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Conceptual Framework for Devolution and the 18th Amendment.

Pakistan needs a new development paradigm to deal with its many economic, social and political problems. The paradigm needs to be different from the one followed in recent years which plunged the country into a deep crisis despite several years of high growth. This manifested itself in various ways. The rate of economic progress slowed down and the incidence of poverty increased. Domestic terrorism grew to a point where Pakistan's ties with the rest of the world were negatively affected. This was particularly troubling since the latter depends on external capital and a decrease in its quantity has a deadening impact on the economy. The poor performance of the economy accompanied by palpably poor governance created an environment in which inter- regional, intra-provincial, inter-economic classes and sectarian conflicts have risen to the surface threatening the very integrity of the Pakistani state.

These have come with heavy economic, social and political costs that will further set back progress.

Pakistan faces multiple threats. Dealing with it must be a priority for those who hold the reigns of power. The new development paradigm must work to restore not only the confidence of the domestic players in the economy but also revive external interest in the country's economic future. An important part of the suggested paradigm is to reform the existing economic, social and political systems in order to bring the government closer to people. The award made by the 7th National Finance Commission (NFC), in late 2009, is a big step in this direction. The other is the passage of the 18th Amendment to the Constitution of Pakistan.

With the passage of the 18th Amendment, decentralised federalism seemingly has made a big leap forward. In March 2012, Pakistan became a formal member of the Global Forum of Federations. How the newest member performs, and to what extent its experiences contribute to the increasing knowledge base of political governance and development, remains to be seen. It is important to properly understand the underpinnings of the new devolution system and to clarify its conceptual basis. This would help guide both its implementation as well as the assessment of its effectiveness.

FEDERALISM

There is no single way to define the best model of federalism. Wherever there is a strong movement for democracy, there is usually an attempt to bring in a federal system. "There has been a mushrooming of federal systems. While Australia, Canada, Switzerland and the USA were the only functioning federal democracies in 1945, today some 25 to 30 countries, with 40 per cent of the world's population, are federal" 2 (Anderson, 2011).

Driven by political and economic imperatives, every federating country has a different model shaped through its own system of democracy, will of politicians and strength of institutions. Many countries have taken actions that they believe are in line with their devolved system only to find that these decisions need to be reversed. Many others have functioned well enough with a semi- or quasi- federal structure and a complex distribution of power and resources between the federating units. The ability to work with such models, and to evolve them over time, depends considerably on both the flexibility and power inherent within the system as well as the resilience of the larger system of democracy _ the latter being a necessary condition for governance.

Birch (1961) terms federalism as a political device "which is adopted to further ends which are always partly and sometimes predominantly economic. How far it succeeds in furthering these ends will depend partly on the nature of the constitutional arrangements, partly on the policies of the political leaders, and partly on the effectiveness with which those concerned with economic development take advantage of the opportunities presented to them."

Decentralisation can take various forms. The first is deconcentration, which is the transfer of responsibility to lower levels of governance. Deconcentration takes place within the same legal entity; has vertical and hierarchical relationships between higher and lower levels; and accountability is administrative so that directions flow from top to bottom in which the lower levels are answerable to higher levels. In delegation, separate legal entities are formed, relationships are vertical but not necessarily hierarchical, and accountability is through a contract - negotiation and agreement. In the process of devolution, accountability is the main differing point. It is vertically defined by law and horizontally to the constituency through a political process (Shivji, 1983).

Gregersen (2004) adopts four types of decentralisation, which include political, administrative, fiscal and market decentralisation. Political decentralisation refers to the groups at different levels of government (central, meso and local), which are empowered to take decisions related to what affects them. The notion of administrative decentralisation relates to administering resources and matters by various levels of governments that are delegated to them through a constitution. In terms of decentralisation as a process of change, and according to the level of transfer of responsibilities, it is useful to distinguish between deconcentration, delegation and devolution. In the case of fiscal decentralisation, previously concentrated powers to levy tax and generated revenues are dispersed to other levels of government, e.g., local governments are given the power to raise and retain financial resources to fulfill their responsibilities.

The concept of market decentralisation refers to a state of affairs where government privatises or deregulates private functions.

These distinct but linked types of decentralisation call for specific changes within the government systems, as illustrated in Chart 1.1.

Chart 1.1 Spectrum of the ideological underpinnings of decentralisation

Degree of systemic change required

Lower###Higher

Administrative###Fiscal###Political###Market

Program###Efficiency,###Holding failing states###Bypassing the

effectiveness,###responsivenes###together###state

breaking###s to local###Promoting ethnic

through###preferences###harmony

bureaucracy'###Enabling

###democratization

###Empowering the

###grassroots, civil

###society

Source: Fritzen and Lim 2006

The systemic changes identified in Chart 1.1 are both necessary for devolution to be effective, as well as those that may be a direct consequence of the devolution process. Perhaps one of the most significant points to be noted is the link between political devolution, democratic processes and institutions (including the role of civil society

FEDERALISM, DEVOLUTION AND HUMAN DEVELOPMENT

Conceptually, federalism and devolution should promote human development, which is explained as "expansion of people's" capabilities and their range of choices. As such, it focuses "on the ability to lead a long and healthy life, to acquire knowledge and to be able to enjoy a decent standard of living. These, in turn, depend upon access to basic services like education and health, expansion of income-earning opportunities, and greater participation in both economic and political processes, along with greater empowerment in terms of freedom of choice"(SPDC, 2007). Devolution contributes to human development through positive influence on "efficiency, equity, participation and impact on local economic activity" (SPDC, 2007).

