IT appears that electoral politics in Pakistan would not allow the federal government to raise the desperately needed resources for development.

Can this be done by the provinces for their own use? The answer is yes provided the provincial capitals are prepared to develop their institutions to mobilise resources in their respective geographic areas.

Properly managed the devolution programme underway as a result of the passage of the 18th Amendment, may offer a solution to the country’s chronic financial problems.

The 18th amendment has provided the four provinces an opportunity to raise their own resources for providing for development as well as managing the affairs of the government. It would be useful to briefly examine the changes introduced by the amendment in the country’s political, administrative and financial structures and analyse how the provinces are responding to the opening of many doors. These opportunities have become available as a result not only of the passage of the amendment but also because of the award of the 7th National Finance Commission.

Ideally the NFC should have issued its award after the passage of the amendment. The fact that the award was given before the process of devolution began has led to a major disagreement between the federal government on the one side and the provinces on the other.

The NFC award significantly increased the share of the divisible pool – the resources collected by the federal government with the promise that a large proportion of these would be handed over to the provinces. The provinces were set to receive 56 per cent of the total amount available in the divisible pool in the first year of the new award. The share is set to increase to 57.5 per cent in 2011-12. The amendment has made this share as the least that will be allowed to the provinces. In other words the constitution will not allow the federal government to finically encroach upon the share of provinces.

The new share for the provinces should have resulted in the transfer of Rs222 billion in the 2010-11 financial year. Of this amount the largest would have gone to Punjab (Rs104 billion), followed by Sindh (Rs59 billion), Khyber-Pakhtunkhwa (Rs38 billion) and Balochistan (Rs21 billion). Actual transfers, however, were much smaller – only Rs49 billion. There were two reasons for this shortfall. The federal government collected a much smaller amount compared to what it had promised. And, in the budget of 2010-11, it unilaterally increased the salaries of government employees by 50 per cent. The total amount available to the four provinces was considerably less than what they were expected to spend as result of the 18th amendment mandated devolution. That amount was estimated at Rs173 billion. However, only about a quarter of that was available.

The financial situation of the federal government is not expected to improve in the financial years 2011-12 and 2012-13. The ruling coalition at the centre and a variety of parties in power in the provinces are not likely to use up their political capital to levy new taxes in order to raise additional resources. This would be politically challenging as they prepare for the next set of elections. This has left the provinces with essentially two options. They can put on the back burner the use of the authority that has come their way as a result of the 18th Amendment. Or, they can create an institutional structure to collect resources from the taxes that were on the books. Sindh is the only province that has made an effort to improve fiscal management. It had already benefited from the effort being made.

Pakistan’s federal system was managed in a way to increase the economic and financial dependency of the provinces on the federal government. In spite of the increasing share of the provinces in the “divisible pool” managed by the centre as a result of the series of NFC awards given over the last few decades, the provinces financed some 80 to 90 per cent of their total expenditure from the federal divisible pool. They made very little effort to raise their own resources.

The record of provincial resource generation tells an interesting story. Between 2000 and 2010, when measured in terms of tax to provincial ratio, there was only a small improvement in one province – the Punjab – while the ratios declined slightly in the remaining provinces. In 2000, the Punjab’s tax to GDP ratio was 1.19, it increased marginally to 1.24 per cent by 2010. Sindh had the second largest ratio but it declined from 0.82 to 0.76 per cent in the same period. In KP, the ratio declined from 0.73 to 0.63 per cent while in Balochistan, it went down slightly from 0.44 to 0.42 per cent.

Sindh is the only province in the federation that has launched a well thought-out effort to improve tax collection. It has created an autonomous body – the Sindh Revenue Board – that has been empowered to handle tax matters. The SRB works under the chief minister. By digitising all matters relating to taxes, it is attempting to introduce transparency into the system.

Individuals can obtain on-line information about their tax obligations, pay their taxes, and access the SRB’s website to evaluate its performance. The aim is to create a new system in which both the individual tax payers and the tax collection authority are accountable.

The most interesting aspect of the SRB’s work is to recognise that it should put effort in the sectors that, being buoyant, have the capacity to yield resources. Since the 2009 NFC award had given the provinces the authority to tax services, this is the sector on which Sindh is focusing most of its attention. It has drawn some lessons from the Indian experience where the service sector has become an important source for public finance. The sector has an impressive collection potential. It is the largest sector of the Pakistani economy; it is even larger for Sindh than for the rest of Pakistan. The SRB has identified 170 services but only 109 of these have been included in developing the tax base. The number of services being taxed has increased from only 26 in 2000-01 to 109 in 2009-10. The number of assesses has grown from 122,000 to 1.3 million in the same nine year period. This is a tenfold increase.

Karachi as a city has about the same role in the Pakistani economy as Mumbai has in India’s. Mumbai accounts for 33 per cent of total Indian tax collection from services. The second city – Delhi – accounts for less than 20 per cent. Bangalore, Chennai , and Kolkata have much lower amounts collected from this particular source.

The conclusions from this brief analysis of the changing structure of finance in Pakistan are clear. Three of these need to be emphasised. One, with the 18th Amendment of the constitution and the 7th NFC award, there is a radical change in the structure of public finance. This will put greater burden on the provinces if they wish to see their economies develop.

Second, each province will have to devise its own strategy and programme to increase tax mobilisation. Sindh has taken the lead; other provinces may want to learn from its experience.

Third, of the many sectors that have the potential to fund the public sector, services have the greatest potential. This can be realised by developing tax management systems by using modern techniques.