- In the case of the BISP, the World Bank seeks that all provinces share the costs.
- Spending allocations still not fully implemented: BM.
- The World Bank suggests adopting a horizontal distribution solution for equalization.
ISLAMABAD: The World Bank (WB) has asked Pakistan to review the National Finance Commission (NFC) grant formula, both vertically and horizontally, and adopt fiscal ‘equalization’ for distribution of resources among provinces based on expenditure needs and projected earning capacity.
The WB also supported excluding the population from the main criteria for the distribution of resources and suggested fiscal equalization as the way forward.
This was mentioned by World Bank Chief Economist and report author Tobias Haque while presenting the report titled “Strengthening Fiscal Federalism in Pakistan” along with Country Director Bolormaa Amgaabazar at the WB 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 amount collected then distributed among provinces, although this would require legislative changes.
The World Bank also noted that of the Rs 1,035 billion in grants committed by provinces to the Center under Article 164, Punjab revoked grants of Rs 546 billion and Sindh of Rs 260 billion. The PTI-led KP and Balochistan governments did not commit any amount to the Center in their provincial budgets for 2026-27.
Regarding the Benazir Income Support Program (BISP), the WB called for the continuation of the national registry at the federal level but with costs shared by all provinces, since social protection falls under the domain of the federated units.
The complaint said: “Fiscal federalism agreements have led to the emergence of a structural federal fiscal deficit.
Provincial revenues, including federal transfers, increased from less than 4% of GDP to an average of 6.5% between FY10 and FY24, but federal expenditures did not adjust proportionately. The loss of federal transfer revenue (1.9% of GDP) was roughly equivalent to the increase in federal primary deficits after devolution (1.7% of GDP).”
In the context of weak overall revenue and macroeconomic performance, the misalignment between federal financing and functional needs has contributed substantially to Pakistan’s fiscal deficit and the accumulation of public debt.”
The WB national director said it was somewhat disappointing that fiscal federalism had not benefited people at the grassroots level. He noted that the report offers a set of options for policymakers, drawing on the experience of other developed and developing economies.
On the issue of the Centre’s failure to increase the tax-to-GDP ratio from 10% to 15%, the WB’s chief economist responded that while the Center lagged behind 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 poorly defined in some areas. The 18th Constitutional Amendment delegated responsibility for social services and economic functions to the provinces.
However, the federal government continues to operate in constitutionally devolved areas, creating waste and blurring accountability, while local governments lack clearly defined or adequately resourced functional mandates. Second, the 18th Amendment caused the fragmentation of the tax system.
While it strengthened provincial tax authority, particularly over the GST on services, it also divided the tax base among five competing jurisdictions. The resulting complexity imposes high compliance costs, discourages interprovincial trade, and has limited aggregate revenue performance. Large potential tax bases (particularly agricultural income and property) remain significantly underutilized.
Third, current federal-provincial transfer agreements – including both the vertical sharing formula and the horizontal allocation formula – fail to achieve important policy objectives.
The NFC-based transfer system provides predictability and protects provincial revenue sharing. However, funding has not followed performance. The current framework reduced federal resources without a proportional adjustment in spending responsibilities, generating a structural federal fiscal deficit.
The horizontal distribution formula also fails to achieve true fiscal equalization and does not provide meaningful incentives for provincial revenue effort or service delivery performance. The current arrangements arguably also deter the federal revenue effort, as a large proportion of revenue is automatically transferred to the provinces.
Finally, despite constitutional recognition under Article 140A, local governments remain fiscally dependent, institutionally unstable and effectively subordinate to provincial discretion. Provincial Finance Commission (CFP) allocations are infrequent and non-binding, transfers are ad hoc, and own revenues are minimal. The devolution planned in 2010 has not been extended significantly below the provincial level.
In the context of weak overall revenue and macroeconomic performance, the misalignment between federal funding and functional needs has contributed substantially to Pakistan’s fiscal deficit and debt accumulation. Second, fiscal federalism arrangements have contributed to continued weak revenues. Fragmentation of the tax base across five jurisdictions has misaligned incentives, raised compliance costs, and created opportunities for evasion.
Federal revenues have continued to significantly underperform. Despite the expansion of provincial revenue allocations, own tax revenues have barely increased. Agricultural income tax remains largely uncollected, despite the sector accounting for more than 20% of GDP. The urban real estate tax generates only 0.13% of GDP, well below comparison countries’ norms of 0.3% to 0.6%.
Third, fiscal federalism arrangements have had, at best, limited impact on aligning public spending and service delivery with needs. In theory, devolution is 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 increase has been in administrative spending.
About 80% of consolidated provincial spending continues to be absorbed by recurrent costs, with most of the incremental spending going to general public services and administrative costs rather than education or health. Spending has also remained geographically inequitable, with allocations to districts driven by historical precedent rather than poverty levels or gaps in service delivery. 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 and at the same time generates positive tax incentives. A transparent fiscal gap approach, replacing the current complex multi-factor formula, would allocate divisible resources based on standardized assessments of spending needs versus own-source revenue capacity, eliminating disincentives to revenue effort and avoiding penalties on provinces for their fiscal efficiency. Using needs and capacity rather than actual spending or revenue avoids penalizing 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 equalization framework could be complemented by conditional transfers linked to measurable results in service delivery in transferred 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 be similarly linked to conditional transfers. In the absence of a complete reform, the existing formula could be improved by assigning greater weight to poverty, backwardness and inverse population density indicators to strengthen redistribution; reward provinces for closing gaps between potential and actual own revenue collection, including underutilized agricultural and property taxes; and link a portion of the pool’s divisible transfers to investments in critical public services, fiscal discipline and budget transparency, climate adaptation, disaster preparedness, and greater devolution to local governments.
The World Bank recommends that the NFC could seek full reunification of the GST base under centralized administration, with constitutional revenue-sharing provisions implemented through an agreed allocation formula.
On income taxes, the NFC could move forward with the implementation of newly modified provincial agricultural income tax regimes to align with the federal system, and establish automatic information-sharing agreements where differences persist to prevent evasion.
In the case of property, the NFC could support the harmonization of all levies related to real estate (taxes, duties, rates and charges) through a common valuation system and a uniform methodology applied consistently across all instruments.
Originally published in The News