The experience of federalism in the world has been mixed. In some developing countries, federalism and devolution have not promoted participation, responsiveness or accountability. "Critics argued that if anything, federalism had undermined these essential aspects of the transition. As Frances Hagopian (1996) argued in her study of Brazil, regional politics in some areas remained traditional, with a narrow concentration of political power, restricted access to decision-making, hierarchical channels of political representation, and limited political competition.

Research shows that the nature of steps taken to introduce federalism, and the relative success achieved depends on the history as well as the manner in which federalism was structured in countries such as Brazil, Argentina, Russia rather than the notion of federalism itself. In these countries, central governments devolved responsibilities but sub- national units were not given authority to raise revenue, and the regions remained dependant on transfers rather than their taxes. Thus, many sub-national governments have unfunded mandates. "Problem federations tended to be the ones where most were shared between levels of government, via non-transparent or 'pork-barrel' style formulas. Lack of firm criteria for allocating federal funds made it especially difficult to plan regional services (Bahry, 2003)". Overdependence on the centre often undermines the horizontal accountability to civil society and the constituency, thus reducing chances of planning for the benefit of local people.

According to a report of the World Democracy Movement (WMD, 2000), a federal structure is "financially expensive, with structures at each tier of government that must be financed, institutionally complex and may demand greater administrative bureaucratic capacity at each level than is available at any point in time and demands a relatively high level of cooperation and active intergovernmental relations." Recommendations of the report for making a federal system are summarised in Box 1.2.

It follows, therefore, that the manner in which the devolution process will be implemented and practiced, alongwith the nature of democracy and democratic institutions, will determine the extent to which Pakistan will benefit from the promise of provincial autonomy stated in the 18th Amendment.

Box 1.2 Recommendations for a Successful Federal System

Each level of government should be autonomous "in a democratic context to enable local people to set priorities and use resources to achieve them.

Federal systems must extract greater resources for effective financing of the structures of governance at each level of autonomy.

Greater capacity at each institutional level of government must be developed to enhance efficiency in the delivery of services to the people; this enhances goodgovernance.

To make a federal government more responsive to the people, a network of intergovernmental relations should be established. These can be formal and/orinformal, constitutional and/or statutory, and/or ad hoc. A network of intergovernmental institutions helps in coordinating the activities and policies of the various levels of government and facilitates greater cooperation among the tiers.

The pattern of fiscal federalism should take into consideration the functions of each level of government and its corresponding tax powers. The demands of fiscal equalisation, to give all units of the federation a sense of participation, cannot be overemphasised.

In the context of a changing global situation and demands for greater autonomy of federative units, there should be a shift from federal control functions to federal interventionist functions. A federal government should seek to intervene to correct inadequacies at the sub-national levels, rather than seek to control them.

Democratic institutional arrangements and processes are important to strengthening federations and enhancing good governance.

Source: "Improving Governance through Federalism: Decentralisation, Devolution, and other Approaches",

Report of the Second Assembly, World Movement for Democracy, November 12-15, 2000

DRIVERS OF FEDERALISM AND DEVOLUTION IN PAKISTAN

The 1973 Constitution of Pakistan declares:

The country shall be such wherein the principles of democracy, freedom, equality, tolerance and social justice, as enunciated by Islam, shall be fully observed; a Federation wherein the units will be autonomous; Therein shall be guaranteed fundamental rights, including equality of status, of opportunity and before law, social, economic and political justice, and freedom of thought, expression, belief, faith, worship and association, subject to law and public morality; Wherein adequate provision shall be made to safeguard the legitimate interests of minorities and backward and depressed classes; that Pakistan would be a democratic State based on Islamic principles of social justice; Dedicated to the preservation of democracy achieved by the unremitting struggle of the people against oppression and tyranny; Inspired by the resolve to protect our national and political unity and solidarity by creating an egalitarian society through a new order (Constitution of Pakistan, 1973).

The Directives of Policy stated that provinces have an equitable share in the federation.

Notwithstanding constitutional principles, Pakistan has largely been governed by alternating military and civil rule, the latter more or less through a centralised bureaucracy. The failure of the government to accord autonomy to federating units resulted in the secession of East 7

Pakistan in 1971 and subsequent years have been tumultuous _ marked by army coups and short-term civilian governments. The year 2010, on the other hand, is a landmark in that a major amendment to the constitution called for the redistribution of legislative powers, transfer of several items from the concurrent to the provincial list, and the reconstitution of the Council of Common Interests to debate issues relevant to the country as a whole. The 18th Amendment, in its design and proposed intent, claims to be aligned to the true spirit of federalism as defined in the directives of policy and the 1973 constitution by devolving power to provincial governments.

However, Pakistan remains a country mired in poverty. It has some of the lowest social indicators, especially in education and health, in the world, and is racked by political polarization, economic backwardness and societal insecurity. Despite claiming economic growth during 2002- 2007, the promised benefits of development have still not reached the majority of the population. The fledgling democratic government is weak, the country has been fighting a war against extremists, both foreign and home grown, and has incurred billions of dollars in cumulated losses since the beginning of the so-called "war on terror".

Moreover, the failure of highly centralist policymaking, disconnect between the state and people, and the state fragility are some of the more pressing drivers that should enable federalism in Pakistan to be practiced more effectively. International experience shows that countries that have continued governing on the basis of a federal structure have done so on the basis of strong democratic principles.

While there are no set tools to determine the effectiveness of any particular federal model, there are certain parameters that may be measured to assess the relative impacts. In its Annual Review of Social Development (2007), SPDC looked at some of the impacts of the local governance system introduced in 2001 by the military government. A presidential ordinance certainly did not meet any criteria of democracy. It also bypassed the provincial governments to put into place an elaborate system of local government bodies.

