Final Policy Memo. From: Naveed Rajput. To: Professor Yinger. Subject: Fiscal
Decentralization in Sindh, Pakistan. Intergovernmental fiscal relations and fiscal ...
Final Policy Memo From: Naveed Rajput To: Professor Yinger Subject: Fiscal Decentralization in Sindh, Pakistan Intergovernmental fiscal relations and fiscal decentralization deal with how public expenditure is organized between these different levels of government and how it is financed. Fiscal decentralization thus constitutes the public finance dimension to decentralization in general, defining how and in what way expenditures and revenues are organized between and across different levels of government in the national polity. The precise nature of intergovernmental fiscal relations and fiscal decentralization policy in any given country varies depending on how sub-national government and administration is organized. 1 Fiscal decentralization, however, is not only a question of transferring resources to the different levels of local government. It is also about the extent to which local governments are empowered, about how much authority and control they exercise over the use and management of devolved financial resources, measured in terms of their control over (i) the provision of the basket of local services for which they are responsible; (ii) the level of local taxes and revenues (base, rates and collection); and (iii) the grant resources with which they finance the delivery of local public services. 2
Fiscal Decentralization in Pakistan is originated from the Devolution plan started in the year 2000 by the present regime. Devolution and Fiscal decentralization in the Pakistan context is defined as “Devolution is the gradual process of transferring power and resources from the central government to the lower levels of government, such as the provinces, districts and tehsils/towns. Decentralization in Pakistan follows the principle of subsidiary, whereby all functions that can be effectively performed at
the local level are transferred to that level. This has meant the decentralization to the districts and tehsils of many functions previously handled by the provincial governments. Alongside administrative and political decentralization, provisions have been made for transfer of funds to the local governments so they can carry out their planning and development functions effectively”.3 It is to be noted here that Decentralization essentially involved a transfer of provincial powers and functions to the district and lower levels of governments but interestingly, no decentralization of any federal powers to either the provincial or local levels. Intergovernmental fiscal relations also include expenditure assignments, revenue assignments, transfers, and sub national borrowing.
Institutional factors such as Political, social, legal, and economic conditions are important for the analysis of Fiscal Decentralization. The institutional context of Fiscal Decentralization entails the overall economic development, the nature of the legal system, the ongoing process of economic and political and judicial reforms, the organization of monetary and financial institutions, and tensions arising from economic differences among and between various tiers of government such as provinces, districts and towns. This institutional background determines the design of the intergovernmental financial system and ultimately affects the outcome of the fiscal decentralization reform process. The establishment of Provincial Finance Commission (PFC) on the lines of National Finance Commission (NFC) can be regarded as the first step towards intergovernmental financial system as well as fiscal decentralization in Pakistan. NFC is a federal body responsible for the yearly grant allocation to provinces on the basis of a formula based on population alone. This fact has brought lot of debates and criticism on the fairness of award over the years. Particularly province of Sindh is extremely unhappy and demands for its distribution on the basis of revenue collection also. As a matter of fact Sindh province has been generating about 70 % of the revenue for the federal
government. Where as the population of Sindh is merely 23 % of the total population of Pakistan. It is generally known that the provinces' own tax base is narrow and lack buoyancy. Government of Sindh's own taxes consist, mainly of Stamp duties, Motor vehicle tax, the Infrastructure. Development Cess (a rate or tax 4); the Agriculture Income Tax and land revenues, Registration fees, and other small taxes (see Appendix D). Irrigation charges and various administrative fees, fines and sale proceeds of government land provide the bulk of non-tax revenues. Other than limited resources, the Government of Sindh's finances remain constrained on account of inflexible expenditures where salaries, pension, and debt servicing account for around 70% of current expenditures. The lack of fiscal space has caused the under-funding of vital human development and infrastructure expenditures and weakened future growth and poverty reduction prospects. Since the discontinuation of Octroi and Zila (District) tax (OZT) on the directive of the Federal Government, the local councils (now Local Governments) predominantly rely on federal provincial transfers from the additional 2.5% General Sales Tax (GST) levied with the objective of off setting the loss of OZT. Octroi (0. Fr. octroyer, to grant, authorize; Lat. auctor) is a local tax collected on various articles brought into a district for consumption 5. The Town Administrations depend on the inherited property tax and the grant they get in lieu of the foregone Octroi revenue. The OZT together accounted for more than 70% revenues of local councils and these were abolished on the agreement that the federal government would compensate the local councils for their losses through the additional 2.5% GST.
