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Efficiency gain in fiscal devolution

By Jawaid Bokhari 2017-11-27
THE seventh National > Finance Commission (NFC) award is opening up space for a more robust fiscal federalism. An initial step towards this can be the execution of a professional study quantifying efficiency gain from devolved collection of sales tax on goods, as recommended by one of NFC`s working groups.

Under Article 160 of the Constitution, sales tax is a provincial subject. Since the working group talks only of `efficiency gain` in devolved collection, it is unclear whether the collection of sales tax would be retained by provinces or they would merely be allowed to collect tax for the divisible pool for a nominal fee as incentive.

The view in certain official quarters is that the collected amount might be transferred to the divisible pool in real time to help the cashstrapped Centre tide over some of its financial difficulties.

As sales tax on goods is a major revenue spinner, it would be difficult to transfer the entire revenue collected from it to the provinces because of a significant adverse impact on sharing resources among the federation and two smaller provinces in the divisible pool.

Implicit in the proposal of the working group is that efficiency gain can be a criterion for assigning the collection of taxes falling in the subnational domain.

Certain levies are collected by the Federal Board of Revenue (FBR) onbehalf of provinces, and the proceeds are directly transferred to federating units in 15 days after the deduction of 2pc collection fee.

They include surcharge and royalties on crude oil and gas.

The working group`s recommendation does not include the issue of levying sales tax on goods, possibly to maintain a standard sales tax rate throughout the country`s integrating economy.

Sindh laments the fact that potential revenue, which could be mobilised by devolved collection of sales tax on goods to provincial level, is lost. The federation frets that it has been deprived of a significant portion of the revenues under the seventh NFC award.

For the ninth NFC award, former finance minister Ishaq Dar proposed that the provinces accept a 7pc reduction in their aggregate share from the divisible pool to enable federal government to allocate funds for security purposes and for the uplift of Federally Administered Tribal Areas, Gilgit-Baltistan and Azad Kashmir.

But the provinces have rejected the proposal on two counts: one, the aggregate share of provinces cannot be reduced except by a next-toimpossible constitutional amendment by two-thirds majority in parliament. This would mean a complete U-turn in their consistent stand. Two, Fata, GB and Kashmir are part of the federal territory and a responsibility of the Centre.

That leaves only one option:increase the size of the revenue pie in the best possible way for the mutual benefit of all stakeholders.

The NFC is undoubtedly facing a deadlock in evolving a formula for its ninth award. It skipped the eighth award for want of agreement among stakeholders. However, only on the basis of give and take can divergent views find space for convergence.

This is what `participatory federalism`, involving interaction of all stakeholders, is all about.

There is room to transfer certain taxes, which have been retained by the FBR and fall in sub-national territory, to the provinces. The duplication and overlapping in collection of sales tax on services need to end.

Sindh claims the right of the provinces to levy and collect sales tax at the retail and wholesale stages which, it says, form the component of the country`s GDP from services.

Similarly, it maintains capital gain tax on immovable property is subnational tax under the constitution.

So far, devolution has been the principal mode of granting fiscal autonomy to the provinces. The spirit of fiscal federalism has, however, been exhibited by the federating units by providing budget surpluses to help the Centre keep consolidated fiscal deficit in manageable limits. But provincial as well as federal efforts in this direction are losing momentum ahead of next year`s general election.

Now some critics are questioning the constitutional validity of the divisible pool that would require a drastic change in the approach for sharing of resources among all stakeholders. Officials in Sindh believe that Article 160 of the Constitution, under which the NFC is set up, merely envisages distribution of tax revenue between the federation and the provinces, on the basis of collection of each federatingunit. There is no mention of horizontal distribution among the provinces or of the so-called `divisible pool`.

Contrary to the devolution process, this would place constitutional responsibility directly on sub-federations to provide a significant part of their tax revenue for the upkeep of the federation and advancement of less-developed regions. It may involve a long-term transition to create such fully autonomous, self-reliant federating units which can be entrusted with this responsibility.

That is the obligation entailed under participatory federalism forged by the18th constitutional amendment.

If this approach is adopted, the federation becomes eligible to seek resources for uplift of federal territories like Fata, GB and Kashmir, which the provinces are now resisting. Currently, the federation shares costs of big provincial projects which are beyond the competence of any province to finance.

Some financial experts suggest that the NFC should have a permanent secretariat in Islamabad, with independent economists and fiscal experts who study the intricate issues involved in fiscal federalism and offer appropriate solutions.

Looking at the short-term in light of the experience gained from the extended tenure of the seventh NFC award, it is time to encourage the provinces to perform better than the FBR in tax collection in their constitutionally mandated tax jurisdiction.

However, there is very little room currently for changing horizontal resource distribution criteria and no space at all for any change in vertical distribution of tax revenue. That explains the NFC deadlock for which the solution lies in capitalising efficiency gain from devolution. •