National Finance Commission Award

An important prerequisite for effective functioning of the federal structure is the framework of distribution of fiscal powers and the manner in which the revenues are collected and distributed between the federation and the provinces. Revenue distribution, thus, is an extremely sensitive and critical factor for the long-term sustainability of Pakistan. However, this has always remained a thorny affair as it has caused much discord, bitterness and acrimony between the federation and the provinces. More specifically, the unfair distributions resulting in the paltry revenue flows to the smaller provinces in the past had generated considerable animosity. Further, such distributions that were aimed at keeping the bulk of the kitty with the federal government also resulted in wasteful and reckless spending of resources.

Introduction

Intergovernmental transfers make a cornerstone of provincial financing system in Pakistan. The Constitution of Pakistan 1973 establishes the basis for transfer of revenues between the federation and the provinces in Article 160 (1) which requires periodical setting up of a National Finance Commission (NFC) to operate the divisible pool by articulating that “Within six months of the commencing day and thereafter at intervals not exceeding five years, the President shall  constitute a National Finance Commission consisting of the Minister of Finance of the Federal Government, the Ministers of Finance of the Provincial Governments, and such other persons as may be appointed by the President after consultation with the Governors of the Provinces.”

The scope and the terms of reference of the Commission are determined by the President.

Background

The NFC Award is formed to support provincial government financially in order to enable them to meet their expenditure liabilities and also to alleviate horizontal imbalances. The Award plays a key role in enhancing the financial status and working ability of the state machinery at provincial as well as federal level. However, due to inter-provincial disparities in income distribution, capabilities in tax collection and expenditure disbursement, there was a strong need for the fiscal arrangement between the federal and the provincial governments. The allocation of means and responsibilities among different tiers of government is a critical issue as its misappropriation may lead to political, economical and social unrest.

The Divisible Pool

Under the 1973 Constitution, the federation and the provinces had, in addition to their exclusive sources of revenues, a divisible pool comprising the net proceeds of specified taxes which is shared by all the provinces. The federal government meets the additional requirement of the provinces through various special transfers such as grants-in-aid, subsidies subvention, assistance, emergency relief and federalization of functions.

The composition of divisible pool is not fixed and the Constitution gives powers to the President to amend it. Under Article 160 of the Constitution of Pakistan, the taxes that may contribute to divisible pool include:

1. taxes on income, including corporation tax, but not including taxes on income consisting of remuneration paid out of the Federal Consolidated Fund;
2. taxes on the sales and purchases of goods imported, exported, produced, manufactured or consumed;
3. export duties on cotton, and such other export duties as may be specified by the President;
4.  such duties of exercise as may be specified by the President; and
5. such other taxes as may be specified by the President

Evolution of NFC Award

Pre-Independence Period

Historically, the system of revenue distribution has evolved from the pre-Independence arrangement that prevailed under the framework of the Government of India Act, 1935. The constitutional responsibilities of the federal government and the constituent units as well as the distribution of revenues between various component units were specifically laid down in the Act. The first revenue sharing award under the 1935 Act was the Niemer Award of 1937.

Post-Independence Period

After independence, the financial relations between the Centre and the Provinces continued to be governed by the Government of India Act of 1935. However, the first NFC Award in independent Pakistan was the Raisman Award which was notified on April 1, 1952. It was named after a civil servant, Sir Jeremy Raisman, who presented his recommendations to the Prime Minister Liaquat Ali Khan’s government in 1947.
The Raisman Award was followed by 1961-62, 1964, 1970, 1974, 1991 and 1997 Awards. Two NFC Awards were appointed in 1979 and 1985, but no award was announced due to lack of consensus among the members of the Commission.

A Critical Analysis

Pre-1973 Constitution
Raisman Award (1951)

• · Under the Raisman Award of 1951, Sales Tax, hitherto a provincial tax, was temporarily handed over to the Centre, subject to allocation of 50 percent of proceeds to the provinces.
• To reallocate the revenue sources between the provinces and the centre, the Award recommended 50 percent of income tax revenue for the provinces.
• East Bengal had to avail 62.50 percent of net proceeds on jute, 10 percent of any additional duty however; the existing limit of share of 35 million was waived.
• Sales tax was not returned to the provinces and was left under the jurisdiction of central government.
• Punjab and Sind had demanded a share of the export duty on collection as equal to the jute .The recommended ratio of 50 percent of the net proceeds of income tax to the provinces is as follows:
• Both Punjab and Balochistan got the share lower than they were entitled to on the basis of their population while Sind and NWFP got higher shares than their population shares.

After the 1951 Award, there were three NFC Awards of 1961, 1964 and 1970. All of these were given in unusual circumstances. As four provinces NWFP, Sind, Punjab, and Baluchistan of West Pakistan were declared as ‘One Unit’ during 1955. The first two awards were during the period of ‘One Unit,’ and the 1970 Award was given during the second martial law and a year before East Pakistan seceded.