The issue is that both Octroi and Zila Tax were highly buoyant levies, which grew at an average growth rate ranging from 11 to 15 percent for different local councils. Subsequent to discontinuation of OZT and related unpredictability and cut in 2.5% GST compensatory funds, the fiscal health of the bulk of Local Governments (LGs) deteriorated. While the fund flow declined the overall cost of expenditures kept on rising on account of pay increments, promotions, pay rises, increase in pension and other liabilities, and rise in cost of goods including electricity, gasoline etc. Of the 102 Town
Municipal Administrations (TMAs), only 40% were able to bear the cost of establishment and undertake some maintenance works. They were however unable to take on any development work and were also unable to meet the spiraling cost of electricity. The remaining 60% were in deficits and were unable to meet even the cost of their salary so much so that many TMAs were making payments on previous scales and had been unable to undertake any functions mandated to them.
Under the Interim-Award 2002 the shares of provincial and district governments were estimated on the basis of benchmark for recurrent expenditures. The provincial government was to retain 60% from the divisible pool, (consisting of federal tax assignment, straight transfers and provincial tax receipts) with 40% to be distributed among the district governments combined. The horizontal distribution amongst the District Governments was decided to be on the basis of population (50%), backwardness (17.5%, to be determined on the development Index prepared by Social Policy Development Centre SPDC), and tax collection (7.5%) with the reminder 25% earmarked for transitional transfer grants for bridging the gap between the expenditure of the district governments and transfer on the basis of the three criteria.
Implementation of the fiscal Award 2002 in last three years must be appraised in view of multiple constraints ranging from issues of fiscal constraints, problems of weak staffing at LGs and a wide range of issues relating to Accounting and Audit. There continues to be a huge mismatch between the functional responsibilities of district governments and the financial resources available to them, too much having been devolved in substantive terms in relation to their fiscal powers. On the one hand, they are excessively dependent upon provincial transfers and, on the other hand, they have a narrow tax base from which they are required to generate revenues for discharging their functional obligations. There are further legislative restrictions on them to mobilize resources through borrowings.
Policy Recommendation
In this perspective, my recommendation is to transfer the powers to levy and collect a potentially buoyant tax like the Agriculture Income Tax (AIT) to the district governments along with the Provincial Finance Commission (PFC) awards to districts and TMAs on the basis of Population (50%), backwardness (17.5%) and Revenue contribution (7.5 %) and 25 % earmarked for transitional transfer grants for bridging the gap between the expenditure of the district governments and transfer on the basis of the three criteria. Other than the positive impact that it could have on the incentive structures for district governments to exploit the full potential of such a tax, it would also reduce their overwhelming reliance on transfers from the provincial divisible pool to finance operations. The distribution criteria governing the PFC Award could be appropriately modified to account for the revenues that would be retained by such district governments and to compensate non-agricultural districts, or those with limited potential for raising substantial revenues from other sources.
There is also a need to devolve some of the Federal revenue generation powers to provinces so that Provincial Tax Base may become broad enough that could decrease their tendency to rely on the NFC award. This step towards provincial autonomy will in turn allow provinces to devolve some of their powers to District Governments. Pakistan has four provinces altogether and each province has one or the other major source of revenue contributing towards national revenue base. Punjab is rich in agriculture produce, Sindh, because of Karachi (only Port city in Pakistan) contribute for almost 70 % of the country’s revenue, NWFP and Balauchistan are rich in natural resources like natural Gas and Water Dams. My recommendation here is that Provinces may be allowed to retain at least 50 % of this revenue generated in their territory and there should be a compensatory function incorporated in the NFC formula award for those provinces whose revenue source is not at par with other provinces on equity grounds. This proposal will also increase economic efficiency as provinces will try to increase their revenue productivity to get maximum benefit from the revenue retention policy.
