- On BISP, World Bank seeks cost-sharing from all provinces.
- Expenditure assignments remain incompletely implemented: WB.
- WB suggests adopting horizontal distribution solution for equalisation.
ISLAMABAD: The World Bank (WB) has asked Pakistan to revise the National Finance Commission (NFC) Award formula, both vertically and horizontally, and adopt fiscal ‘equalisation’ for resource distribution among the provinces based on spending needs and projected revenue capacity.
The WB also supported excluding population from the main criteria for resource distribution and suggested fiscal equalisation as the way forward.
This was mentioned by World Bank lead economist and report author Tobias Haque while launching the report titled “Strengthening Fiscal Federalism in Pakistan,” alongside Country Director Bolormaa Amgaabazar at the WB’s office on Wednesday.
The bank highlighted the fragmented General Sales Tax (GST) on goods and services as a major challenge and proposed a unified collection mechanism, with the collected amount then distributed among provinces — though this would require legislative changes.
The WB also noted that out of Rs1,035 billion in grants committed by provinces for the Centre under Article 164, Punjab reversed grants of Rs546 billion and Sindh Rs260 billion. The PTI-led KP and Balochistan governments did not commit any amount for the Centre in their provincial budgets for 2026-27.
On the Benazir Income Support Programme (BISP), the WB asked for the continuation of national registry at the federal level but with cost-sharing from all provinces, as social protection falls under the domain of federating units.
The reprot stated, “Fiscal federalism arrangements have led to the emergence of a structural federal fiscal deficit.
Provincial revenues, including federal transfers, rose from less than 4% of GDP to an average of 6.5% over FY10 to FY24, but federal expenditures did not adjust commensurately. The loss in federal revenues from transfers (1.9% of GDP) was roughly equivalent to the increase in federal primary deficits post-devolution (1.7% of GDP).”
In the context of weak overall revenue and macroeconomic performance, the misalignment between federal financing and functional needs has been a material contributor to Pakistan’s fiscal deficit and to the accumulation of public debt.”
The WB’s country director said it was somewhat disappointing that fiscal federalism had not delivered benefits to people at the grassroot level. She noted that the report provides a set of options for policymakers, drawing on the experience of other developing and developed economies.
On the question of the Centre’s failure to raise the tax-to-GDP ratio from 10% to 15%, the WB’s lead economist replied that while the Centre lagged on this front, the provinces also failed to increase their contribution beyond 0.7% of GDP annually, against a potential of 1.15%.
The WB report states that expenditure assignments remain incompletely implemented and inadequately defined in some areas. The 18th Constitutional Amendment devolved responsibility for social services and economic functions to provinces.
However, the federal government continues to operate in constitutionally devolved areas, causing waste and blurring accountability, while local governments lack clearly defined or adequately resourced functional mandates. Second, the 18th Amendment led to fragmentation of the tax system.
While it strengthened provincial tax authority, particularly over GST on services, it also split the tax base between five competing jurisdictions. The resulting complexity imposes high compliance costs, discourages interprovincial trade and has constrained aggregate revenue performance. Large potential tax bases — particularly agricultural income and property — remain significantly underutilised.
Third, the current federal-provincial transfer arrangements — including both the vertical share and horizontal allocation formula — do not achieve important policy objectives.
The NFC-based transfer system provides predictability and protects provincial revenue shares. However, financing has not followed function. The current framework reduced federal resources without a commensurate adjustment in expenditure responsibilities, driving a structural federal fiscal deficit.
The horizontal distribution formula also does not achieve genuine fiscal equalisation and provides no meaningful incentives for provincial revenue effort or service delivery performance. Current arrangements arguably also deter federal revenue effort, with a large share of revenues automatically transferred to provinces.
Finally, despite constitutional recognition under Article 140A, local governments remain fiscally dependent, institutionally unstable and effectively subordinate to provincial discretion. Provincial Finance Commission (PFC) awards are infrequent and non-binding, transfers are ad hoc, and own-source revenue is minimal. The devolution envisaged in 2010 has not extended meaningfully below the provincial tier.
In the context of weak overall revenue and macroeconomic performance, the misalignment between federal financing and functional needs has been a material contributor to Pakistan’s fiscal deficit and debt accumulation. Second, fiscal federalism arrangements have contributed to continued weak revenue performance. Fragmentation of the tax base across five jurisdictions has misaligned incentives, raised compliance costs and created opportunities for avoidance.
Federal revenues have continued to significantly underperform. Despite expanded provincial revenue assignments, own-source tax revenue has barely increased. Agricultural income tax remains largely uncollected, despite the sector accounting for more than 20% of GDP. Urban immovable property tax generates only 0.13% of GDP, far below comparator country norms of 0.3% to 0.6% .
Third, fiscal federalism arrangements have had, at best, a limited impact on aligning public spending and service delivery with needs. Devolution is theoretically expected to reduce accountability loops and better align spending with public needs. While provinces have increased spending on basic services since the 18th Amendment, the largest single increase has been in administrative expenses.
Around 80% of consolidated provincial expenditure continues to be absorbed by recurrent costs, with the largest share of incremental spending going to general public services and administrative costs rather than education or health. Spending has also remained geographically inequitable, with district allocations driven by historical precedent rather than poverty levels or service delivery gaps. Local governments have seen their share of total government spending fall from around 10% in 2005 to approximately 4.7% in 2024.
The WB recommends adopting a horizontal distribution solution that achieves equalisation while generating positive fiscal incentives. A transparent fiscal gap approach — replacing the current complex multi-factor formula — would allocate divisible pool resources based on standardised assessments of expenditure needs versus own-source revenue capacity, eliminating disincentives to revenue effort and avoiding penalties on provinces for fiscal efficiency. Using needs and capacity rather than actual spending or collection prevents penalising provinces that perform well.
Unconditional transfers under this approach preserve provincial fiscal autonomy. Several countries have adopted variations of this model, including Australia, Canada, China, Nigeria and South Africa.
This equalisation framework could be complemented by conditional transfers tied to measurable service delivery outcomes in devolved sectors such as education and health, with disbursements verified by an independent third party and supported by strengthened federal and provincial statistical systems.
Other national priorities — revenue collection, environmental goods, governance and effective local government — could similarly be linked to conditional transfers. Short of a full overhaul, the existing formula could be improved by assigning greater weight to poverty, backwardness and inverse population density indicators to strengthen redistribution; rewarding provinces for closing gaps between potential and actual own-source revenue collection, including underutilised property and agricultural taxes; and tying a share of divisible pool transfers to investments in critical public services, fiscal discipline and budget transparency, climate adaptation, disaster readiness and further devolution to local governments.
The WB recommends that the NFC could pursue full reunification of the GST base under centralised administration, with constitutional revenue-sharing provisions implemented through an agreed allocation formula.
On income taxation, the NFC could advance the implementation of provincial agricultural income tax regimes recently amended to align with the federal system, and establish automatic information exchange arrangements where differences remain to prevent evasion.
On property, the NFC could support harmonisation of all immovable property-related levies — taxes, duties, fees and charges — through a common valuation system and uniform methodology applied consistently across instruments.
Originally published in The News
