By Staff Reporter
ISLAMABAD: Pakistan has made meaningful progress toward decentralising fiscal power to its provinces since 2010 but continues to deviate from international norms in critical areas, including the formula used to divide tax revenue between the federal government and the provinces, the World Bank said in a report published on Tuesday.
The report, titled “Strengthening Fiscal Federalism in Pakistan,” said the shortcomings have contributed to a structural federal budget deficit, weak tax collection, and public spending that is poorly aligned with the needs of citizens, more than a decade after Pakistan’s landmark 18th constitutional amendment devolved wide-ranging powers to provincial governments.
The World Bank identified four areas where the South Asian nation’s fiscal federalism model falls short of good international practice: unclear division of responsibilities between federal and provincial governments, a fragmented tax system, a transfer mechanism that does not achieve its policy goals, and local governments that remain financially dependent on provinces despite constitutional guarantees of autonomy.
“Expenditure assignments remain incompletely implemented and inadequately defined in some areas,” the report said, noting that the federal government continues to operate in policy areas that the constitution formally handed to the provinces in 2010. That overlap, it said, has caused wasteful duplication of spending and blurred lines of accountability, while local governments lack clearly defined or adequately funded responsibilities of their own.
TAX BASE SPLIT FIVE WAYS
The 18th amendment strengthened provincial authority over the general sales tax on services, the report said, but in doing so split the country’s tax base between five competing jurisdictions – the federal government and four provinces. The World Bank said the resulting complexity has raised compliance costs for businesses, discouraged trade between provinces, and constrained overall revenue collection.
Agricultural income and property, it added, remain significantly underused as sources of tax revenue. Agriculture accounts for more than a fifth of Pakistan’s economic output but the tax on farm income is largely uncollected, the report said, while urban property tax generates only 0.13% of gross domestic product, well below the 0.3% to 0.6% range typical of comparable countries.
The report also took aim at the National Finance Commission, the constitutional body that determines how revenue is divided between Islamabad and the provinces. While the commission’s awards have provided predictability and protected provincial revenue shares, the World Bank said, that financing has not translated into better public services on the ground.
“The current framework reduced federal resources without a commensurate adjustment in expenditure responsibilities, driving a structural federal fiscal deficit,” the report said, adding that the commission’s distribution formula has not achieved genuine equalisation between richer and poorer provinces and provides no meaningful incentive for provinces to raise their own revenue or improve service delivery. A large share of revenue is transferred automatically to the provinces, the report said, which also weakens the federal government’s own incentive to collect taxes.
Provincial revenues, including federal transfers, rose from less than 4% of GDP to an average of 6.5% between the 2010 and 2024 fiscal years, the report found, but federal spending did not fall by a corresponding amount. The loss of federal revenue to transfers, equivalent to 1.9% of GDP, was roughly matched by a 1.7% of GDP increase in the federal government’s primary deficit after devolution, it said, a mismatch the World Bank said has contributed to Pakistan’s fiscal deficit and rising public debt.
LOCAL GOVERNMENTS LEFT BEHIND
The report said local governments, which the constitution’s Article 140A requires provinces to establish and empower, remain fiscally dependent, institutionally unstable and effectively subordinate to provincial authorities. Provincial Finance Commission awards, which are meant to govern transfers to local governments, are issued infrequently and are not binding, the report said, while transfers to local bodies are ad hoc and locally generated revenue is minimal. Total government spending at the local level fell from 10% in 2005 to 4.7% in 2024, according to the report.
Despite rising overall spending on basic services by the provinces since 2010, the World Bank said the largest single increase has gone to administrative expenses rather than education or health. About 80% of total provincial spending covers recurrent costs, it said, with most of the incremental increase absorbed by general public services and administration. Spending across districts has also remained geographically uneven, the report said, driven more by historical funding patterns than by poverty levels or gaps in service delivery.
The World Bank also faulted the institutions responsible for coordinating fiscal federalism, saying they have failed to monitor or safeguard the system’s performance. The Council of Common Interests, a constitutional body required to meet quarterly, held only 11 meetings between 1973 and 2010, the report said, while a new National Finance Commission award to replace the current one has been delayed for more than 15 years.
REFORM PRIORITIES
The World Bank set out a series of recommended reforms, starting with better aligning federal and provincial responsibilities with the resources each level of government controls. It urged Pakistan to prioritise an ongoing federal “rightsizing” exercise aimed at cutting spending that duplicates provincial mandates, regardless of the fate of broader reforms, and said a subsequent assessment of federal revenue potential should determine whether further rebalancing between the two levels of government is needed.
Remaining gaps, the report suggested, could be addressed through targeted deductions from the divisible pool of shared revenue to help fund continued federal spending on items such as national transport infrastructure, security, debt servicing, social protection, environmental programmes, interprovincial water infrastructure and national policy coordination.
On the distribution formula itself, the World Bank called for replacing the current multi-factor formula with a more transparent approach based on standardised assessments of each province’s expenditure needs against its own revenue-raising capacity, which it said would remove disincentives for provinces to raise their own revenue while preserving their fiscal autonomy. It cited Australia, Canada, China, Nigeria and South Africa as examples of countries using similar models. The World Bank said this framework could be paired with additional transfers tied to measurable outcomes in devolved sectors such as education and health, verified by an independent third party.
The formula could also be adjusted to give greater weight to poverty, underdevelopment and low population density to strengthen redistribution to poorer areas, the report said, while rewarding provinces that narrow the gap between their potential and actual tax collection, including from underused property and agricultural levies.
On revenue collection, the World Bank described the fragmentation of the sales tax between goods and services – administered by multiple collection agencies with different rates, definitions and refund systems – as the primary constraint on Pakistan’s revenue performance and called for it to be treated as a first-priority reform. It suggested the National Finance Commission could push for a harmonised tax base through common definitions and a unified digital filing system, or alternatively pursue full reunification of the sales tax base under centralised administration with revenue shared through an agreed formula.
The World Bank also recommended that the commission promote recently amended provincial agricultural income tax regimes designed to align with the federal system, and establish automatic information-sharing arrangements to prevent tax evasion where differences remain. On property, it called for harmonising all property-related levies through a common valuation system applied consistently across provinces.
The report’s fourth recommendation focused on empowering local governments, calling for clear minimum standards for devolving administrative and financial authority to them while preserving provincial autonomy. It said transparent and regularly updated formulas for provincial transfers to local governments should account for defined expenditure needs and revenue capacity, with performance-based grants used to encourage better service delivery and local revenue generation. It added that broader governance reforms, including a review of existing local government tiers and clearer revenue and expenditure roles, would be needed to make such empowerment effective.
Finally, the World Bank urged Pakistan to revive its fiscal federalism institutions, saying a revised National Finance Commission could reinvigorate coordination bodies such as the Council of Common Interests and clarify their mandates. More ambitious reforms, it said, could establish binding mandates for those bodies and set minimum standards for their resourcing and representation. Simply convening the commission on a regular basis, the report said, would lower the political stakes of any single negotiation and create ongoing opportunities for dialogue on fiscal federalism issues.
Copyright © 2021 Independent Pakistan | All rights reserved
