KARACHI: In an interview with The News, World Bank lead economist Tobias Haque says Pakistan’s fiscal challenges stem less from how revenues are divided between the federation and provinces than from a misalignment between spending responsibilities, financing and incentives. He argues that the federal government should first complete a spending review and rightsizing exercise before revisiting the National Finance Commission (NFC) Award.
The News reached out to Haque after the World Bank released a report titled ‘Strengthening Fiscal Federalism in Pakistan’ in early July. Haque authored the report.
The News (TN): The Pakistan government recently retained over Rs1 trillion from the provinces’ share. Does the report suggest the current framework still needs revision?
Tobias Haque (TH): The report does not comment on this specific action. Rather, it examines a broader range of structural issues related to the alignment of revenues, spending responsibilities and incentives within Pakistan’s fiscal federalism framework — problems that need addressing.
The report suggests that the right response to any potential vertical imbalance is a structured process beginning with a federal spending review first, followed by an assessment of whether a fiscal gap remains, followed by a negotiated solution.
TN: Has the resource-sharing model gone too far in favour of provinces, or is the issue a mismatch between revenue allocation and spending responsibilities?
TH: The report frames the issue primarily as a mismatch between revenue allocation, expenditure responsibilities and fiscal incentives rather than simply a question of the size of the provincial share.
The 7th NFC increased the provincial share of the divisible pool from 45 per cent to 57.5 per cent. Federal transfers to provinces rose from an average of 3.2 per cent of GDP (FY02-09) to 5.1 per cent (FY10-24). That may have been broadly appropriate given the spending responsibilities being devolved, but the division was not based on a careful technical assessment.
Another point is that the federal government did not reduce its own spending to reflect the devolution of roles. Federal expenditure rose from an average of 11.2 per cent of GDP to 13 per cent over the same period. With no reduction in federal spending, the loss in federal revenues from transfers (1.9 per cent of GDP) was roughly matched by the increase in federal primary deficits (1.7 per cent of GDP).
The report therefore emphasises the importance of better aligning spending responsibilities with financing arrangements, while expanding the overall revenue base.
TN: How can Pakistan address the duplication trap where both tiers spend on the same devolved subjects?
TH: The report identifies this as a key priority. Federal spending on constitutionally devolved subjects rose from 0.5 per cent to 0.7 per cent of GDP between FY08 and FY24.
The first step is to complete and implement the federal rightsizing exercise that is currently underway. This should identify and eliminate spending on functions that are constitutionally provincial. The report suggests that this type of review should take place before considering changes to vertical resource-sharing arrangements.
In some cases, notably including the BISP system, there may be specific provincial mandates where the national delivery of public goods requires some federal involvement. Federal delivery in such cases could be financed through function-specific deductions from the divisible pool.
TN: Why is it preferable to give population a smaller role in resource allocation, and will fiscal equalisation mean lower-capacity provinces get more?
TH: Population alone is a crude measure of spending need. A province with a younger population, higher poverty rates, or more dispersed settlements costs more to serve per capita than one that is wealthier and more urbanised. The current formula does partially account for this through the poverty and backwardness component, but at only 10.3 per cent of the total weight these factors are not driving allocations.
The report recommends a fiscal gap approach as an alternative. Under this approach, a technical assessment is conducted to identify what it actually costs a province to deliver a standard level of services, and what it can raise from its own revenue sources. Transfers would then be quantified to help close that gap.
Provinces with lower revenue capacity and higher expenditure needs would tend to receive larger transfers under this approach. Australia, Canada, China, Nigeria, and South Africa all use variations of this approach.
TN: How can Pakistan ensure a new formula does not discourage provinces from improving their own revenue collection? Why have provinces struggled to raise own-source revenues despite having greater tax powers after the 18th Amendment?
TH: The current formula does not incentivise revenue effort. Revenue generation has a 5.0 per cent weight in the horizontal distribution formula, but it is not linked to performance on major provincial revenue handles.
The fiscal gap approach would encourage improved revenue by using revenue capacity (what a province could realistically collect) rather than actual collections. Provinces collecting below estimated capacity would have a larger fiscal gap to fill.
A fiscal gap approach could be combined with a conditional transfer system that explicitly rewards revenue collection improvement. Several countries use performance-based transfer top-ups for exactly this purpose.
The report identifies several factors explaining why own-source revenues have underperformed. Tax authority is fragmented across five jurisdictions, raising complexity and compliance costs. The two largest untapped bases — agricultural income and urban property — face significant political resistance. Also, because provinces receive around 90 percent of their total revenue as transfers, they arguably have a weak incentive to strengthen performance.
