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Whither fiscal federalism?

Is the federal proposal to divert the three per cent resources from the federal divisible tax pool to a new National Security Fund — under the next National Finance Commission award — an attempt to cut the provincial share and roll back the landmark 7th award?

This proposal could have been put forth to pay the bills for the ongoing military action against militants in the country’s tribal backyard — and elsewhere — as well as for the protection of the China Pakistan Economic Corridor (CPEC).

Or could this move be — in the wake of the devolution of several federal subjects to federating units under the 18th constitutional amendment — a ruse to stall the provinces’ demand for more financial resources and power to meet their new expenditure responsibilities?


The federal minister’s impromptu announcement took even the participants of the National Finance Commission meeting by surprise


Or is it just a reflection of Islamabad’s frustration over its failure to control and manage its large budget deficits in spite of fudging numbers and using accountancy tricks?

Either, or all, of these factors might have prompted Finance Minister Ishaq Dar to ‘put the proposal on the table’, out of the blue, during a media briefing on the proceedings of the second meeting of the Commission early last week.

“We have proposed that the National Security Fund (NSF) meet (additional) security expenditures and allocate 3pc of the divisible pool (to it),” Dar was quoted to have said in answer to a question regarding a change in the vertical (between the centre and the provinces) and horizontal (among the provinces) distribution formulae of the divisible tax pool (in the next award).

The minister’s impromptu announcement took even the participants of the National Finance Commission (NFC) meeting by surprise. “The minister had not formally shared his proposal with the provinces prior to or during the NFC meeting. He sprung a surprise on us by floating it in front of the media,” insisted a senior Punjab government official.

Naturally, the provinces remain unaware of the objective of the finance minister. Or so they say.

“At this moment we don’t know anything as to what Minister Dar has in mind. We aren’t aware if Islamabad wants to deduct 3pc of the total divisible pool before its vertical distribution (as is being done to compensate Khyber Pakhtunkhwa for its losses on account of terrorism under the 7th award),” the official said. “Nor do we have any idea if the provinces will be required to individually contribute to the security fund after the redistribution of their share among themselves.”

But the proposal has certainly alerted the federating units to the direction in which future negotiations over the new award are likely to move.

Interestingly, KP wants compensation for its losses, on account of terrorism, raised from 1pc to 5pc. Sindh too is seeking a fixed financial share of 5pc of the total divisible pool resources for security expenditure, as long as it’s hosting the Rangers operation in Karachi.

Under successive constitutional amendments and decisions by the NFC, the transfers to the provinces have increased sharply — from 48.75pc in FY10 to 57.5pc, at present, of the divisible pool since the 7th award took effect in FY11.

Many, including, the International Monetary Fund (IMF), blame the increased provincial share for the financial woes of Islamabad that has been struggling to grapple with budget deficits. They have called for ‘rebalancing’ expenditure responsibilities between the federation and the federating units and ‘revamping’ the vertical revenue sharing formula.

While sanctioning the $6.64bn extended fund facility in 2013, the IMF, for example, said: “… A better match needs to be obtained between revenue and expenditure responsibilities which would not leave the federal government with chronic deficit, while the provinces run surpluses.”

Others cite the government’s failure to raise tax to GDP to 15pc (as envisaged in the last award) for its chronic financial difficulties and deficits. They underscore the fact that the 18thconstitutional amendment, that devolved a host of federal subjects and functions to the provinces, also guarantees that the future awards will not reduce the provincial share from the pool.

Dar too acknowledged this fact, saying the federal government could not reduce provincial share in the net proceeds of divisible taxes but could find new ways to share national responsibilities. “We will discuss (in future NFC meetings) how to create fiscal space for national security and other requirements of the federal government.”

Economists not working with the government are divided on whether or not new resources should be allocated to finance the military operation and the CPEC security. But they agree that the provincial share from the pool guaranteed in the 7th award should not be slashed from the present level in the next one under any circumstances.

Prominent economist Hafiz Pasha, for instance, is in favour of the creation of a security fund financed by money from the tax pool because implementation of the National Action Plan (NAP) — especially its civilian part — has been sluggish.

But he is also against reducing the existing provincial share from the pool in view of their new responsibilities on account of devolution of federal subjects as well as in connection with the sustainable development goals (SDGs).

“The next award must reflect (financial) implications of the 18th amendment (for the provinces). Therefore, I’d suggest that after diversion of 3pc of the divisible pool funds into the new security fund, the provincial share from the remainder (97pc) available for vertical distribution should be jacked up to 59.3pc with a view to protecting their present guaranteed share of 57.5pc,” Pasha argued.

Essentially, he is proposing that the security needs should be financed from the federal share in the taxes.

Economist Asad Sayeed, who suspects that the proposal at a broader level is an attempt to roll back the 2009 award and its constitutional protection, argues that the country’s existing defence expenditure needs to be scrutinised in a transparent manner before additional resources are allocated for the security fund.

He is spot on when he demands that the defence spending should first be made transparent and examined to see if there’s room for its rationalisation (for creating resources for protecting the NAP and the CPEC).

How else can people know whether their money is being spent for the purpose it is appropriated for unless the country’s large defence budget is open to public inspection? Diverting more funds without a thorough scrutiny of the existing security expenditure will be a mistake and cost the people heavily in terms of quality of social service delivery.

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