ISLAMABAD: Pakistan has made meaningful progress on its fiscal federalism system since 2010, however, it retains certain structural weaknesses across critical dimensions that constrain its performance, a recent report by the World Bank warned.
Fiscal federalism refers to the distribution of taxation and spending powers across levels of government, usually federal, provincial and local. Constitutional reforms introduced by Pakistan in 2010 significantly increased the provincial share of federal revenues and devolved major service delivery responsibilities to provinces. Provinces became responsible for vital sectors such as health care, education, local infrastructure and law and order.
The National Finance Commission (NFC) Award in Pakistan determines how tax revenues collected by the federal government are distributed among Pakistan’s four provinces.
“Pakistan has made meaningful progress on fiscal federalism since 2010 but important deviations from international norms and good practices exist across four critical dimensions,” the Executive Summary of a World Bank report said.
Titled ‘Strengthening Fiscal Federalism in Pakistan,’ the report was released on Monday. It pointed out that the federal government continues to operate in constitutionally devolved areas, causing waste and blurring accountability, while local governments lack clearly defined or adequately resourced functional mandates.
The World Bank report further said that constitutional reforms in 2010 caused further fragmentation of the tax system, noting that while it strengthened provincial tax authority, particularly over General Sales Tax (GST) on services, it also split the tax base between five competing jurisdictions.
“The resulting complexity imposes high compliance costs, discourages interprovincial trade, and has constrained aggregate revenue performance,” the report said. “Large potential tax bases, particularly agriculture income and property, remain significantly underutilized.”
It said that the tax base’s fragmentation has misaligned incentives, raised compliance costs, and created opportunities for avoidance.
The World Bank noted that federal revenues have continued to significantly underperform, adding that agriculture income tax remains largely uncollected despite the fact that it accounts for more than 20 percent of the country’s Gross Domestic Product.
The report said improved outcomes from devolving powers depend on subnational finance systems, noting that Pakistan’s provinces exhibit mixed performance in the strength of their public finance systems.
“Key shortcomings include weak predictability of resource availability, large and unpredictable in-year reallocations, limited performance orientation through the budget cycle and across levels of government, and constrained local discretion to manage effective resource use,” the report said.
RIGHTSIZING, EMPOWERING LOCAL GOVERNMENTS
The report recommended that the federal government’s ongoing federal rightsizing exercise, aimed at reducing redundancies through downsizing, merging, and privatizing federal ministries and state-owned enterprises, should be prioritized.
“Once achievable savings are realized, a federal revenue potential assessment should determine whether further vertical rebalancing is needed and to what degree,” it added.
The report pointed out that the fragmentation of the GST between goods and services results in multiple collection agencies applying different rates, definitions, withholding rules, input adjustment mechanisms, and refund systems.
It said that this serves as a primary constraint on revenue performance and should be treated as a “first-priority reform.”
“The NFC could incentivize harmonization of the GST base through common definitions based on a shared negative list, harmonized place-of-supply rules, expedited rollout of a unified digital filing and payment system, and comprehensive data-sharing arrangements,” it said.
The World Bank said that NFC agreements could also establish clear guidelines for local government structures and minimum standards for the devolution of administrative and financial decision-making.
“Increased local level allocations should target key national priorities including health and education, and performance-based grants should incentivize improved service delivery and local revenue generation,” it added.