References 1. http://72.14.203.104/search?q=cache:8_JNHaNL4U8J:www.undp.org/govern ance/docs/DLGUD_Pub_FDPR.pdf+fiscal+decentralization+defined&hl=en&gl =us&ct=clnk&cd=4&client=firefox-a 2. http://72.14.203.104/search?q=cache:8_JNHaNL4U8J:www.undp.org/govern ance/docs/DLGUD_Pub_FDPR.pdf+fiscal+decentralization+defined&hl=en&gl =us&ct=clnk&cd=4&client=firefox-a
3. http://www.jang.com.pk/thenews/dec2005-daily/16-12-2005/oped/o4.htm 4. http://www.selfknowledge.com/15377.htm 5. http://en.wikipedia.org/wiki/Octroi
Appendix-A
Political, Demographic and Social Indicators of Pakistan Total Area
796,096 Sq. kilometers
Total Districts
105
Capital
Islamabad
Annual Growth Rate 1981-1998
2.6 %
Population density per Sq.k.
164 persons
Population 1998
Male
Female
Urban
Rural
130 m
68 m (52%)
62 m (48%)
42 m (32%)
88 m (68%)
Administrative Units and Population Distribution (%) Punjab
Sindh
NWFP
Balochistan
56 %
23 %
13 %
5%
Federal Units 3%
Economy and Employment GDP growth Per capita income
5.1 % US$ 492
Exports during July-April 2002-03
US $ 10.5 billion
Foreign investment
US $ 700 million
Percentage of population below poverty line
32 %
Inflation rate (consumer primary index)
3.3 %
Unemployment rate
7.8 %
Urban
10 %
Rural
6.94 %
Fiscal deficit as percentage of GDP Annual population growth rate
5% 2.1 per annum
Appendix- B
Fiscal System in Pakistan Fiscal Constitution
Decentralized Federation
Provincial Government Constitutional Status
Strong
Local Government Constitutional Status
Weak
Actual provincial control of local Government
Strong
Range of local Government Responsibilities
Limited
Citizen Participation
Low in rural, to moderate in Urban
Bureaucratic orientation
Command and Control
Political and bureaucratic corruption
High
Red Tape
High
Private provision of public services Provincial fiscal autonomy
Extensive Strong
Local fiscal autonomy
Weak
Local Administrative autonomy
Weak
Local government role in public service provision Transparency and predictability of the system
Constrained Good
Design of provincial-local transfers
Non-existent
Quality and quantity of public services
Non-existent
Source: http://isp-aysps.gsu.edu/training/summer2001/hasanjuma.pdf
Appendix- C
Fiscal Decentralization Pakistan 1) Expenditure Assignment - Share expenditure responsibility -Provincial and Local responsibilities - - Central responsibility 2) Revenue Assignment -Central Own revenue - Revenue sharing - Transfer from central government Provincial and local Govt. 3) Borrowing -Central Government -Provincial Government -Local Government 4) Inter-government Transfer N/A -General Allocation -Emergency Grants
Source: http://isp-aysps.gsu.edu/training/summer2001/hasanjuma.pdf
Appendix: D Table 3. Revenue Responsibility and Disposition Revenue in Pakistan Responsibility Revenue
Disposition Revenue%
Base
Rate
Admin
Center
Province
Local
C
C
C
100
0
0
Income taxes
C
C
C
67
33
0
Wealth Tax
C
C
C
65
35
0
C
C
C
100
0
0
Capital Value Tax
C
C
C
65
35
0
Sales Tax
C
C
C
65
35
0
Property
C
C
C
10
90
0
Civil Administration
C
C
C
100
0
0
Import duties
C
C
C
100
0
0
Excises
C
C
C
100
0
0
Export tax
C
C
C
100
0
0
Land Building tax
CP
CP
CP
15
85
0
Mining land rents
C
C
C
10
0
0
Motor Vehicle tax
CP
CP
CP
0
100
0
Vehicle transfers tax
CP
CP
CP
100
0
0
Fuel Tax
C
C
C
80
20
0
Entertainment taxes
C
C
C
100
100
0
Power Supply Tax
C
C
C
100
100
0
Oil and gas receipts
Workers
Welfare
Tax
C= Central, P= Provincial Source: http://isp-aysps.gsu.edu/training/summer2001/hasanjuma.pdf