PROPOSED PRINCIPLES OF DEVOLUTION FOR PAKISTAN

The 18th Amendment, which has paved the way for maximal provincial autonomy, was formally approved as a constitutional obligation in April 2010. Consequently, the implementation process has devolved ministries and institutions from the centre, set up new structures at provincial levels and put into place fora for debate and discussion. The impacts of the process can only be measured after a few more years have passed, but it is important to examine the manner in which devolution is taking place and how relevant authorities, at both central and provincial levels, are responding to their changed responsibilities.

We propose a set of principles that may be used to guide which functions of the devolved sectors should be devolved and which should be retained or taken at the central level. The Constitution of Pakistan allows for national functions to be performed at the centre, and also underscores decentralisation and devolution to where development affects the lives of people the most. Only then the real spirit of the 18th Amendment, which we believe is to ensure quality services to the citizens of Pakistan and to improve the state of human development in the country, may be realised.

The conceptual framework linking decentralisation and human development is presented in Chart 1.3. It shows how administrative, political and fiscal decentralisation would lead to macroeconomic stability, efficiency, empowerment and equity. According to this framework, macroeconomic stability would promote economic growth; efficiency would further enhance local service provision and the degree of economic development; equity would reduce urban/rural gaps and regional disparities; and empowerment would enable the people to raise their voice, be heard and make choices. These combined would produce improvement in human development.

Some keys principles emanating from the above framework are as follows:

Common Markets: Allocation of expenditures and fiscal powers should not disrupt the operation and functioning of national common markets.

Macroeconomic stabilisation: Allocation of expenditure responsibilities should be consistent with allocation of revenue assignment. Sub-national governments should have the resources to fulfill fundamental responsibilities and be allowed to access capital markets to expand their resources envelopes. However, as central government is generally the "guarantor and provider of last resort", fiscal prudence requires agreement on limits to borrowing and some regulation through promulgation of fiscal rules by both the federation and the federating units.

Promotion of growth through uninterrupted investments on key sectors: There is need for sectoral policies in key areas including social and economic infrastructure. In these areas, not only should public investment continue uninterrupted, but there should be planning in which the provinces and the federal government play their respective roles.

The incentive environment: Another factor which will determine the impact on growth is the extent to which decentralisation will influence the level of fiscal effort in terms of impacting the national tax-to-GDP ratio and thereby generate more resources for development. The financing arrangements for devolved functions should, to the extent possible, also be devolved. For example, some slackening in resource mobilisation from own sources has been witnessed following receipts of larger intergovernmental revenue sharing transfers in Pakistan.

Subsidiarity: The efficient provision of government services requires that government satisfy the needs and preferences of tax payers as well as possible. This is best achieved through the subsidiarity principle. The principle of subsidiarity allows for decisions to be taken at a level closest to where the impacts of the decisions take place.

Box 1.3 Conceptual Basis of Expenditure Assignment

Expenditure###Policy,###Provision###Comments

Category###Standards###Administration

###and Oversight

Defense###F###F###Benefits and costs are national in scope

Foreign Affairs###F###F###Benefits and costs are national in scope

International Trade###F###F###Benefits and costs are national in scope

Monetary policy,###F###F###Benefits and costs are national in scope

Currency, Banking

Interstate Commerce###F###F###Benefits and costs are national in scope

Transfer Payments###F###F###Redistribution

to Persons###

Subsidies to Business###F###F###Regional development, industrial policy

and Industry###

Immigration###F###F###Benefits and costs are national in scope

Unemployment Insurance###F###F###Benefits and costs are national in scope

Airlines and Railways###F###F###Benefits and costs are national in scope

Fiscal Policy###F,S###F,S,L###Coordination is possible

Regulation###F###F,S,L###Internal common market

Natural Resources###F###F,S,L###Promotes a common market

Environment###F,S,L###S,L###Benefits and costs may be national,

regional, or local in scope

Industry and Agriculture###F,S,L###S,L###Significant inter-jurisdictional spillovers

Education###F,S,L###S,L###Transfers in kind

Health###F,S,L###S,L###Transfers in kind

Social Welfare###F,S,L###S,L###Transfers in kind

Police###S,L###S,L###Primarily local benefits

Water, Sewerage, Refuse###L###L###Primarily local benefits

Fire Protection###L###L###Primarily local benefits###

Parks and Recreation###F,S,L###F,S,L###Primarily local responsibility, but national

###and provincial governments may

###establish own parks.

Highways

Interstate###F###S,L###Internal common market

Provincial###S###S,L###Provincial benefits and costs

Interregional###S###S,L###Interregional benefits and costs

Local###L###L###Local benefits and costs

Spending Power###F,S###F,S###Fiscal transfers to advance own

objectives

Note : F is federal responsibility, S is state or provincial responsibility, and L is local responsibility.

Source: Shah (1994)

National Public Goods: Linked closely to the principle of subsidiarity is the argument that leaving the supply of public services with wider benefits areas to smaller units of government is likely to result in inefficient underprovision of services. For example, when a tertiary hospital providing regional services is solely financed by a single municipality. Likewise delegation of decisions with interstate impacts (externalities) to the state may result in spillover effects. For example, leaving drug quality regulation to the provincial level with little monitoring.

Linking costs to benefits: Efficiency in the provision of public services is enhanced if consumption benefits are linked to costs of provision via fees, charges and /or taxes.

