HARD-PRESSED for resources, the centre is trying to enhance the federal share in the National Finance Commission’s (NFC) divisible pool by expecting the reluctant provinces to share its expenses such as those relating to loss-making state-owned enterprises, debt repayments and subsidies.

The policymakers in Islamabad argue that the centre’s share In NFC’s divisible pool has dropped by 11 per cent under the decade-old 7th NFC award, creating a resource crunch at the federal level. However independent analysts attribute the financial crunch primarily to the tax-to-GDP ratio which has remained stuck under 10pc since the 7th NFC award was announced.

The centre has not been able to increase tax revenues to 15pc of the GDP stipulated in the 7th NFC award though still retaining certain taxes and levies falling in the provincial jurisdiction. Under the existing taxation regime, federal revenues are not moving as fast as expected, outpaced by growing spending funded by more and more debts.

In this backdrop, a view is gaining ground that revenues will go up significantly if the collection of provincial taxes and levies retained by the centre are devolved while agriculture income tax is centralised.

On the other hand, it also argued if the provincial share in the 7th NFC award has been elevated to 57pc, the centre does not share non-tax revenues with the provinces as per NFC resource distribution formula.

According to State Bank data, the federation gets a major share in the overall tax and non-tax revenue — 12.7pc of the GDP against 7.8pc of the four provinces combined as recorded for 2018-19. In the ten months of the current fiscal year, according to the finance ministry’s update, non-tax revenues soared by 159pc to Rs1.09 trillion compared to Rs422 billion last year. As against this, the Federal Board of Revenue’s (FBR) tax collection rose by 10.8pc over the same period. During July-May, the growth rate further fell to 7.7pc.

The move to make provinces share centre’s expenses has come at a time when the federal transfers from the NFC’s divisible pool are crumbling owing to a sharp drop in federal tax revenue growth. Dr Hafeez Pasha estimates that federal transfers to the provinces would fall by Rs300bn in the last quarter of this fiscal year. Despite the shortfall in federal transfers, he says the provinces have doubled their contribution to the consolidated fiscal deficit to 1pc of GDP from O.5pc prior to and as agreed under the 7th NFC accord.

Critics accuse the federation of not devolving functions which are outside the federal legislative list to the provinces for political reasons and for avoiding rightsizing of the cumbersome administrative apparatus.

To highlight the potential of tax revenue through devolution, provincial tax experts compare the improved performance of provincial tax authorities versus the apex body since the collection of general sales tax (GSTS) on services was restored to the federating units. For example, in a pioneering effort with teething problems, Sindh raised Rs25bn from GSTS in 2011-12 as against Rs8bn it received as its share from FBR-collected revenue on this account a year earlier.

In GSTS and other direct transfer cases, the FBR was accused of not taking any interest in boosting revenues as it only got the tax collection fee.

The latest State Bank data shows that in the first half of the current fiscal year, provincial tax revenues grew by 26.4pc. The major spinner was GSTS with the collection growing at 19.9pc. In the same period, the tax revenues collected by the FBR increased by 16.7pc. The province’s tax-to-GDP ratio stands at 1pc of GDP against 8.9pc of FBR collection. All the rich revenue-yielding taxes have been retained by the federation.

Tax experts recognise that GSTS on both goods and services should ideally be collected by the same agency. GSTS on goods is also a provincial subject under the 1973 constitution but collected by the centre.

And if local bodies were to get constitutionally mandated fiscal, administrative and legislative autonomy, their dependence on provincial exchequer could be reduced. There is a view that the authority to levy octroi and zila tax needs to be restored to the local bodies without disturbing the existing financing arrangements.

Property tax, a district government item, is still retained by the federating units though devolution can improve collection owing to local knowledge.

The provinces have also failed to increase stagnant revenue from agricultural income tax (AIT) due to the political influence of landed aristocracy. Currently, the landlords have the option to pay tax on their net incomes or on the size of their landholdings which yields lower revenue and is devoid of equity.

The returns filed by many taxpayers claim exemption from the federal income tax on the grounds that the declared income is derived from agriculture. It is stated that the FBR does not probe the creditability of such claims.

According to a Federal Tax Ombudsman’s report, only one-fourth of the total declarations were actually paid to the provincial tax agencies during tax years 2016 and 2017. The World Bank has advised the federal authorities to help the provinces raise AIT revenues.

Dr Kaiser Bengali says the separation of agricultural and non- agricultural income tax bases has created a shelter for its payees and facilitated its evasion. He says the AIT should be federalised with an objective to make the taxation system progressive.

The real problem is the fundamental difference in approach of the federation and the provinces towards fiscal federalism.

In the 7th NFC award explanatory memorandum the federal finance ministry says: “the nature and the extent of inter-government revenue-sharing arrangements have to be evolved in a flexible manner so that changing expenditure of the two levels of governments and their ability to finance the obligations can be adequately addressed.”

The centre’s approach has been made irrelevant by Article 160(3A) of the Constitution. It provides that the share of the provinces in each award of the NFC shall not be less than the previous award. The provinces are so far sticking to this position.

More, and not less, devolution is needed to put inter-governmental fiscal relations on a sound footing in order to boost tax revenues.

Published in Dawn, The Business and Finance Weekly, June 8th, 2020