Second NFC Award (1961-62)

Then after a gap of 10 years a Commission was appointed in 1961 which gave its recommendations in 1962 setting the provinces’ share on the following basis:

Taxes on income including corporate tax 50%; sales tax 60%; federal excise duty on betel nuts, tea and tobacco; exports duty on jute and cotton 100%; estate and succession duties 100%; and capital value tax on immovable property 100%.

• Under the award, out of the divisible pool (70 percent of sales tax plus other taxes), East Pakistan and West Pakistan got 54 and 46 percent share, respectively.
• 30 percent of sales tax was specified to the provinces on the basis of collection in their respective areas.
• Remaining duties on agricultural land and capital value tax on immovable property were given to the units as per their collection.

Third NFC Award (1964-65)

The 1964 National Finance Commission was set up under article 144 of the 1962 Constitution.

• The divisible pool consisted of collection from income tax, sales tax, excise duty and export duty.
• 30 percent of sales tax was distributed in accordance with its collection in each province.
• The respectiveshare out of divisible pool between centre and provinces was 35:65 percent.
• The share of East Pakistan and West Pakistan remained unchanged at 54 percent and 46 percent respectively.
• On 1st July 1970, the West Pakistan was disbanded into Punjab, Sind, NWFP and Baluchistan, thus the 46% share of West Pakistan was divided among the four provinces: Punjab 56.5%, Sind 23.5%, NWFP 15.5% and Baluchistan 4.5%.
• The commission had also recommended that agricultural income should be taxed.

Fourth NFC Award (1970)

A new Commission was set up in 1970 which gave its Award in 1971, before the secession of Bangladesh.

• Provinces got the major boost as their share in the divisible pool was raised to 80% from 65%.
• However, provinces retained 30% of sales from their region and 70% was divided on population basis.
• In the 1970 Award, distribution based solely on population shares of the provinces. Even this arrangement had some incentive for the provinces to raise the payment of sales tax.

Post-1973 Constitution

First NFC Award (1974)

The 1974 NFC Award was the first one concluded after the promulgation of 1973 Constitution and it was enforced in 1975. In this Award, the scope of divisible pool remained limited to income taxes, sales tax and export duty. Moreover, fewer taxes were included in the divisible pool which consisted of income tax, sales tax and export duty while the criterion used for resource redistribution was recommended to be population.

• Resources were vertically distributed among federal and provincial governments at a fixed ratio of 20:80 as before.
• As population being the sole criterion for distribution, Punjab’s share had increased from 56.50 percent (1970 award) to 60.25 percent.
• Annual grants of Rs 50 and Rs 100 million respectively were also allocated to Baluchistan and NWFP governments to compensate their weak financial situation.
• The previous arrangement regarding sales tax was retained.

Second NFC Award (1979)

President General Zia-ul-Haq constituted the second NFC under the Chairmanship of Mr Ghulam Ishaq Khan, the then Federal Finance Minister, in 1979. Unfortunately, it never held any meeting and resultantly made no proposals. Therefore, for resource distribution in the interim period, the 1974 award was followed.

After the new census of 1981, population proportions changed and resource shares were adjusted, accordingly. This led to somewhat improved situation in Baluchistan and Sind while the share of NWFP remained unchanged.

Third NFC Award (1985)

In 1985, the third National Finance Commission was established in which Dr Mahbub ul Haq, the then Federal Finance Minister, had suggested giving more taxes to the provinces and that the center should retain income tax, corporate tax and customs duty only. Although, the Commission held nine meetings in three years, it could not finalise its recommendations. This was mainly contributed due to the internal as well as external political instability. Thus the third NFC Award 1985 as of its previous 1979 Award also failed to bear any fruit. The resource distribution from divisible pool remained same as of 1974 up to 1990.

Fourth NFC Award (1990)

After almost 16 years of break in declaring a consensus NFC Award, Prime Minister Nawaz Sharif’s government constituted the fourth Commission in 1990. This NFC was headed by Finance Minister Sartaj Aziz and it came up with some positive recommendations in April 1991. The most significant development under this Award was the expansion of the divisible pool.

• The excise duties on sugar and tobacco which erstwhile were part of non-divisible pool became a part of the divisible pool.
• The divisible pool under fourth NFC Award 1990 consisted of number of taxes/duties which include income tax, sales tax, export duty and excise duty.
• Custom duty still remained with federal government.
• The Commission failed to achieve consensus for the diversification in the resource-sharing formula despite the demands from the provinces. Thus, population remained the sole element for revenue sharing criterion in the NFC Award.
• Revenue deficits were adopted as the basis for determining the amount of subvention requirement.
• The sharing of the divisible pool between federal and provincial governments continued to remain at 20:80 percent, respectively
• The 1990 Award raised the provincial shares by around 18 percent as compared to the 1974 Award. This increase was due to the inclusion of excise duty on two items, sugar and tobacco, in the divisible pool.