Income Equalisation: Expenditures undertaken by the government for equity or income equalisation reasons, such as social welfare, are generally thought to be the domain of the central government. The general argument is that regional governments would not be able to sustain independent programmes of these natures because they would attract the needy from other areas. While funding of these expenditures should be a central government responsibility, implementation can be left to state/local governments which may have informational and other comparative advantages.

Equity among federating units and reduction of inequality and disparity: To the extent that mobility of households is limited, regional governments may effectively be able to carry out their own distributional policies. Each province differs from others socially, economically and in its resource base. These differences have been hugely compounded by negligent, inequitable, partisan and patronage-oriented development that has take place for the last 64 years. One of the core principles which should form the cornerstone of the devolution process is that actions ensure equitable division of benefits with preference to those that are less developed.

Minimum standard of service provision: To address disparities in interstate and intra-state service provisions, introducing policies that guarantee desired minimum standards is an important principle. National standards can be enforced in several ways such as incentivising provincial governments with matching grants programme or penalising underperforming governments through denying full receipt of grants. Programmes in which national standards may be required include social services like education, health, population welfare, water supply and sanitation. However, restrictions should be imposed carefully to protect provincial autonomy.

National unity and integrity: Where issues are related to the country as a whole and require a single, shared and common approach, it is best to consider placing these at a central level although the basic principles of a federation require even such a process to be consultative and participatory. National decisions need to be taken by consensus and all provinces need to be a part of the decision-making process.

Recognition and promotion of diversity and differences:

Pakistan's constitution places value on diversity and real democracy

can be strengthened only in a multicultural environment. The decision to devolve or not to devolve must recognise that the objective of unity should not be to create a homogenous, unidimensional population but to promote diverse views and opinions.

Cooperation between federating units: Federations are successful where shared resources and benefits are distributed through a cooperative and consultative process, and a policy of cooperation is adopted over competition and confrontation.

Resolution of issues through consensus and debate: Institutional fora should be made effective, as the mark of an effective and workable devolution process, where political resolutions that are widely debated are non-personalised and can be said to have general agreement. This would be the approach preferred over legal battles fought in courts.

Explicit inclusion in constitution: If a particular sector, function or institution is stated by the constitution to be devolved, it should be after consideration of what the devolution would mean in terms of discharging relevant duties and responsibilities, and what resources may be required.

The expenditure assignment based on the above conceptual basis is presented in Box 1.3.

The above provides a guideline and assessment tool if it were to be nested within an overarching framework of centre-province and province- province relations. Decisions related to what is devolved, with which responsibility, authority and resources, and whether and how the devolved functions would take into consideration the needs and aspirations of the people would all be checked against the filters of macroeconomic stability, efficiency, equity and empowerment. compulsions to retain control and power have raised serious questions on it. We suggest the establishment of a commission to determine the extent to which the goals of the 18th Amendment have been achieved and steps necessary to ensure full implementation.

IMPLICATIONS OF THE 7th NFC AWARD ON SUB- NATIONAL FINANCES

The financial state of provincial governments in Pakistan largely depends on intergovernmental revenue transfers which take place according to the provisions of the NFC awards. However, because of difficulty in building consensus between the federation and each federating units, there have been only three NFC Awards (1974, 1991 and 1997) while there was one Presidential Distribution Orders (2006) prior to the 7th NFC Award. Five NFCs were unable to reach a consensus; and therefore, there was no award.

Key Elements of the 7th NFC Award

The 7th NFC Award has brought some profound changes in the resource distribution formula in terms of changes in the divisible pool transfers, straight transfers and grants. Principally, the overall size of the divisible pool was enlarged, Khyber Pakhtunkhwa's role as a frontline province against the war on terror was recognised through earmarked additional transfers, provincial share in the divisible pool was increased, revenues from GST on services was accepted as a provincial tax and not a divisible tax, formula for gas development surcharge (GDS) computation was revised, rate of excise duty on gas was increased, arrears on the payment of hydel profits to Khyber Pakhtunkhwa and GDS to Balochistan was approved and a grant of Rs6 billion was given to Sindh though all discretionary grants-in-aid to all provinces was abolished.

The 7th NFC Award has resulted in an increase in the share of provinces in the divisible pool of taxes to 57.5 percent 2011-12 onwards and expanded the distribution criteria for divisible pool to provinces. The criteria now includes: population (82 percent), poverty and backwardness (10.3 percent); revenue collection/generation (five percent) and inverse population density (2.7 percent).

Financial Implications of the 7th NFC Award

Federal transfers to provinces increased by over Rs160 billion in 2010- 11, Rs230 billion in 2011-12 and Rs285 billion 2012-13 due to the changes in the design of divisible pool transfers. In percentage terms, transfers to provincial government are higher by 23 to 28 percent as a result of changes made in distribution formula in the 7th NFC Award. This increase in transfers reduces revenues of the federal government from the divisible pool by about one-fifths.

The Award has, expectantly, had a differential impact on the four provinces benefiting disproportionately the smaller provinces. In 2010-11, percentage gains in transfers to Balochistan, Khyber Pakhtunkhwa, Sindh and Punjab are more than 100 percent, 50 percent, 20 percent and 15 percent respectively. Thus the 7th NFC is fiscal equalising and the objective to ensure horizontal equalisation through non-discretionary, transparent mechanisms appears to be successful.

