- On BISP, the World Bank is seeking cost sharing from all provinces.
- Expenditure tasks remain incompletely implemented: WB.
- WB proposes to adopt a horizontal distribution solution for equalization.
ISLAMABAD: The World Bank (WB) has asked Pakistan to revise the Formula for National Finance Commission (NFC) Award, both vertically and horizontally, and adopt fiscal “equalization” for resource allocation among provinces based on expenditure needs and expected revenue capacity.
The WB also supported the exclusion of the population from the main criteria for resource allocation and suggested fiscal equalization as the way forward.
This was mentioned by World Bank Chief Economist and report author Tobias Haque while launching the report titled “Strengthening Fiscal Federalism in Pakistan,” along with Country Director Bolormaa Amgaabazar at the WB office on Wednesday.
The bank singled out the fragmented general sales tax (GST) on goods and services as a major challenge and proposed a unified collection mechanism where the amount collected would then be distributed among the provinces – although this would require legislative changes.
The WB also noted that out of Rs1.035 billion in grants granted by provinces to the Center under Article 164, Punjab returned grants of Rs546 billion and Sindh Rs260 billion. The PTI-led KP and Balochistan governments did not commit any amount to the Center in their provincial budgets for 2026-27.
On the Benazir Income Support Program (BISP), the WB asked for the continuation of the national registry at the federal level, but with cost sharing from all provinces, as social protection falls under the domain of the federating units.
Reproten 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 spending was not adjusted accordingly. The loss in federal transfer receipts (1.9% of GDP) roughly matched the increase in federal primary deficits after devolution (1.7% of GDP).
In the context of weak overall revenue and macroeconomic performance, the mismatch between federal funding and functional needs has been a major contributor to Pakistan’s fiscal deficit and to the accumulation of public debt.”
The WB country director said it was somewhat disappointing that fiscal federalism had not delivered benefits to people at the grassroots level. She noted that the report provides a set of options for policy makers, drawing on the experiences of other developing and developed economies.
On the issue of the Centre’s inability to raise tax-to-GDP from 10% to 15%, the WB’s chief economist replied that while the Center was lagging 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 spending allocations remain incompletely implemented and inadequately defined in some areas. The 18th Constitutional Amendment transferred responsibility for social services and economic functions to provinces.
However, the federal government continues to operate in constitutionally decentralized areas, causing waste and blurring of accountability, while local governments lack clearly defined or adequately resourced functional mandates. Second, the 18th Amendment led to the fragmentation of the tax system.
While it strengthened provincial tax authority, particularly over GST on services, it also divided the tax base between five competing jurisdictions. The resulting complexity imposes high compliance costs, discourages interprovincial trade and has limited overall revenue. Large potential tax bases – especially agricultural income and property – remain significantly underutilized.
Third, current federal-provincial transfer arrangements—including both the vertical share and the horizontal allocation formula—fail to achieve important policy goals.
The NFC-based transfer system provides predictability and protects provincial revenue shares. However, the financing has not followed function. The current framework reduced federal resources without a corresponding adjustment in spending responsibility, leading to a structural federal fiscal deficit.
The horizontal distribution formula also fails to achieve true fiscal equalization and provides no meaningful incentives for provincial revenue input or service provision. Current arrangements probably also discourage federal revenue efforts, with a large part of the revenue automatically transferred to the provinces.
Finally, despite constitutional recognition under Article 140A, local governments remain fiscally dependent, institutionally unstable and effectively subject to provincial discretion. Provincial Finance Commission (PFC) allocations are infrequent and non-binding, transfers are ad hoc and own resources are minimal. The decentralization planned in 2010 has not extended significantly below the provincial level.
In the context of weak overall revenue and macroeconomic performance, the mismatch between federal funding and functional needs has been a major contributor to Pakistan’s fiscal deficit and debt build-up. Second, fiscal federalism arrangements have contributed to continued weak earnings. Fragmentation of the tax base across five jurisdictions has misaligned incentives, increased compliance costs and created opportunities for avoidance.
Federal revenues continue to significantly underperform. Despite expanded provincial revenues, tax revenues from own sources have barely increased. Agricultural income tax remains largely uncollected, despite the sector accounting for more than 20% of GDP. City tax on real estate generates only 0.13% of GDP, well below the benchmark countries’ norms of 0.3% to 0.6%.
Third, schemes of fiscal federalism have had, at best, a limited impact on aligning public spending and service delivery with needs. Decentralization is theoretically expected to reduce accountability loops and better align spending with public needs. While the provinces have increased spending on basic services since the 18th Amendment, the biggest single increase has been in administrative spending.
About 80% of consolidated provincial spending 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 uneven, with district allocations driven by historical precedent rather than poverty levels or lack of services. Local governments have seen their share of total public spending fall from around 10% in 2005 to around 4.7% in 2024.
The WB recommends adopting a horizontal distribution solution that achieves equalization while generating positive fiscal incentives. A transparent approach to the fiscal gap – replacing the current complex multi-factor formula – will allocate divisible pool resources based on standardized assessments of spending needs versus own revenue capacities, eliminate obstacles to revenue efforts and avoid penalties on provinces for fiscal efficiency. Using need and capacity rather than actual spending or collection avoids penalizing provinces that perform well.
Unconditional transfers under this approach preserve the province’s fiscal autonomy. Several countries have adopted variations of this model, including Australia, Canada, China, Nigeria and South Africa.
This equalization framework could be supplemented by conditional transfers tied to measurable service delivery outcomes in devolved sectors such as education and health, with payments verified by an independent third party and supported by strengthened federal and provincial statistical systems.
Other national priorities – revenue collection, environmental benefits, governance and effective local government – could also be linked to conditional transfers. Without a complete overhaul, the existing formula can be improved by giving greater weight to poverty, backwardness and vice versa population density indicators to strengthen redistribution; reward provinces for closing the gaps between potential and actual own-source revenue collection, including underutilized property and agricultural taxes; and tying a proportion of divisible pool transfers to investment in critical public services, fiscal discipline and budget transparency, climate adaptation, disaster preparedness and further devolution to local government.
The WB recommends that the NFC may seek full reunification of the GST base under centralized administration, with constitutional revenue sharing provisions implemented through an agreed allocation formula.
In terms of income taxation, the NFC could promote the implementation of provincial agricultural income tax schemes that have recently been amended to align with the federal system, and establish automatic information exchange schemes where differences still exist to prevent evasion.
In the area of real estate, the NFC could support the harmonization of all real estate-related charges – taxes, duties, fees and charges – through a common valuation system and uniform methodology applied consistently across instruments.
Originally published in The News
