A new fiscal order

THE seventh NFC Award and the passage of the 18th Amendment have furthered provincial autonomy and the process of devolution to an unprecedented degree.
However, in meeting the spirit of the 1973 constitution, these two seismic developments have added a layer of complexity and challenge to both the governance and fiscal framework of the federation.
On paper, the envisaged quantum increase in the transfer of resources to the provinces under the seventh NFC award, nearly doubling in size, with stepped-up increases to follow in later years, was to be financed from two sources: the introduction of an integrated (i.e. with goods and services in its ambit) and centrally collected value added tax (VAT) and the transfer of expenditure obligations from the federal budget to the provinces in line with the process of devolution of functions. The latter, however, was to occur after a lapse of one year to allow provinces to prepare, leaving the federal budget under considerable strain during the interim period.
In practice, the transfers under the NFC award have kicked in without the launch of an integrated VAT (or any successor arrangement such as Reformed General Sales Tax, or even any meaningful fiscal effort by provinces), and devolved functions have been nominally transferred to the provinces without the expenditure obligations. Hence, instead of expenditures totalling Rs187bn that were to be transferred to provinces under the devolution exercise (the original calculation worked out at the time of NFC deliberations in 2009), according to the Ministry of Finance, provinces have agreed to take on only Rs5bn to Rs6bn on to their budgets for 2011-12. This leaves the federal budget to cope with an additional fiscal burden of some 2.7 per cent of GDP at a time when it is trying to bring some sanity to the fiscal framework.
The combination of a lack of overall fiscal effort to meet the increased resource transfers, and the lack of preparation and enhancement of capacity by the provinces to take on the expenditures as well as functions relating to devolved subjects, unless managed properly, is a potential source of a permanent ‘structural’ fiscal deficit.
Of equally great concern, however, is the potential impact on service delivery. With provinces unwilling to finance key devolved functions such as education and health services, for example, and the federal budget unable to do so with its current constraints, the whole purpose of devolution could be defeated by the potential for near-collapse of service delivery to the common citizen. At its most basic level, for example, the Rabbani commission does not appear to have taken into consideration the need for physical working facilities and provision of housing for the thousands of employees required to staff the devolved functions in the provinces.
Hence, in addition to an existential threat from the lack of fiscal effort, the whole devolution exercise suffered from a fundamental weakness in the formulation stage: the overlooking of the state of provincial capacities to absorb the additional resources in a transparent and well-directed manner, and the absence of a road map on how to build those capacities before functions are transferred.
The critical issue now is how the country’s overall fiscal situation post-NFC and the 18th Amendment can be salvaged, and how the overall fiscal framework can be placed on a structurally sounder footing in the post-devolution environment. A number of recommendations to this end:
The ‘architecture’ of fiscal planning in the country needs to change fundamentally in the light of the 18th Amendment.
Essentially, five different government budgets (one centre plus four provincial) need to be synchronised more than ever before to yield one consolidated, workable overall fiscal framework. This should be done at the level of the Council of Common Interests (CCI), as propounded by Dr Ishrat Hussain.
Once the CCI has endorsed the framework, any provincial surplus targets would become binding on the provinces. Failure to do this prior to the formulation of the 2011-12 federal and provincial budgets has resulted in the disconnect between the finance ministry where it programmed a consolidated budget surplus by the provinces equal to 0.7 per cent of GDP while the individual budgets of the provinces yielded a deficit.
In the interim, the federal and provincial governments may need to consider a standstill agreement to be applied to the NFC transfers. This is important since servicing the fiscal transfers to the provinces was contingent on additional resource mobilisation. While the introduction of VAT was explicitly discussed in the NFC deliberations as a prerequisite for the framework to be viable, it was not made a formal, binding part of the NFC agreement. This was a mistake. However, contrary to popular perception, the provinces had lived up to their commitment on the issue till the shenanigans of two top federal bureaucrats unravelled the trust deficit built on the back of the NFC award, and by default, made the integrated VAT
unworkable, at least for Sindh.
Where the provinces have not lived up to their expectations is in the level of their own fiscal effort. With virtually most large tax bases domiciled in the provincial domain (such as agriculture, real estate and services), for tax collection by provinces to total an abysmal 0.5 per cent of GDP is untenable. Without a minimum threshold of provincial fiscal effort, the NFC transfers should be held in abeyance till certain benchmarks are achieved. The ‘trigger’ for NFC transfers to resume could be, for example, achievement of tax collection equal to one per cent of GDP by the provinces.
Finally, since the provinces will be able to borrow commercially after the passage of the 18th Amendment, it may become necessary to have provincial legislatures pass their own Fiscal Responsibility and Debt Limitation laws to establish the overall debt ceiling.
The writer heads an economic consultancy based in Islamabad.
Source: Dawn News