Transfer of GST on services to the provinces, changes in the GDS distribution formula and excise duty has increased straight transfers to the provinces by 63-72 percent over the last two years. The 7th NFC through discontinuation of grants has led to a reduction in grants to provinces while payment of arrears on gas and electricity and grant to Sindh leads to an increase, with a net reduction of 16-26 percent under this head. Altogether, the impact of the provisions of the 7th NFC Award results in an additional 26-28 percent revenue transfer to the provinces compared to the previous intergovernmental revenue transfer arrangements. The largest beneficiary, with an increase of more than 60 percent throughout the tenure of the NFC Award, is Balochistan followed by Khyber Pakhtunkhwa. The relative picture substantiates the point made earlier that the 7th NFC Award will be fiscally equalising as its provisions disproportionately benefit the relatively backward provinces more.

Local Government Finances After the 7th NFC Award

Prior to the 7th NFC Award, one-sixth of GST on revenues in the provincial divisible pool was earmarked for local governments as a compensation for the abolition of octroi and zila tax (OZT). This amount was distributed on audited collection share of OZT. The 7th NFC Award abolished the separate basis of distribution of one-sixth of GST goods and merged it with other divisible pool taxes to be shared on the basis of multiple criteria discussed earlier. As a result, earmarking of revenues for the local governments has ceased and the transfer is now at the discretion of the provincial governments.

Significant variations in the pattern of growth of intergovernmental fiscal transfer from provincial to local governments across provinces is witnessed in the pre- and post- 7th NFC award period. In Balochistan, no transfer from provincial governments to local governments is reflected in budget documents 2011-12 onwards. Sindh also shows a significant decline. In contrast, in Punjab and Khyber Pakhtunkhwa the transfers exhibit a growth in the last two fiscal years.

There has been growing concern about the financial viability of large cities in face of the pressures of rapid urbanisation. This is also an emerging issue in Pakistan although it is yet to hit the headlines. The basic problems are, first, that financing needs per capita are higher than those of small cities and, second, that the incremental costs of absorbing additional population rise rapidly, especially of water supply (due to procurement from more and more distant sources) and urban road network (due to the spatial expansion of metropolitan areas). Potentially, the tax base should also be larger due to greater economic activity, but this is not adequately exploited either due to limited fiscal powers (usually the same for small and large cities) or because of underdevelopment of the tax machinery and high levels of tax evasion (especially due the sizeable informal economy in large cities). Therefore, there is a tendency for the financing gap to rise on a per capita basis as cities expand.

The solutions have to be both of immediate short term and medium term in character. In the short term, the focus has to be on solution of the liquidity problems of water supply and sanitation agencies. In the medium term, local revenue sources will have to be better exploited and possibly more fiscal powers given to the municipal governments of large cities. In most cities, user chargers are linked mostly (except for metered bulk consumers) to the Gross Annual Rental Values (GARVs), assessed for the purpose of levy and collection of the Urban Immoveable Property Tax (UIPT) which are only a fraction (one-fifth to one-fourth) of current market rental values. Consequently, the user charge collection is low in the presence of high inflation.

Clearly, the time has come for the UIPT to be transferred to large city governments, which are big enough to have their own specialised tax machinery. In the interim period, water and sewerage charges should be enhanced on an ad hoc basis by up to 150 percent to cover the financing gap and stronger measures adopted to enforce payment of bills, while keeping affordability considerations in mind with regard to the poorer segments of the population. Over time special measures, in the form of additional fiscal powers, may have to be granted to metropolitan governments. This could include 'piggy backing' on the federal income tax and a small surcharge on the provincial sales tax on services.

RESOURCE MOBILISATION BY PROVINCIAL GOVERNMENTS

It is important that the provincial governments maximise their revenue collection and finance, partly, the additional expenditure liabilities created by the devolution process. Besides explicit tax assignments, tax bases not explicitly assigned to the federal government fall under the provincial fiscal domain, according to the provisions of the constitution. As such, some important taxes are under provincial fiscal powers including GST on services, agricultural income tax and taxation on immovable property.

The Sales Tax on Services

Prior to the 7th NFC award and the 18th Amendment, the FBR collected

GST on services under two regimes: one as provincial sales tax on behalf of provinces which was reverted back to the province of origin and GST on services (under the Central Excise Mode) which is basically taxation on services but was part of the divisible pool. This arrangement adversely affected the provincial revenues because the FBR had little incentive to maximise collection under the first regime and a share of revenues collected under the second regime was retained by the federal government. Estimates show that the latter, over the ten-year period cumulatively, has effectively cost a revenue loss to the provinces of as much as Rs155 billion.

In the post-NFC period, a comparison of budgeted with revised figures show that the FBR, which continues to collect GST on services(in CE mode, now referred to as GST on telecommunications) has not been able to achieve the revenue target. There has been a shortfall of 26 percent. As opposed to this in Sindh, where revenues were collected by the newly established Sindh Revenue Board(SRB), the revenue target was achieved. Also, while the FBR has budgeted an increase of 10 percent in 2012-13, Sindh budgetary target shows a growth of 28 percent. Interestingly, Sindh has targeted an increase in both GST in telecommunications and other services.

As to whether the growth in Sindh's revenue collection is an outcome of improvement in tax efficiency or broadening in base, available details support the hypothesis that growth was more due to improvement in tax administration. Moreover, the SRB also shows some revenue heads, which are not mentioned in the FBR yearbook like services provided by medical diagnostic laboratories, pathological laboratories, and property developers and promoters. This may be an indication of broadening in tax base of GST services.

Based on the success of provincial sales tax collection, the outlook for GST in Pakistan levied in an integrated VAT mode, as aspired by the federal government, does not appear realistic and politically feasible.