The major contribution of this Award was the acceptance of the financial autonomy demand of the provinces. In addition to this, for the first time the provinces’ right on net hydel profit, development surcharge (on gas) and excise duty on crude oil was admitted and amounts relocated in the shape of straight transfers to the provinces.

Fifth NFC Award (1996)

Malik Meraj Khalid, the then caretaker Prime Minister of Pakistan, constituted NFC in December, 1996 with Mr Shahid Javed Burki, the then Finance Minister as its Chairman. However, it announced the Award in February 1997 during Nawaz Sharif’s second stint. This Award was a departure from the previous ones in many respects; most notably, it not only expanded the size of the divisible pool with the inclusion of all tax revenues into it but also extended the royalties and development surcharges on crude oil and natural gas to the provinces in the form of straight transfers.

• All taxes/duties were included in the divisible pool.
• Royalties on crude oil and net development surcharges on natural gas were also given to the provinces.
• Incentive of matching grant was introduced, although up to a certain limit, to the provincial governments that if they exceed their revenue growth target of 14.2 percent, they would be provided matching grants.
• It bifurcated the public expenditures into priority (defence, debt servicing, social sector and development) and non-priority (general administration, community services and law and order) expenditures.
• The federal government included more taxes in the divisible pool that slightly increased provincial share.
• The share of the federal government in the divisible pool was pushed up to 62.5 percent from just 20 percent in the past and that of provinces was slashed to 37.5 percent from 80 percent.

Sixth NFC Award (2000)

On 22nd July 2000, the then President of Pakistan, Gen Perveiz Musharraf, constituted NFC under the Chairmanship of Mr Shaukat Aziz. The Commission held 11 meetings but could not finalise its recommendations due to lack of consensus among its members. The provinces were demanding for higher share in the divisible pool (upto 50 percent) as well as the diversification of the distribution criteria.

The second attempt was made during 2005-2006 when the new NFC was constituted on 21st July, 2005 but it also failed because no consensus could be developed among the members to have a mutually-acceptable mechanism for judicious resource distribution. The provinces had sent their representatives to the NFC meeting but with resolution passed by respective provincial assemblies on their stand. The representatives would not budge from their stated stand, and would show complete inflexibility. This gave rise to a deadlock and finally all the provincial Chief Ministers vested the authority to the President to announce a just award. As a result the President under Article 160(6) of the Constitution of Islamic Republic of Pakistan, through Ordinance No. 1 of 2006, made amendment to the “Distribution of Revenues and Grants-in-Aid Order, 1997”. Consequently, the new NFC was announced to take effect from 1st July 2006.

Seventh NFC Award (2009)

The federal and provincial governments developed a landmark consensus on the 7th National Finance Commission (NFC) Award after thirteen long years. The 7th NFC Award was unanimously decided by all political parties in 2009. The Award was signed in Gwadar on December 30, 2009 by the finance ministers of the four provinces and the federal government. This Award redefined the basic structure of the resource distribution formula.

The 7th NFC Award recognized, for the first time, ‘other’ factors for allocation of resources. Although the weightage assigned to these factors was paltry, it was a seminal shift in favour of the provinces.

The NFC Award 2009 was made applicable with effect from fiscal year 2010-11 through “Distribution of Revenues and Grants-in-Aid Order 2010.”

According to the Award, the four factors including population, poverty/backwardness, revenue collection and inverse population were balanced against each other. Population was allocated a weight of 82 percent in the horizontal distribution formula, poverty/ backwardness 10.3 percent, revenue collection / generation 5 percent and inverse population density 2.7 percent.

Under the new formula:

The percentage share of Punjab was reduced to 51.74 from 53.1 percent; Sindh’s share declined to 24.9 from 24.55 percent and NWFP’s share to 14.62 from 14.88 percent. In view of the special needs of the Balochistan province, the three provinces mutually agreed to reduce their shares thereby increasing the share of Balochistan to 9.09 from 7.17 per cent.

The Next NFC Award?

The finance ministry has notified and convened the belated meeting of the 8th National Finance Commission (NFC) to develop a mechanism for distribution of resources between federal government and the provinces for the next five years.

Balochistan, KP and Punjab have recommended names of Kaiser Bengali, Ibrahim Khan and Aisha Ghaus Pasha respectively for nomination as technical members to President Mamnoon Hussain. Sindh has not yet submitted its nomination, delaying the announcement of the 8th NFC.

The President has powers to issue an interim order, extending the 7th NFC Award until Commission achieves consensus on the 8th Award. The federation will try to win back some of the concessions that it had given to the provinces under the 7th award. It cannot reduce provincial shares below 57.5%, as it has been guaranteed in the Constitution. But the Centre will try to shift some of its expenditures onto the provinces.