With Pakistan facing yet another challenging fiscal year, the spotlight has returned on the provincial shares from the federal tax divisible pool under the National Finance Commission (NFC) award, which distributes financial resources between the federation and provinces.

The prime minister has already announced his plan to convene the reconstituted NFC next month, ostensibly to address the issue of an acute vertical imbalance due to enhanced provincial share amid rising federal expenditures on debt servicing, climate resilience and infrastructure, and defence.

The International Monetary Fund (IMF), too, has repeatedly, and rightly, insisted on increasing the provinces’ fiscal responsibilities in the wake of their enhanced share from the NFC arrangement for reducing the burden on the federal budget. The production of provincial cash surplus to help the centre control the consolidated fiscal deficit has been part of every recent IMF programme.

Moreover, the NFC is constitutionally required to be reconstituted once every five years. But 15 years have passed with no new NFC Award, as various attempts to convene the new commissions have failed.

The last NFC award had increased the provinces’ share in the divisible pool from 47.5 per cent to 56pc in 2010–11 and to 57.5pc from 2011 onwards. The award also shifted from a population-only formula for horizontal distribution of the provincial share to a multiple-indicator model, allocating 10.3pc weight to poverty, 5pc to revenue generation, and 2.7pc to inverse population density.

The resource distribution arrangement should focus on resolving outstanding issues and not reversing the process

The population still dominated the new formula with an 82pc weight. Khyber Pakhtunkhwa was awarded an additional 1pc share to make up for the cost of security operations, while Balochistan received a guaranteed transfer of its share. At the same time, the 18th Amendment provided constitutional protection to the provincial share, stipulating that a province’s share in any future award must not be less than its share in the previous award. This provision ensures a minimum guaranteed flow of resources to provinces.

Apart from the shrinking federal fiscal space, the 7th NFC award has also come under scrutiny because of its weak incentive structure for provinces. Despite receiving guaranteed transfers, they have failed to develop robust tax bases, particularly in high-potential sectors like services, agriculture and real estate. The dominance of population in the horizontal formula is also considered problematic and an incentive for the federating units to not control population growth, as pointed out by the finance minister in his post-budget press conference.

The formula also ignores geographic, infrastructural, and security-related expenditures of the provinces. Sparsely populated Balochistan, for example, faces high service delivery costs but receives low transfers. Thus, the dominance of population is also considered a major reason for the unequal economic development of less populous provinces.

Indeed the federal budget has major macroeconomic implications, but the provinces hold the key to socioeconomic development for sustainable growth and fiscal consolidation as the 7th NFC Award and the 18th Constitutional Amendment shift the responsibility of delivering essential public services to the provincial governments. The federating units are doing much better now on this front than in the past.

The last NFC award had increased the provinces’ share in the divisible pool from 47.5 per cent to 56pc in 2010–11 and to 57.5pc from 2011 onwards

In spite of the federal condition of showing significant cash surplus each year under the IMF programme, they have massively raised their annual development allocations, as is reflected by Punjab’s Rs1.24 trillion development spending plan — nearly 25pc bigger than the federal public sector development plan of Rs1tr — for the present fiscal year. Even Balochistan has enhanced its development allocations to Rs290 billion despite resource constraints. Besides, they have been showing the required provincial cash surplus in compliance with the IMF stipulations to reduce the consolidated fiscal deficit.

Nonetheless, they have miserably failed to enhance the provincial tax revenues, which remain 0.7–0.8pc of the country’s GDP. The low provincial tax revenues reflect their administrative weaknesses and reluctance to tax the politically powerful lobbies.

Economists maintain that the provincial tax revenue can be raised to at least 2pc of the size of the country’s economy in the short- to medium-term by effectively taxing immovable urban property, agriculture income, services and real estate.

The provinces have also lagged in devolving fiscal powers and responsibilities to the third tier of government in line with the spirit of the present NFC arrangement and the 18th Amendment.

A new NFC award is needed as soon as possible in view of the massive changes in the economy and the unmet targets of the previous award. The resource distribution formula should be changed to include indicators like poverty reduction, provincial revenue effort, climate impact, and fiscal decentralisation to the district level.

Furthermore, the focus of the new resource distribution arrangement under the next NFC should be on the resolution of the outstanding issues while deepening fiscal devolution and not on reversing the process started with the existing NFC award and the 18th amendment. Any attempt at curtailing provincial share from the federal taxes to make up for the centre’s own failure to boost its revenues and curtail wasteful expenditure would prove to be counterproductive.

Published in Dawn, The Business and Finance Weekly, July 8th, 2025