Development of Agricultural Income Tax

Total tax collection in the four provinces combined aggregated to about Rs1 billion only in 2011-12, with over 70 percent of the revenue being generated in the province of Punjab. This level of collection is an insignificant proportion of the national value added by the agricultural sector. Therefore, the sector is effectively exempt from income taxation. Lack of proper implementation, in particular, problems in the derivation of net taxable income, is the principal cause of this under exploitation.

The report while developing a case for the effective levy of AIT, presents mechanisms of enhancing revenues. Application of the simple progressive fixed tax regime is suggested which will not only greatly simplify the tax system but will also reduce the possibilities of tax evasion. The fixed rates also need to be enhanced in order to make the tax burden more significant. The estimated revenue yield from the reformed AIT is Rs35 billion for the four provinces combined, with 80 percent collection efficiency. This will increase provincial own-tax revenues by almost 50 percent while almost 95 percent of the farmers will continue to remain exempt.

Development of Taxes on Real Estate

There is evidence of multiple taxation on property transactions including stamp duty, capital value tax and tax on transfer of property. Consequently, the combined tax rate is high and encourages under- declaration of property values. The desired reform in this area of taxation of real estate is to rationalise the tax rates, eliminate the tax on transfer of property and update the valuation lists of District Collectors.

In the case of urban immovable property tax, the assessed rental values are only a minor fraction of the current market rental values. Reforms of the property tax will include: decentralisation of levy and collection of the tax to at least the large municipal metropolitan governments, extension of rating areas, survey of properties to update rental values and rationalisation of exemptions and concessions. Given the multiplicity already of taxes on real estate, the introduction of CGT by the federal government appears to be an ill-advised move.

Provincial Borrowing Powers

Given the low level of outstanding provincial debt, there is perhaps a case for enhancing the access of provincial governments to the capital market. Besides enlarging the provincial resource envelope, this will expose such governments to market discipline, greater reporting requirements and fiscal transparency. Further, this will ensure that since infrastructure investments also benefit future generations, they should also bear some of the cost. However, it is important to ensure sustainability of sub- national debt if problems of financial insolvency are to be avoided in the medium to long run, leading to a situation where the federal government has to engage in bail out operations as 'lender of the last resort' Also, excessive sub-national borrowing could jeopardise the adherence to the macroeconomic and fiscal framework of the country.

The report while examining international experience, recommends fiscal rules, to be imposed by provincial assemblies through Provincial Fiscal Responsibility and Debt Limitation Acts. The National Economic Council may monitor the adherence to limits imposed by the provincial Fiscal Responsibility Acts. In the absence of such an act enacted by the provincial assembly of a particular province, the NEC may specify the limits and the conditions for borrowing by such a province.

To conclude, if provincial governments continue to make minimal attempts at tax reforms and present 'tax-free' budgets then it is unlikely that the tax-to-GDP ratio will rise significantly in coming years. Also, there will be a need to establish norms of fiscal responsibility through appropriated legislation which regulates provincial borrowing.

THE FUTURE OF LOCAL GOVERNMENTS

The 18th Amendment has accepted the long-standing demand for constitutional recognition to the third tier of government in Pakistan. Extracting lessons from international experience, the report presents principles for allocation of functions, local resource mobilisation, intergovernmental revenue transfers and financial management and accountability. It reviews the 2001 devolution plan and the status of proposed legislation.

Local Government Act (LGA)

Undertaking a detailed analysis of Punjab and Sindh Local Government

Acts (LGAs) with respect to allocation of functions, structure of local government, allocation of fiscal powers, borrowing powers and financial accountability, the report concludes that overall, the proposed LGA of Punjab represents a retreat from the wide ranging functions transferred to local governments in 2001. However, revenue sources have been consolidated and some additional fiscal powers given along with strengthening of financial controls. It is imperative that the new law be legislated quickly by the provincial assembly so that local elections are held soon, as per the directive of the supreme court.

Deliberations have been ongoing between the PPP and MQM over the former's proposed Sindh Local Government Act 2009 draft in order to find a middle ground, which is more or less replica of Sindh LGO 1979. As in the case of Punjab, the report looks at the allocation of functions, structure of local government, allocation of fiscal powers, provincial financial commission and fiscal transfers and accountability. The overall conclusion is that the hiatus in local governments must be resolved urgently. The grass-roots participation of citizens and the provision of basic services at the doorstep to the people are one of the fundamental pillars of democracy. The constitution clearly recognises local governments as a provincial subject. Therefore, it is to be expected that different provinces will enact different LGAs within their respective jurisdictions, in line especially with the prevailing political economy and ground realities.

But it is important that the broad principles for good local governance, as identified in the report, be adhered to in the laws that must be enacted soon, to be followed by early elections.

INITIAL IMPACT OF NFC AWARD ON SOCIAL DEVELOPMENT

It was expected that the increase in provincial fiscal space following the 7th NFC award will largely be diverted to social sector expenditures. However, the expenditures show a growth of 19 percent in 2010-11, compared to an increase of 38 percent in revenues. This increase in expenditures is largely due to current expenditure escalation in response to the salary increase announced by the federal government while development expenditures show a decline of five percent. Another, unexpected outcome is that the provincial governments preferred to generate budget surpluses rather than initiate projects to enhance the pace of social development in their respective provinces, perhaps due to limited institutional capability to design and implement a larger development portfolio, particularly in the smaller provinces.

Provincial Governments' Pro-Poor Expenditures

The Government of Pakistan, in the PRSP-II has identified seventeen budgetary heads as expenditure on pro-poor sectors. PRSP expenditures, as a percentage of GDP, substantially increases from 2.5 percent in 2000-01 to 4.7 percent in 2007-08. However, they declined to 4.3 percent of GDP in 2009-10. It was expected that these expenditures will increase after the 7th NFC Award. Indications are that these expenditures will close at the level of 3.92 percent of GDP in 2011-12. While, Balochistan shows an increase in PRSP expenditures in 2010-11, the remaining three provinces show a decline.

