NFC – historical perspective

Reconciling the irreconcilable is not an easy task. So when Finance Minister Shaukat Tarin says he is going to smooth out the conflicting position taken by the provinces and knock-together the 7th National Finance Commission Award by the end of this month, it seems he is being over optimistic.

Why, with the best of intentions it is improbable to solve this conundrum in this short time? This is not difficult to forecast. In the first place any NFC award that might be hammered together in a hurry would be satisfactory for the provinces. As a matter of fact without sorting out the sensitive provincial autonomy issue, deciding on the division of revenue resources among the provinces and provinces and center, is putting the cart before the horse. Before we go into the current issue, it is necessary to have a brief overview of the history of NFC Awards in Pakistan in the first part of this article.

Under Government of India 1935 Act the center was made responsible exclusively for the conduct of foreign affairs, defence, communications and currency control. Concurrently it was dealing with maintaining law and order, agriculture and social sector services like health and education. The point to be noted here is that was the time when the British Raj wanted to keep a tight control of the central government.

This division of power became the basis of the Niemeyer Award 1937. Provinces were awarded 50% of the income tax collected in their region and 62% of the export duties on jute. This tax structure was adopted by Pakistan after independence, but was amended in 1948 owing to the influx of refugees and defence needs. Sales tax which was a provincial subject was temporarily undertaken by the center, subject to allocation of 50% proceeds to the provinces. Two major demands of the smaller provinces is based on this historical fact that even in the colonial period the center took only 50% of the income tax collected in the region and that sales tax was a provincial tax.

Again in Raisman Award 1951, Sir Jermey Raisman awarded net proceeds of the income, excluding corporate tax and federal taxes, to the provinces. And 50% of the net collection of sales from their respective provinces was shared with them. Now even if this formula is adopted Sindh would be better off as it is generating a major bulk of personal income tax and sales tax.  The net loser would be Pakhtunkhwa and Balochistan.

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 immoveable property 100%.

To provide more for the development of provinces NFC was appointed in 1964, which gave its award in 1965. Provinces managed to push the center to raise their share from 50 to 65%. The commission had also recommended that agricultural income should be taxed. But in spite of such a recommendation by the urban population and some time by the center, elusive agricultural income could not be taxed till today.

The prevailing formula to divide the resources among the provinces on population basis was the outcome of an ad hoc arrangement when one unit was dissolved by General Yahya Khan. The 46% share of West Pakistan was divided among the four provinces: Punjab 56.5%, Sindh 23.5%, NWFP 15.5% and Balochistan 4.5%.

A new commission was set up in 1970 which gave its award in 1971, before the liberation 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. Even this arrangement had some incentive for the provinces to raise the payment of sales tax.

The first NFC award that came after the 1973 constitution was promulgated in 1975. This was based on the new strategy under which 80% of the divisible pool was distributed on population basis. Ironically, a Sindh Prime Minister, Zulifikar Ali Bhutto’s government dished out the NFC Award that was tilted heavily in favour of Punjab. The previous arrangement regarding sales tax was retained.

Martial Law government of General Ziaul Haq appointed the second commission under the 1973 constitution in 1979. In spite of the fact that all the provinces had military administrators, the provinces could not come to a consensus. While Punjab wanted to maintain the status quo, Sindh was against the distribution on the basis of population alone.

In 1985, the third NFC commission was established in which Dr. Mahbub ul Haq had suggested giving more taxes to the provinces and that the center should retain income tax, corporate tax and customs duty only. This commission died without an off-spring. The military government failed to give NFC award during its 11 years tenure, although it is mandatory in the constitution to constitute the National Finance Commission every five years and review the distribution of financial resources. The major reason of Zia regime’s failure was that the conflicting interests of the provinces could not be reconciled and the provincial autonomy issue remained a ticklish issue that they did not want to touch. The civil servants who represented their respective governments did not budge in spite of the pressure from the center. The resource distribution from the divisible pool thus remained same as awarded in 1974 up to 1990.

Prime Minister Nawaz Sharif government constituted the fourth commission in 1990. This NFC was headed by Finance Minister Sartaj Aziz which declared the award successfully after almost 16 years of break. The most significant development under this award was the expansion of the divisible pool. The excise duties on sugar and tobacco which were earlier part of the non-divisible pool become a part of the divisible pool in this award. However, this commission also failed to reach a consensus on changing the population based formula for the distribution of resources.

It was interesting to note that contrary to the smaller provinces fears that the Punjabi Prime Minister led government would not increase the share of provinces; the 1990 award did raise 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 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. However, the proportion of horizontal distribution remained the same because population was still the sole criteria for resource distribution and there was no census since 1981.

The 5th NFC was constituted in December 1996. But the commission announced the award in February 1997 during Nawaz Sharif’s second stint. All taxes/duties were included in the divisible pool. Which comprised: (a) income tax (b) wealth tax (c) capital value tax (d) sales tax (e) export duties (f) custom duties (g) excise duties (excluding excise duty on gas, charged at wellhead), and (h) any other tax collected by the federal government. In addition to that, 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.

An important aspect of 1996 NFC award was that it bifurcated the public expenditures into priority and non-priority expenditures. The priority expenditures were described as expenses on defense, debt servicing, social sector and development expenditures while those on general administration, community services and law and order were termed to be the non-priority expenditures. This according to a PIDE report was done to solve the emerging financial challenges, issues and accordingly prioritise the path of development.

However, while on one hand the federal government included more taxes in the divisible pool that slightly increased provincial share, on the other hand the share to 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 share was slashed to 37.5 percent from 80 percent, previously.

The 6th NFC Award was constituted in July 2000 under the Chairmanship of Mr. Shaukat Aziz, the Federal Finance Minister. It held 11 meetings but could not finalise its recommendations due to lack of consensus among its members. In an interview to me for Pakistan Business Update, which was telecast for 11 years by PTV, Mr. Aziz like Mr. Tarin was also very optimistic. He said that he would be able draw a consensus in a month’s time, I had warned him about the complications and that the reconciliation is not in sight.

The 7th NFC was commissioned in July 2005, but it met with the same fate and could not come up with an award. As a result 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 announced an award through an Ordinance.

Under the prevailing award, the provincial share was revised and decided to be 45 percent (share in total divisible pool + grants) for the 1st financial year and would reach 50 percent with subsequent increase of 1 percent per annum. The divisible pool consisted of the items i.e. (a) income tax (b) wealth tax (c) capital value tax (d) sales tax (e) export duties (f) custom duties (g) excise duties (excluding excise duty on gas, charged at wellhead), and (h) any other tax collected by the federal government. (To be continued) (ayazbabar@gmail.com)

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