Revisiting the 18^th Amendment

Is 7th NFC Award the bone of contention?

Zafrullah Saroya Advocate

After the outbreak of coronavirus pandemic in Pakistan there has been a lot of debate on the 18^th Amendment to the Constitution of Pakistan. Some federal ministers like Shibli Faraz and Asad Umar flared up the debate by hinting that the government wants to change the 18^th Amendment. For instance, Federal Minister for Planning and Development, Asad Umar, opines that the amendment has some flaws which must be removed, especially a flaw pertaining to administrative matters between the federal and provincial governments needs a serious review of the amendment. On the other hand, Federal Information Minister, Senator Shibli Faraz, has termed it ‘a hurdle in preparing a uniform policy to fight the coronavirus across the country’ as after the amendment the federal government’s role in various spheres had been limited to issuing policy guidelines. He, however, said the government would adopt rational approach for resolving all the issues including NFC and the 18th Amendment.

Reports are abuzz in Pakistan’s mainstream media that the federal government wants to revisit the 18th Amendment and fill the gaps therein. What has been a source of concern to the centre is the Seventh National Finance Commission (NFC) Award under which the share of provinces in the divisible pool taxes was raised from 46.5 percent to 57.5 percent from 2011-12 onwards, with a commensurate decline in the centre’s share from 53.5 percent to 42.5 percent. Under the 7th NFC Award, the four provinces are collectively entitled to 57.5 percent of divisible pool taxes, besides the revenue from income tax, wealth tax, capital value tax, general sales tax, customs duties and federal excise duty. The provincial governments get their horizontal shares on the basis of population, poverty, revenue collection and inverse population density, allowing Punjab to get 51.74 percent, Sindh 24.55 percent, Khyber Pakhtunkhwa 14.62 percent and Balochistan 9.09 percent share.

In order to ensure that the share of provinces in the divisible pool would not be rolled back in times to come, the government inserted Article 160 (3A) in the Eighteenth Amendment which stipulates that “[t]he share of provinces in each award of NFC shall not be less than the share given to the provinces in the previous award.” And here is the crux of the problem: the centre is unable to fund its expenses from the remaining resources available from the divisible pool.

Take last fiscal year (2018-19) as an example. The revised estimates for the year showed FBR tax collections of 4.150 trillion rupees with the provincial share at 2.37 trillion rupees and the federal share as low as 1.78 trillion rupees. This amount could not fund the combined allocation (revised estimates) on defence 1.13 trillion rupees and debt servicing 1.98 trillion rupees with a combined allocation of 3.28 trillion rupees. The federal government revenue from other taxes (including petroleum levy, gas infrastructure development cess and natural gas development surcharge) was 243.8 billion rupees last year and 637.7 billion rupees from non-tax revenue (revised estimates) giving a combined total of 881.5 billion rupees. Thus the federal government’s combined total tax and non-tax revenue (revised estimates) for last year was 2.66 trillion rupees giving a shortfall of 0.62 billion rupees with respect to meeting just the two largest budgetary items.

However if the centre’s share was 53.5 percent of the divisible pool taxes as in the pre-18th Amendment period, its share last year would have been 2.2 trillion rupees, still not sufficient to meet the combined allocation on defence and debt servicing. If one adds other taxes and non tax revenue the total would still be lower than the combined allocation for defence and debt servicing though of course the shortfall would lower which in turn implies that a constitutional amendment would not obviate the need to reduce expenditure and raise revenue. And this is precisely what donors maintain, including development finance institutions (DFIs).

Both the 18th Amendment and the 7th NFC Award, thus, fundamentally restructured how Pakistan is governed — a change that has also generated a deep divide between the proponents of a strong Centre and those of a genuinely devolved federal system. This divide has widened over the last ten years and has been especially intense over the fiscal implications of the 18th Amendment. The critics of the amendment contend that it is having a negative effect on the fiscal stability of Pakistan.

Below is a brief description of its major fiscal implications.

Firstly, the provinces have been authorised to generate additional revenue through sales tax on services, capital gains tax on properties and income tax on agriculture (which, indeed, has their mandate since 2001).

Secondly, the provinces were assured through the insertion of Clause 3(A) in Article 160 of the constitution that their share in any future NFC Award shall not be less than the share given to them in the previous Award.

Thirdly, they were given an enhanced say, through the Council of Common Interest (CCI), in formulating and regulating policies related to major ports, water reservoirs, electricity, public debt, national census, industries and production among many other similarly common subjects. The council was to have a permanent secretariat and was supposed to meet at least once after 90 days to build consensus on all divisive issues — including a lockdown over Covid-19.

Lastly, the provinces were given greater access to domestic and/or foreign borrowing.

In an ideal situation, these provisions would have helped the provinces develop large, progressive and buoyant tax bases to be able to take care of their added administrative responsibilities under the amendment. They were also supposed to have distributed financial resources among their districts through provincial finance commissions — and under the same criteria that is being used by the National Finance Commission. In the same vein, the federal and provincial governments would have jointly worked to expand the tax base and increase the tax to GDP ratio.

In order to ensure that the federal government could live within its reduced financial resources under the revised NFC formula, it was supposed to have only less than a dozen ministries and divisions.

