Pakistan made 'meaningful' progress in fiscal federalism, but deviations remain: WB

Pakistan has made “meaningful” progress on fiscal federalism since 2010; however, deviations from “international norms” and “good practices” remain, including in the current federal–provincial transfer arrangements, the World Bank said in a report released on Tuesday. In its report titled “ Strengthening Fiscal Federalism in Pakistan ”, the WB highlighted four critical dimensions in which Pakistan lacked in terms of fiscal federalism. “First, expenditure assignments remain incompletely implemented and inadequately defined in some areas,” the report said and highlighted that the government continued to “operate” in constitutionally devolved areas despite the 18th Constitutional Amendment. It added that the involvement had caused waste and blurred “accountability”, while local governments lack clearly defined or adequately resourced functional mandates. It also pointed out that the 18th Amendment had caused “fragmentation” of the tax system. “While the Amendment strengthened provincial tax authority, particularly over General Sales Tax (GST) on services, it also split the tax base between five competing jurisdictions,” the report added, adding that complexity led to higher compliance costs, discouraged inter-provincial trade and constrained aggregate revenue performance. It noted that tax bases, especially agricultural income and property, remained “significantly underutilised”. The report pointed out that the existing federal–provincial transfer arrangements, such as the National Finance Commission (NFC), had failed to achieve “important policy objectives”. It noted that while the NFC provided “predictability and protected provincial revenue shares”, this financing had not translated into functional outcomes. “The current framework reduced federal resources without a commensurate adjustment in expenditure responsibilities, driving a structural federal fiscal deficit,” the report read. The report maintained that NFC’s horizontal distribution had not achieved “genuine fiscal equalisation”. It further added that the formula provided “no meaningful incentives for provincial revenue effort or service delivery performance”. “Current arrangements arguably also deter federal revenue effort, with a large share of revenues automatically transferred to provinces.” Highlighting the final area, the report said that despite the recognition of Article 140A — which stipulates that each province shall, by law, establish a local government system and devolve political, administrative and financial responsibility and authority to the elected representatives of the local governments — local government continued to be “fiscally dependent, institutionally unstable, and effectively subordinate to provincial discretion”. “Provincial Finance Commission (PFC) awards are infrequent and non-binding, transfers are ad hoc, and own-source revenue is minimal,” it said, stressing that proposed devolution had not “extended meaningfully below the provincial tier”. The report further noted that deviations from good practices had also led to negative outcomes, including a structural federal fiscal deficit, weak revenue performance, limited impact on aligning public spending and service delivery with needs, and a failure to safeguard the performance of the fiscal federalism system. “Provincial revenues, including federal transfers, rose from less than 4 per cent of gross domestic product (GDP) to an average of 6.5pc over fiscal year 2010 (FY10) to FY24, but federal expenditures did not adjust commensurately,” the report read. It continued: “The loss in federal revenues from transfers (1.9pc of GDP) was roughly equivalent to the increase in federal primary deficits post-devolution (1.7pc of GDP).” The report added that “misalignment” between federal financing and functional needs had contributed to “Pakistan’s fiscal deficit and accumulation of public debt”. On weak revenue performance resulting from the existing fiscal federalism framework, the report said: “Fragmentation of the tax base across five jurisdictions has misaligned incentives, raised compliance costs, and created opportunities for avoidance. “Federal revenues have continued to significantly underperform. Despite the expanded provincial revenue assignments, own-source tax revenue has barely increased.” It noted that agricultural income tax was “largely uncollected”, even though the sector accounted for over 20pc of the country’s GDP. “Urban immovable property tax generates only 0.13pc of GDP, far below comparator country norms of 0.3 to 0.6pc,” it read. Additionally, the WB report highlighted that fiscal federalism has had a “limited impact in aligning public spending and service delivery with needs, which is contrary to the expected outcomes of the devolution. “While provinces have increased spending on basic services since the 18th Constitutional Amendment, the largest single increas