Provinces receive rising transfers while federation bears debt pressure, stabilisation costs
KARACHI:
For decades, the National Finance Commission (NFC) Award has been treated as a political taboo – too sensitive to touch, too convenient to exploit, and too dangerous to reform. Each government solemnly acknowledges its structural distortions, only to defer meaningful action in the name of “provincial harmony”. However, considering the swift delivery of the recent constitutional amendments with “unprecedented unanimity,” it seems that the stage is set for addressing the structural issues associated with the current award.
At its core, the NFC Award governs how national income is shared between the federation and the provinces. What began as a legitimate attempt to strengthen provincial autonomy following devolution has gradually evolved into a structural imbalance that weakens the federal state while failing to deliver commensurate improvements in provincial governance or public services. The result is a system where authority over spending is decentralised, responsibility for revenue mobilisation is diluted, and accountability is conspicuously absent.
The tension between the federation and the provinces over the NFC is often framed as a constitutional or political dispute. In reality, the most affected stakeholders, such as salaried individuals or documented businesses, sit far from negotiating tables, bearing the burden of this unresolved arrangement. As federal finances are squeezed after mandatory transfers, the response is predictable: higher taxes, reduced exemptions, and repeated policy shocks imposed on the same narrow tax base.
The hole in public finances is filled not by reforming the system, but by extracting more from those already within it. The scale of the problem becomes evident when current fiscal numbers are examined. In the ongoing fiscal year, the total divisible pool of federal taxes is estimated at roughly Rs9.6 trillion. Of this, approximately 57.5% – nearly Rs5.5 trillion – is transferred to the provinces, leaving the federation with around Rs4.1 trillion. This represents a sharp nominal increase from five years ago, when the pool stood near Rs4.7 trillion.
However, inflation during this period has been exceptionally high, eroding purchasing power across the economy. Even after adjusting for inflation, provincial fiscal space has expanded meaningfully, while the federal government’s ability to meet its obligations has steadily deteriorated. Provincial spending, meanwhile, has grown faster than inflation, driven largely by current expenditure rather than development outcomes.
Wage bills, administrative expansion and politically motivated schemes dominate provincial budgets. In contrast, the federation is left to finance debt servicing, defence, pensions, subsidies, and major infrastructure – all after making NFC transfers. Unsurprisingly, borrowing has become the default mechanism to bridge the gap, entrenching a cycle of debt that no amount of short-term fiscal tightening can resolve.
What makes this arrangement particularly unsustainable is the near absence of provincial revenue effort. Provinces retain constitutional authority over key tax bases such as agricultural income, property, services, and certain excises. Yet their contribution to overall tax collection remains modest.
Agriculture, a major component of the economy, remains undertaxed due to political sensitivities. Property taxation is outdated and poorly enforced. Services taxation varies widely in efficiency. The incentive structure is clear: guaranteed transfers reduce the urgency for politically difficult reforms at the provincial level.
The debate is further complicated by proposals to devolve additional federal responsibilities, including major social protection programmes such as BISP, to the provinces. While decentralisation can, in theory, improve service delivery, transferring large spending heads without parallel reforms in financing and oversight risks deepening fiscal fragmentation. If programmes such as income support schemes are shifted to provinces without performance benchmarks or sustainable funding models, the outcome is likely to be higher spending with limited improvement in outcomes.
Perhaps the most glaring weakness of the NFC framework is its failure to link transfers with results. For more than a decade, provinces have received trillions of rupees with little scrutiny over whether these funds have translated into better health, education, or human development indicators. Social outcomes remain uneven and, in some cases, disappointing. Yet the NFC operates largely as an entitlement-based mechanism, with no formal system to evaluate performance or penalise persistent inefficiency. Fiscal federalism, instead of fostering competition and innovation, has encouraged complacency.
This disconnect also complicates economic stabilisation efforts. The federal government commits to fiscal targets under stabilisation programmes, but lacks direct control over a large share of public spending. Provinces, meanwhile, face no binding obligation to align their fiscal behaviour with national objectives. The result is a coordination failure.
Reforming the NFC does not require dismantling provincial autonomy. It requires redefining it. A sustainable framework would preserve equitable transfers while embedding incentives for revenue mobilisation, expenditure efficiency, and measurable improvements in service delivery. The divisible pool formula must evolve from a purely distributive mechanism into a performance-aware system. Equally important, the federation must retain sufficient fiscal space to meet its core responsibilities without perpetual borrowing. The NFC has long been the elephant in the room. Whether it remains so will determine whether Pakistan’s fiscal crises continue to repeat themselves – or finally begin to recede.
The writer is a functional market enthusiast and is associated with Pakistan’s stocks, commodities and emerging technology
