Resource Distribution Mechanism in Pakistan

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Pakistan is a federation comprising of four provinces, federally administered tribal areas, northern areas and Islamabad Capital Territory. Revenues are collected by centre for subsequent redistribution vertically between federal and provincial governments and horizontally among the provinces based on their population sizes. The revenues that are shared are generated through income tax, sales tax, custom duties, and excise duties. In addition there are other types of revenues, called straight transfers, are collected by federal government but paid to provinces, e.g. royalties etc. other than these, provinces are also assigned collection of minor taxes such as agricultural tax, stamp duties, motor vehicle tax and others which are levied and retained by provincial govt. Further all non-tax receipts are levied and retained by Federal government. The resource allocations had been a major bone of contention among the federation and the federating units.
Historical Background of NFC Award

In Pakistan, these resources are distributed among the federation and provinces according to the National Finance Commission (NFC) which has undergone many changes and has dynamically grown to its present shape. NFC is established by law for the smooth and judicious re-distribution of resources collected by centre according to the need and goals for development of federation and federating units. NFC is constituted under Article 160(1) of the 1973 constitution and proposed to be held at the intervals of five years. Its members are Federal Finance Minister (Chairman), Provincial Finance Ministers and other concerning experts which the President may appoint after consultation with provincial Governors (Constitution of Pakistan 1973).  As per Article 160(2)

It shall be the duty of the National Finance Commission to make recommendations to the President as to-

  • the distribution between the Federation and the Provinces of the net proceeds of the taxes mentioned in clause (3);
  • the making of grants-in-aid by the Federal Government to the Provincial Governments;
  • the exercise by the Federal Government and the Provincial Governments of the borrowing powers conferred by the Constitution And
  • any other matter relating to finance referred to the Commission by the President.

Chronology of NFCs

Table 1 Chronology of NFCs
S.No. Name Status
First NFC 1974 Conclusive
Second NFC 1979 Inconclusive
Third NFC 1985 Inconclusive
Fourth NFC 1991 Conclusive
Fifth NFC  1995 Inconclusive
NFC 1997 Conclusive
Sixth NFC  2002 Inconclusive
DRGO 2006 _
Seventh NFC  2010 Conclusive
The 7th NFC Award

A new NFC was formed to resolve the demands of the provinces in 2005 but no consensus among the members was developed to have a mutually acceptable mechanism for judicious resource distribution. This gave rise to a deadlock and finally all the provincial Chief Ministers vested the authority to the President to announce a just award. As a result the President under Article 160(6) of the Constitution of Islamic Republic of Pakistan, through Ordinance No. 1 of 2006, made amendment in the “Distribution of Revenues and Grants-in-Aid Order (DGRO), 1997”.

The consensus was finally developed among the provinces and federal government resolving key issues in 2009 in which the resources were distributed on multiple indicators and not just the population. Punjab was interested in population being sole criteria, Sindh wanted a fair share in revenue generation and collected, and KPK also wanted Poverty and Balochistan emphases on the inverse population density in the awards. A brief percentage share based on multiple indicators is summarized in the table;

Revenue Sharing Formula for 7th NFC Award 2009

Revenue Sharing Formula for 7th NFC Award 2009
Multiple Indicators Weight Share of Provinces in term of Indicators
Punjab Sindh KP Balochistan
Population 82.00% 57.36% 23.71% 13.82% 5.11%
Poverty / Backwardness 10.30% 23.16% 23.41% 27.82% 25.61%
Revenue Generation & Collection 5.00% 44.00% 50.00% 5.00% 1.00%
Inverse Population density 2.70% 4.34% 7.21% 6.54% 81.92%
  100.00% 51.74% 24.55% 14.62% 9.09%

Impact of 7th NFC Award on Federal & Provincial Finances

Key Elements of the 7th NFC Award

The 7th NFC Award has brought some significant changes in the resource distribution formula. The changes can be classified under three broad groups: (1) divisible pool, (2) straight transfers and (3) grants/others.

Types of Changes Description of Changes
Changes in Divisible Pool
  • The collection charges of the federal government have been reduced from five percent to one percent thereby increasing the overall size of the divisible pool.
  • One percent of net proceeds of the divisible pool has been earmarked for Khyber Pakhtunkhwa to compensate for losses due to war on terror for the entire award period.
  • This award ensures that Balochistan gets at least Rs83 billion out of the divisible pool transfers. In case the estimated share of Balochistan is less than Rs83 billion, the balance funds will be contributed by the federal government.
  • GST on services collected in the central excise (CE) mode was            accepted as a provincial tax; and therefore, its revenue proceeds are to be reverted to the provinces and not be part of      the divisible pool.
Changes in Straight Transfers
  • GST on services collected on CE mode is also accepted as a provincial tax. Provinces have been given the choice to collect GST on services provincially or allow the Federal Board of Revenue (FBR) to collect it on their behalf with proceeds reverted back as a straight transfer.
  • On the demand of the Government of Balochistan, the formula for the computation of gas development surcharge (GDS) was revised.
  • The rate of excise duty on gas was increased from Rs5.09 to      Rs10 per MMBTU.
  • Arrears on the payment of hydel profits to Khyber Pakhtunkhwa were ensured.
  • GDS arrears are to be paid retroactively to Balochistan.
Changes in Grants/Others
  • Discretionary grants-in-aid to all provinces were abolished.
  • Sindh was given a grant of Rs6 billion to partly offset losses due to the merger of one-sixth of GST in the divisible pool.
Vertical Distribution of Divisible Pool
  • According to the revised formula agreed under the 7th NFC Award, the provincial share has increased from 46.25% to 57%.
  • Share of Federal government in the divisible pool has proportionately decreased.
Horizontal Distribution of the Divisible Pool
  • Until DGRO, the entire distribution of the divisible pool among provinces was based only on population.
  • The criteria now includes: population (82 percent), poverty and backwardness (10.3 percent), revenue collection/generation (5 percent) and inverse population density (2.7 percent).
Financial Implications of the 7th NFC Award

The changes made in the 7th NFC Award have significant implications on federal and provincial finances.  An analysis based on a comparison with DGRO 2006 is summarized below:

Financial Impact Explanation
Federal and Provincial Revenues from Divisible Pool Taxes
  • The FBR tax revenue is projected to increase to Rs2,363 billion by 2012-13. The reduction in collection charges has increased the size of the divisible pool and exclusion of GST CE mode from the divisible pool has reduced it.
  • The combined federal transfers (budgeted) to provinces increased by over Rs160 billion in 2010-11, Rs230 billion in 2011-12 and Rs285 billion in 2012-13. In percentage terms, transfers to provincial government are higher by 23 to 28 percent as a result of changes made in the distribution formula in the 7th NFC Award.
  • This increase in transfers reduces revenues of the federal government from the divisible pool by almost 20%.
  • The Award has had a differential impact on the four provinces, benefiting disproportionately the smaller provinces. For example in 2010-11, Balochistan was the largest gainer acquiring an additional Rs48 billion (equivalent to a 140 percent increase) followed by Khyber Pakhtunkhwa. In percentage terms, gains of Balochistan, Khyber Pakhtunkhwa, Sindh and Punjab are more than 100 percent, 50 percent, 20 percent and 15 percent respectively due to a change in the formula.