Focusing on social expenditures, provincial government expenditures on social sectors as a percentage of GDP show a similar pattern. Expenditures increase up to 2007-08, decline thereafter upto the post NFC period when there is some recovery. Except Khyber Pakhtunkhwa, there is an increase in social sector expenditures in the other three provinces'. Provincial governments' priority to social sectors (provincial government expenditures on social sectors as a percentage of total provincial expenditures), shows an upward trend. These expenditures increased from 31 percent in 2000-01 to over 38 percent by 2011-12. Therefore, the expectation that improvement in provincial financial position will lead to an improvement in social sector allocations appears to be materialising, though the gains are very limited yet.

Social Development Before and After the 7th NFC Award The report attempts to study the impact of the Award on social development. Initial outcomes are discussed in the report for eradication of the extreme poverty, undernutrition, education, child immunisation and health indicators. The overall conclusion is that while there is substantial progress during the period 2000-01 to 2007-08, a decline in growth momentum is witnessed thereafter. The post-NFC award period does show some improvement in most indicators, but provinces have a long way to meet their international commitments related to the MDGs.

Overall, the chapter concludes that the 7th NFC award provided the much-needed fiscal space to provincial governments. It was expected that this fiscal space would be used for the betterment of citizens, particularly of backward regions. However, in the first two years following the 7th NFC Award, we witness that this fiscal space was primarily used to either generate budget surpluses or increase in current expenditures. There was in fact a decline in development expenditures at provincial level. Given that most of the indicators of social development show a loss in growth momentum after 2007-08, it is essential that more of the revenue gains from the NFC award be channeled to the social sectors. Clearly, in the absence of such a concerted effort, Pakistan is unlikely to meet most of the targets of the MDGs by 2015.

EMERGING ISSUES FROM THE 18th AMENDEMENT

Given that the 18th Amendment entails profound changes in the structure of government, implementation is bound to be problematic. Creation of new stress points and tensions within the federation are likely to emerge. The report discusses a number of emerging issues which will need to be eventually resolved by consensus among the federating units, especially by discussions within the Council of Common Interests.

Electricity

The major change with regard to electricity in the 18th Amendment is the shifting of this subject from the now defunct Concurrent List to the Federal Legislative List Part II. The country today faces the highest levels of power load-shedding in its history. The major reasons for this crisis include non-utilisation of full capacity due to poor O and M, increase in oil prices and circular debt, depletion of gas reserves, accelerating system losses, seasonal variation in the availability of hydropower and growth in demand. Power shortage has resulted in severe disruptions to economic activity and large losses of income and employment. According to recent estimates, the total economic cost of load-shedding to industry, commerce, agriculture and domestic consumers combined exceeded Rs1 trillion in 2011-12 equivalent to more than five percent of the GDP. This has led to large-scale public protests.

The impact of load-shedding has affected the four provinces differently. Biggest decline in consumption is observed in distribution companies of Punjab and Balochistan. As opposed to this, consumption has increased by nine percent in KESC. Consequently, the problem of severe load-shedding and its regional distribution is imposing severe stresses on the federation. Since issues related to electricity are to be resolved by the CCI following the 18th amendment, a resolution has been passed in the last meeting of the Council that the burden of load-shedding be distributed equally throughout the country. What are the implications of following this strategy? Given that the distribution companies in Punjab appear to be more efficient in generating revenues due to substantially lower transmission losses and higher rates of recovery of billing, both equity and efficiency considerations are better met by distributing the burden of load-shedding more uniformly throughout the country.

Also, to incentivise provincial generation of energy a proviso should be added to Clause2 of Article 157 stating "a province may construct power houses and grid stations and lay transmission lines for use within the Province subject to the provision to the commitments and obligations as on the commencing day." The commencing day in this case will be the time when province start supplying to the national grid. This will confirm that the existing supply to the province from the national grid will not be reduced if the province generates additional electricity on its own and supply to the national grid.

Gas

1Constitution provisions with respect to gas imply that in periods of shortage, given the priorities of the government, the power and fertiliser sectors have been relatively deprived of gas and the interests of consumers in the domestic and transport (CNG) sectors have been largely preserved and the gas producing province (Sindh) has precedence over other parts of Pakistan in meeting the demand. Consequently, as the shortage has worsened, the regional distribution of gas consumption has altered. As such, the only option available for ensuring efficiency in the allocation of a scarce and valuable resource like gas is to let market forces act by deregulating the pricing of the gas sector.

Given the change in Article 172, the provincial governments may legitimately argue that they should also be involved in the granting of concessions for gas exploration. There may also be a case for establishment of companies at the provincial level like the Oil and Gas Development Company. Also, in recognition of the role of provincial governments in the regulation of the sector, especially in price setting, representation of each province may be ensured in the Board of the NEPRA.

EOBI and WWF

The abolition of the Concurrent List in the Constitution following the 18th

Amendment has resulted in the devolution of the labour and manpower to the provinces. There is, however, ambiguity if workers' welfare activities also are to be devolved. The EOBI has sizeable assets today of over Rs200 billion. The annual benefits paid are about Rs8 billion. Therefore, the annual accrual to the EOBI is almost Rs22 billion. As such, EOBI is a strong and financially viable entity.