Having said this, provincial own-source revenue has grown from 0.3 per cent of GDP in FY09 to around 0.7 per cent in FY24. This is faster than federal revenue growth, but still well short of the 1.15 per cent of GDP target set in the 7th NFC Award.
TN: Will the World Bank recommend revising the NFC Award immediately, or should reforms be introduced gradually?
TH: The report presents a menu of options, not a sequenced prescription. However, the 11th NFC is a significant opportunity. The current Award is 15 years old, and several structural problems have compounded over that period. Some reforms could happen immediately regardless of the NFC. The federal rightsizing exercise, GST harmonisation work, and improvements to provincial PFM systems do not require a new award. Others may require more time for dialogue, consultation, and technical background work.
TN: What specific problems does the current fragmented GST system create for businesses and revenue collection?
TH: Pakistan’s GST is split between goods (collected by FBR at the federal level) and services (collected by four separate provincial revenue authorities), each applying different rates, definitions, and rules. For businesses operating across provinces or selling both goods and services, this means multiple registrations, multiple returns, and compliance with multiple different regulatory frameworks. This increases business compliance costs, deterring investment, and discouraging the payment of taxes.
The fragmentation also creates arbitrage opportunities. Where definitions differ across jurisdictions, transactions can be structured to minimize liability. Where enforcement differs, avoidance is easier. The result is that Pakistan’s GST base is narrower and less productive than it should be. Total provincial own-source tax revenue is only around 0.7% of GDP despite provinces having had GST on services authority since 2010.
TN: Should provinces receive fewer federal transfers if they fail to improve their own revenue collection?
TH: The report does not recommend punitive reductions in transfers. Cutting transfers to provinces with weaker revenue performance would most directly hurt service delivery for citizens who are already underserved.
Instead, the report recommends a fiscal equalization approach potentially with performance-based top-up transfers conditional on meeting agreed revenue targets or implementing specific tax reforms.
Agricultural income tax and property tax might represent opportunities for performance-based incentives. These are the two largest untapped bases. Agriculture accounts for over 20 per cent of GDP and agricultural income tax is largely uncollected. Urban property tax generates only 0.13 per cent of GDP against a developing-country norm of 0.3-0.6 per cent. The potential is substantial but stronger incentives seem necessary.
TN: How can Pakistan create incentives for provinces to expand their tax base without compromising provincial autonomy?
TH: The most direct mechanism is reforming the horizontal distribution system so that revenue effort is rewarded.
Performance-based conditional transfers linked to agreed revenue milestones could provide a financial incentive without requiring provinces to surrender control over their tax systems.
On GST harmonization, a unified filing system with revenue shared on the back end preserves provincial ownership of the tax while dramatically reducing the compliance burden that currently suppresses the base.
The report is explicit that provincial fiscal autonomy is a feature of the system. The goal is to reach consensus and align the incentives while respecting that autonomy.
TN: How much of Pakistan’s fiscal challenge can realistically be addressed through NFC reforms alone?
TH: NFC reforms are necessary but not sufficient. The report is clear on this. Pakistan’s average fiscal deficit was 6.2 per cent of GDP between FY10 and FY25, up from 3.2 per cent in FY02-09. The structural causes include the vertical financing-function mismatch but also interest payments that have risen to around 8.0 per cent of GDP by FY24, energy sector liabilities, and weak revenue collection at both levels.
Better fiscal federalism arrangements can address the structural mismatch, improve revenue incentives, and redirect spending toward human capital. These are significant contributions.
Separate reforms would be required in parallel to address FBR underperformance, resolve the energy sector’s circular debt, improve the quality of public spending, and — most importantly — create an environment that drives higher investment and economic growth.
TN: Would reforming fiscal federalism reduce Pakistan’s reliance on borrowing over the medium term?
TH: Better alignment between federal functions and spending could be expected to reduce the deficit, leading to lower debt over time.
Perhaps more importantly, better-designed fiscal federalism arrangements could also support improved education and health outcomes, helping raise productivity and growth. Faster growth means higher revenues and greater space for sustainable borrowing. Pakistan has grown at roughly half the pace of structural comparators over recent decades. Closing that gap is the most powerful fiscal consolidation tool available.
The report does not quantify the borrowing reduction from NFC reforms specifically. However, without addressing fiscal federalism weaknesses, it will be difficult for the country to have stronger growth outcomes, meet basic human development needs, and deliver for its rapidly growing population. Broader reforms to macroeconomic management, business regulation, privatisation, and in the energy sector are also required.
