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

The revenue-raising capacity of the provinces is somewhat limited because of the taxation powers in the Constitution and the structure of GST in VAT mode. This is not to suggest that the provinces have done enough to generate revenue. Historically, they haven’t been sufficiently aggressive in collecting taxes on incomes derived from agriculture (AIT) — making it worse by also treating land rented out as agricultural income — or to make urban property tax more progressive and robust. However, they have made a decent effort in recent years to mobilise additional revenues by widening their base of GST on services. As for AIT, there are outlandish claims about what can be generated from the crop sector as well as exaggerated estimates of the size of the livestock sector.

Over the years, Islamabad has pre-empted and exploited the revenue base of the provinces that everyone wants them to exploit — motor vehicles, real estate and services. It has levied a variety of silly withholding taxes on motor vehicles and property — in the latter also a capital gains tax — a tax on ‘deemed income’ and now even excise duty.

Similarly, it has narrowed down provincial options to exploit the full potential of GST on services. For instance, by what twisted logic can Islamabad levy GST on the distribution of electricity, gas, etc treating them as goods, and impose excise duties on financial services in lieu of GST that the provinces could have levied, and have conceptually bizarre legislation that empowers it to levy GST on retail outlets by treating them as selling goods whereas all they are doing is adding value as a service by selling finished goods? These entities are providing services — which are treated as services under the national income accounts — and GST on services is a provincial tax under the Constitution.

The federal demand that the provinces raise more revenues is somewhat bizarre.

There is certainly an issue at the provincial level of multiple revenue-collecting authorities: one agency collects GST on services, one collects property tax and motor vehicle tax and one 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 adversely affecting administrative and economic efficiency, leading to higher transaction and operational costs, the unnecessary duplication of functions and databases, and inconsistent legal and other treatment of similar taxes. Such a complex arrangement has raised the cost of compliance for taxpayers, causing increased aggravation.

What is, however, worrying is that instead of correcting these anomalies in tax structures, Islamabad, commentators and the IMF are intent on consolidating and strengthening flawed existing systems. They want the provinces to generate, by hook or by crook, more revenues to plug some magical number of the budget deficit. So much for their refrain that tax reforms are being studiously implemented.

The demand that the provinces should raise more revenues is also somewhat bizarre when examined against the political economy fallout of related decisions were they to heed such advice. Why on earth would any government impose or increase a tax — and, resultantly, provoke the ire of its constituents — to muster additional resources, which it would be required to save for the federal government to spend? For this year, the provinces are required to produce surpluses in excess of Rs1,215 billion! Why would they accede to such a ridiculous demand to generate surpluses for Islamabad to spend? For KP, it would be even more politically peculiar to do so, 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 is itself bloated and continues to show little serious intent to right-size its workforce it has this year revised salaries by close to 25pc and pensions by 15pc, demanding belt-tightening from the rest of the population to be able to loosen theirs. The resulting increases have imposed a huge burden on the provinces, which employ close to 80pc of the civilian workforce in the public sector — excluding defence personnel. It is politically impossible for them to deny their employees similar pay hikes even if they cannot afford it.

There are other recurrent expenditures of the provinces, resulting from decisions taken by the federal government. Until the 18th Amendment, the federal government determined both the level and the terms at which the provinces could borrow from a source. Islamabad used this provision to lend to them at interest rates substantially higher than what it itself was 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 federal government needed foreign exchange to discharge its external liabilities.

To summarise, it is easy to be critical of the provinces for not marshalling adequate resources. One must be mindful of this given the context in which the provinces are operating, the baggage they are either already carrying or that is being placed on them because of federal decisions that impact their budgets or expect them to share the expenditure on a host of schemes initiated and designed by Islamabad, and launch politically harsh tax-augmenting measures to generate savings for Islamabad to fund politically driven wasteful and unproductive recurrent expenditures and projects.

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

Published in Dawn, July 13th, 2024