We, however, are not living in an ideal world. Provincial revenue authorities set up in Punjab and Sindh did make an impressive start but could not sustain their performance. In the words of the State Bank of Pakistan — as stated in its Annual Report for 2018-19 — the lack of institutional capacity among provinces has given “rise to lower revenue collection, less tax-to-GDP ratio and poor fiscal consolidation efforts”. The provinces are also not willing to share their revenues with districts. At the level of the central government, too, the number of federal departments has not gone down as it should have. Instead, federal expenses have increased. The Federal Board of Revenue (FBR) could also neither expand the tax base nor increase the tax to GDP ratio.

Resultantly, the federal government is barely left with funds to pay for its two non-discretionary expenses — debt servicing and defence. Rest, it had to borrow to finance even its administrative and development expenditures. In the current fiscal year, it does not have sufficient funds to service its debt — for which it will have to borrow even more. The provinces, especially Sindh, are simultaneously complaining that they are not receiving their due share from the federal divisible pool.

All these monetary and fiscal issues aside, the federal and provincial governments have failed to utilise the CCI and other such forums for inter-provincial coordination. As is obvious from the different approaches being taken in different parts of the country over a lockdown to avoid the spread of coronavirus, these institutional arrangements have been rendered irrelevant in clear violation of Article 154 of the constitution which states: “The Council shall formulate and regulate policies in relation to matters in part II of the Federal Legislative List and shall exercise supervision and control over related institutions.”

This is not to say that the current governments in the Centre as well as in the provinces are exclusively to be blamed for this state of affairs. If one looks back at the three democratically elected dispensations over the last ten years, one can say that both the provincial and the federal parts of them implemented the provisions of the 18th Amendment only selectively — solely on the convenient basis of what suited their political and partisan interests. This explains why expert opinion for or against the amendment remains deeply divided.

This division, however, should not be used as an excuse by the federal authorities to roll back the 18th Amendment unilaterally. Without first letting the full benefits of a fiscal and administrative devolution reach the provincial and district levels and then conducting an evidence-based assessment of service delivery before and after the 18th Amendment, no conclusion should be reached about its future. Such a step will only create further divisions and conflicts in the federation — particularly if it is taken without a thorough understanding of the actors and factors involved.

 

The 10th National Finance Commission

On May 12^th, the government, after approval of its terms of reference from President Dr Arif Alvi as required under Article 160 (1) of the Constitution, constituted the 10th National Finance Commission (NFC) to announce a new award for sharing of federal divisible resources between the Centre and the provinces. It is an 11-member commission that will, however, effectively comprise 10 members given the president has also authorised the adviser to the prime minister on finance and revenue to chair meetings of the NFC in the absence of the federal finance minister. The commission will have four provincial finance ministers and four non-statutory members representing the provinces and the federal finance secretary as official expert.

The ToRs set under clause 2 of Article 160 require the 10th NFC to distribute between the Centre and the provinces the net proceeds of five major tax categories, besides looking into expenditure requirements for special areas and special needs of the country. These include taxes on income, including corporation tax but not taxes on income consisting of remuneration paid out of the Federal Consolidated Fund. Also included in the list are taxes on sale and purchase of goods imported, exported, produced, manufactured or consumed and export duties on cotton, and such other export duties as may be specified by the president. It also includes excise duties and any other taxes as may be specified by the president.

For the first time a new subject has been added to the list of discussions suggesting that the Centre wants the provinces to bear some additional fiscal responsibilities. This pertains to “exploring ways to reduce losses of state-owned enterprises and agreeing on mechanism for sharing these losses between the federal government and the provincial governments”.

The NFC will also be required to make grants-in-aid by the federal government to the provincial governments and set powers and conditions for the federal and provincial governments for borrowing, besides assessing and allocating resources to meet expenditures relating to Azad Jammu and Kashmir, Gilgit-Baltistan and newly merged districts of Khyber Pakhtunkhwa (erstwhile Fata).

Two terms of reference not part of previous NFCs include: (i) assessment and allocation of resources to meet expenditures on security, natural disasters and calamities; and (ii) assessment of public debt and allocation of resources for its payment.

The parameters of the next NFC award are expected to change for various provinces, particularly after addition of about five million people from the tribal region to Khyber Pakhtunkhwa. This requires a meeting of the Council of Common Interests to endorse census results, notwithstanding objections, because a massive exercise of census could neither be repeated nor ignored

What is NFC Award?

Pakistan is a federation and has four federating units, i.e. Sindh, Punjab, Khyber-Pakhtunkhwa (K-P) and Balochistan, as well as other territories including Gilgit-Baltistan and Azad Jammu and Kashmir which come under the federal government directly. The NFC award is meant to distribute financial resources between the federal government (vertical distribution), and the provinces (horizontal distribution).

After the promulgation of the Government of India Act, 1935 which introduced provincial autonomy in colonial India, then British government announced the first award called Niemeyer Award in 1936.

The Raisman Programme formerly known as the Raisman Award was the succession of the on-going programme of economic reforms in Pakistan announced by Prime Minister Liaquat Ali Khan. The then Secretary Finance, Sir Jeremy Raisman was appointed to prepare the mechanism for the distribution of tax revenues. Later, the award was renamed as the National Finance Commission.

The NFC award includes the distribution of taxes collected by the federal government which form a divisible pool. This pool includes taxes on income including corporate tax, sales tax and export duties, etc.

Pakistan has historically been a highly centralised federation, and the federal government has massive powers to collect tax revenue, which are then distributed among the provinces. It determines the tax base: who should be taxed, the percentage of tax as well as the tax collection mechanism.

According to Article 160 of the Constitution, after every five years the president will constitute the NFC for a period of five years.

Once there is a consensus of all stakeholders on a particular formula to distribute the finances, the award will be implemented for the next five years.