THE provinces have become the favourite punching bag of Islamabad, donors and commentators alike. They are being chastised for failing to generate adequate resources to fund their constitutional responsibilities to provide social and economic services including law and order, education, health, water, sanitation, etc. This article examines the fairness of this censure without getting into the merits of the last NFC Award that has given provinces close to 60pc of the national divisible resource pool.

Lest we forget, the revenue-raising capacity of the provinces is limited because of taxation powers enshrined in the Constitution and the structure (GST in VAT mode) put in place under an earlier IMF programme. This is not to suggest that the provinces have done enough to generate revenues. Historically, they haven’t been aggressive enough in collecting taxes on incomes derived from agriculture (they’ve made it worse by treating land rented out also as agricultural income) or by making urban property tax more progressive. However, they have put in some decent effort in recent years to mobilise additional revenues by widening the base of GST on services.

Unfortunately, the federal government has pre-empted and exploited the revenue base of the provinces that everyone wants the latter to exploit — motor vehicles, real estate and services. For instance, it has levied a variety of silly withholding and other taxes on motor vehicles and property transfers. Islamabad has also narrowed provincial options to exploit the full potential of GST on services. By what twisted logic can Islamabad levy GST on distribution of utilities (electricity, gas etc.), impose excise duties on services in lieu of GST the provinces could have levied and have conceptually bizarre legislation empowering it to levy GST on retail outlets by treating the latter as outlets selling goods — whereas all they are doing is adding value in the nature of a service by selling finished goods purchased from manufacturers and importers?

All these entities are providing services, and a GST on services is a provincial tax under the Constitution, with no federal role. But then, Islamabad operates in a world of its own in which actions and decisions are not driven by, or argued on, the basis of, logic.

Why on earth would any province impose or increase a tax to muster additional resources for the centre to spend?

Moreover, the taxation regime has become increasingly complicated, because provinces do not allow the deduction of GST paid on inputs (eg GST on the electricity bill), simply shrugging their shoulders when taxpayers remind them that the country is supposedly administering a system of GST in VAT mode. This raises costs of operations and unnecessarily raises consumer prices and affects competitiveness.

Then there is the issue of multiple revenue-collecting authorities — in the provinces one agency collects GST on services, one collects property and motor vehicle tax, and another registers property transfers and collects stamp duty. Resultantly, taxpayers have to contend with different authorities for different taxes.

This multiplicity of revenue-collecting agencies is also adversely affecting administrative and economic efficiency, leading to higher transaction and operational costs, unnecessary duplication of functions and data bases and inconsistent legal and other treatments of even similar types of taxes. Such a complex arrangement has raised the cost of compliance for taxpayers by creating difficulties for them.

What is, however, worrying is that the anomalies in the tax structures mentioned here are not being corrected. This could be done, for example, by ensuring that GST on inputs paid by service providers is adjustable against their GST on outputs or making related legislation, processes and institutional mechanisms less harassing for existing taxpayers, etc. Instead, Islamabad, commentators and the IMF are intent on consolidating and strengthening flawed existing systems to generate, by hook or by crook, more revenues at both levels of government to reach some magical number of the budget deficit. So much for their refrain that the tax reforms are being studiously implemented.

The demand that provinces should raise more revenues is also somewhat bizarre when examined against the political economy fallouts of other related decisions were they to heed such advice. Why on earth would any government impose or increase a tax, provoking the ire of its constituents, to muster additional resources which it would be required to save for the federal government to spend?

Under the on-going IMF programme, provinces are required to produce surpluses budgeted at Rs289 billion for this year. Why would they accede to such a demand simply to generate surpluses for Islamabad to spend? For Khyber Pakhtunkhwa it would be even more politically outlandish to adopt such a route with large sums owed to them for hydel profits and the local economy struggling to function in an insecure and debilitating environment.

Furthermore, the biggest share of provincial expenditures is that of salaries and pensions. Whereas Islamabad does not have a well-conceived policy to regulate the size of its workforce, it periodically revises salaries and pensions. The resulting increases are lumpy and introduced in an ‘ad-hoc’ manner, imposing a massive burden on the provinces that employ close to 80pc of the civilian workforce in the public sector for whom it would be politically impossible to deny its employees pay hikes even if it cannot afford it.

There are other recurrent expenditures of the provinces that have resulted from decisions taken by the centre. Until the 18th Amendment, the federal government determined both the level and terms at which the provinces could borrow from any source. Islamabad used this provision to lend to them at interest rates substantially higher than what it was itself paying. The provinces were also forced to accept foreign loans without regard to their capability to service the debt even for projects of dubious value because the centre needed foreign exchange to discharge its external liabilities.

To summarise, it is easy to run down the provinces for not marshalling adequate resources, without factoring in the context in which they are operating, the baggage they are either carrying, or that is being placed on them on account of federal decisions which impact their budgets and for being expected to launch politically harsh tax-augmenting measures to generate savings for Islamabad to fund politically driven unproductive schemes.

The writer is a former governor of the State Bank of Pakistan.

Published in Dawn, May 12th, 2015

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