goods should be assigned to the Sindh Revenue Board (SRB), to make this levy more efficient, explaining that the “SRB can collect that tax on behalf of the FBR and retain service charges.” 

Shah emphasised that Gas Infrastructure Development Cess (GIDC) needs to be transferred to the provinces as it is a provincial subject, and also demanded Sindh’s due share from the amount collected by the federal government under the GIDC so far.

In order to rationalise federal and provincial tax collection, to broaden the tax net to add to the divisible pool, and to eliminate duplication in tax collection, the chief minister of Sindh has proposed constituting a joint committee of federal and provincial governments and to consult international experts. This, in his view, will help achieve the goal of good governance and fiscal discipline.