NFC blues

A National Finance Commission has been convened some four years too late. The cause of the delay was the dilly-dallying by the PML-N government to accommodate rising security expenditure by re-defining the federal-provincial share determined in the 7^th NFC award in 2010. Reportedly, the IMF also sees that award as a contributor to the federal government’s fiscal woes, while other donors find it convenient to deal with the federal government as a partner. This is where the grumbling about the provincial governments’ poor capacity is sourced. Interestingly, the provinces have started posting deficits in the last two years, a sign of the expanding capacity to spend, but a red herring for the overall fiscal deficit. While the 18^th amendment allows provincial borrowing, the limits set by the National Economic Council have been observed. In addition, the 18^th Constitutional amendment is blamed for tying the federal hands by making the provincial share irreversible [Article-160 (3A)]. The federal government lacks the numbers in parliament to force its way. Rightly, it did not use the vague room for manoeuvre for the president in Article-160 (6). New population census results will automatically affect the horizontal distribution, with Punjab being the loser and K-P the gainer. The federal government’s commitment to allocate three per cent of the divisible pool to ex-Fata will translate into action as its population is added to K-P’s population, plus the continuation of one per cent of the divisible pool allocated to K-P to defray the expenses on the War on Terror. With peace returning, there is no other justification for its continuation. Any change in the federal-provincial shares or in the criteria for inter-provincial distribution is infeasible.

What is feasible is the enlargement of the pie through the much-delayed tax reform by the federal government. The 7^th NFC award had expected the federal and provincial governments to “streamline their tax collection systems to reduce leakages and increase their revenues through efforts to improve taxation in order to achieve a 15% tax-to-GDP ratio by the terminal year.” The baseline for the federal government was 8.9 per cent of the GDP. In 2017-18, it stood at 11.8 per cent, or an increase of just 33 per cent. In contrast, the provinces have increased their tax collection from 0.4 per cent to 1.2 per cent of GDP, or by three times. On the whole, the tax-to-GDP ratio at 13 per cent remains less than the NFC target set for 2014-15. Until the achievement of this target, the federal government must contain expenditure by strictly adhering to the subjects left to it by the 18^th amendment.

Provinces have ignored the 7^th NFC recommendation to “initiate steps to effectively tax the agriculture and real estate sectors.” Out of its 19.2 per cent share in GDP, agriculture pays 0.6 per cent in taxes. The total collection of agricultural income tax by all the provinces is around Rs2 billion. According to the State Bank, the amount is 0.03 per cent of gross value added. The distinction between agricultural and non-agricultural incomes for tax purposes is a major source of evasion and avoidance. Assigning agricultural income tax to the federal government is the only change that has win-win prospects. Treating agricultural income as part of federal income tax is likely to increase the yield manifold. As part of the divisible pool, both the federal government and the provincial governments will enjoy extra revenue in proportion to their respective shares. Attempts to build a consensus around this constitutional amendment will be mutually beneficial. It will also finally end a colonial relic.

Published in The Express Tribune, February 8^th, 2019.

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