As for WWF, the total revenues collected by FBR as contributions to the WWF were Rs5 billion in 2010-11. 25 percent of the revenues were from Islamabad, 17 percent from Punjab, 54 percent from Sindh and four percent from the two smaller provinces. The regional distribution of revenues clearly reflects the location of head offices of corporate entities in Pakistan.

The demand for provincialisation of EOBI and WWF has already been voiced in the CCI. In case of devolution, there would be the issue of collection and distribution of funds _ how should these be determined and the issue of division of financial and physical assets that belong to the WWF and EOBI among the provinces. Moreover, if workers with domicile of one province work in another province and after retirement go to their home province, the issue for EOBI then will be cross-border generation and distribution of pensions.

The potential solutions lie, first, in keeping EOBI as a federal institution and continuing with the operation of the EOBI act 1976 with the provision that the Board will have the representatives from each province. The case for this can be made on the ground that a large social security scheme enables greater pooling of risks and enhances the financial viability of the scheme. Second, WWF can effectively be decentralised because it is more in the nature of a development programme for workers. The formula for distribution among the provinces, like in the case of the Zakat Fund, may be based on population shares.

Higher Education Commission

Today, the HEC provides financing of public universities through recurring and development grants and regulates all universities. The total recurring budget in 2010-11 was almost Rs15 million while development budget was Rs9 billion. An initial attempt was made to devolve HEC functions after the passage of the 18th Amendment. However, on the petition by the HEC, the supreme court issued a stay order. The CCI has allowed an independent working and continued federal financing of the HEC till 2014.

Beyond 2014-15, it appears that, following the 8th NFC Award, financing of universities will be transferred to the provinces. Administrative control and senior appointments in public universities are already the responsibilities of the provincial governments.

The decentralisation of curriculum development and syllabus at the primary and secondary level has led to some concerns about problems about standardisation of quality and the implications of a common national identity among the younger generation from different parts of the country. This is an important issue and may be resolved by the CCI.

Drug Regulation

The drug regulatory function prior to the 18th Amendment was being performed by the Federal Ministry of Health as per the Drugs Act of 1976. The Supreme Court of Pakistan has since given a directive for the establishment of a Drug Regulatory Authority (DRA). According, an Ordinance was promulgated by the President of Pakistan in February 2012 for the formation of a centralised regulation body of the pharmaceutical industry, despite objections from the Punjab government, but with the consent of the other provinces. The agency will control pricing of drugs, quality assurance, import/export and the issuing of licences to drug manufacturers.

The centralisation of drug regulation is essential because the international experience is that the risk of a race to the bottom, whereby there is a tendency to slacken regulatory standards due to competition in attracting pharmaceutical companies.

Agricultural Policy

The Ministries of Food and Agriculture and Livestock and Dairy Development at the federal level have been abolished with the intent of transferring functions to the provinces. Ministry of National Food Security and Research has been established in Islamabad with diverse functions including stabilisation of farm income/consumer prices and provision of regulatory and assessment services. The issue which arises relates to the fixation of support/ procurement prices for different crops. Decentralisation could have a number of implications, like the provinces producing sizeable crop will have edge in making unreasonable profit ( if price fixing is left to them)and without national planning, any province can declare that it cannot produce much or beyond its own need causing a disorder in demand-supply equation and pushing the price up. The solution potentially lies in following the practice adopted in India.

The Commission for Agricultural Coast and Prices (CACS) recommends the support price for different crops following discussions with State governments and Central Ministries/Departments this function can be performed in Pakistan by the Agriculture Policy institute (originally named the Agricultural Prices Commission). The support/procurement price for a particular crop can then be decided in the CCI.

Environmental Protection

Following the abolition of the Concurrent List, Environmental Pollution and Ecology stands transferred to the provinces. A key emerging issue relates to setting and enforcement of the National Environmental Quality Standards (NEQs). Devolution of the Ministry of Environment (MoE) has been opposed by NGOs basically on the grounds of lack of capacity and readiness in the Provinces. It is necessary to maintain national-level institutions for: (a) effective policymaking and interprovincial coordination; (b) negotiation, oversight, monitoring and reporting implementation of international treaties and agreements; and (c) liaison with donors.

The solution appears to lie in retaining the functions of the federal Environmental Protection Council (EPC), which already provides for membership of the provincial chief ministers and ministers in charge of the subject of environment in the provinces. Post-18th Amendment there is need for an explicit statement on the delegation of powers and functions. The newly set-up federal Ministry of Climate Change should have minimum regulatory functions and enforcement of existing environmental laws should be the responsibility of provincial governments. However, the setting and monitoring of NEQS should continue to be performed by the federal EPC. This will require considerable strengthening of the provincial environment departments.

The emerging issues discussed in the report are already debated and discussed by different stakeholders. Solutions will need to be found which are consistent with the objective of greater decentralisation but are pragmatic in nature and focus on maximising the public good. The prime forum for discussion and consensus building will be the CCI. The strength of the federation in years to come will hinge on success fully implementing this initiative and achieving progress in the presence of strong vested interests which want to preserve the status quo.

To sum up, the analysis in this report leads to the conclusion that overall the 7th NFC Award has effectively led to fiscal decentralisation, the 18th Amendment has created the perception of a major enhancement in the autonomy of the provincial governments. The reality, however, has turned out to be somewhat different. Political considerations, legal impediments and the desire of the bureaucracy for centralised control have led to a significant roll back in the process of the implementation. Positive impact of devolution on social development will hinge on the commitment of both the federal and provincial governments to sustain the process and ensure implementation which provides the environment conducive to social development.
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Publication:Annual Review Social Development in Pakistan
Article Type:Essay
Geographic Code:9PAKI
Date:Dec 31, 2012
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