- Concerning the BISP, the World Bank is seeking cost sharing from all provinces.
- Expenditure allocations remain incompletely implemented: BM.
- The World Bank suggests adopting a horizontal distribution solution for equalization.
ISLAMABAD: The World Bank (WB) has asked Pakistan to revise the allocation formula of the National Finance Commission (NFC), both vertically and horizontally, and adopt fiscal ‘equalization’ for distribution of resources among provinces based on spending needs and projected revenue capacity.
The World Bank also supported the exclusion of population from the main criteria for resource distribution and suggested fiscal equalization as a way forward.
This was mentioned by World Bank Senior Economist and report author Tobias Haque while launching the report titled “Strengthening Fiscal Federalism in Pakistan” alongside Country Director Bolormaa Amgaabazar at the WB office on Wednesday.
The bank highlighted that the fragmentation of the general sales tax (GST) on goods and services poses a major challenge and proposed a unified collection mechanism, with the amount collected then distributed among the provinces – although this would require legislative changes.
The WB also noted that out of Rs 1,035 billion in subsidies incurred by provinces for the Center under Article 164, Punjab canceled subsidies of Rs 546 billion and Sindh Rs 260 billion. The PTI-led KP and Balochistan governments have not committed any amount for the Center in their provincial budgets for 2026-27.
Concerning the Benazir Income Support Program (BISP), the WB requested the maintenance of the national register at the federal level but with cost sharing by all provinces, because social protection falls under the domain of the federated units.
The reproduction stated: “The provisions of fiscal federalism have led to the emergence of a structural federal budget deficit.
Provincial revenues, including federal transfers, rose from less than 4% of GDP to an average of 6.5% between fiscal years 2010 and 24, but federal spending has not adjusted accordingly. The loss of federal transfer revenues (1.9% of GDP) was roughly equivalent to the increase in federal primary deficits after devolution (1.7% of GDP).”
Against the backdrop of low overall revenue and macroeconomic performance, the mismatch between federal financing and functional needs has contributed significantly to Pakistan’s fiscal deficit and the accumulation of public debt.
The WB country director said it was somewhat disappointing that fiscal federalism had not brought benefits to the grassroots. She noted that the report offers a set of options for policymakers, drawing on the experience of other developed and developing economies.
Asked about the Centre’s inability to increase the tax/GDP ratio from 10% to 15%, the WB’s principal economist replied that while the Center was lagging behind on this front, the provinces have also failed to increase their contribution beyond 0.7% of GDP per year, against a potential of 1.15%.
The WB report indicates that spending allocations remain incompletely implemented and insufficiently defined in certain 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 decentralized areas, leading to waste and blurring responsibilities, while local governments lack clearly defined or adequately resourced functional mandates. Second, the 18th Amendment led to the fragmentation of the tax system.
While strengthening provincial tax authority, particularly with respect to the 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 revenues. Large potential tax bases – particularly agricultural income and property – remain largely underutilized.
Third, current federal-provincial transfer agreements – including the vertical allocation formula and the horizontal allocation formula – do not achieve important policy objectives.
The NFC-based transfer system provides predictability and protects provincial revenue shares. However, funding has not kept up with the function. The current framework has reduced federal resources without a commensurate adjustment in spending responsibilities, resulting in a structural federal budget deficit.
The horizontal distribution formula also does not make it possible to obtain true fiscal equalization and does not offer any significant incentive to provincial efforts in terms of revenue or service delivery. Current arrangements also arguably discourage federal revenue efforts, with much of the revenue automatically transferred to the provinces.
Finally, despite constitutional recognition under Article 140A, local governments remain financially dependent, institutionally unstable and effectively subordinate to provincial discretion. Subsidies from the Provincial Finance Commission (CFP) are rare and non-binding, transfers are one-off and own-source revenues are minimal. The decentralization envisaged in 2010 did not extend significantly below the provincial level.
Against the backdrop of low overall revenue and macroeconomic performance, the mismatch between federal financing and functional needs has contributed significantly to Pakistan’s fiscal deficit and debt accumulation. Second, fiscal federalism provisions have contributed to persistently low revenues. The fragmentation of the tax base across five jurisdictions has misaligned incentives, increased compliance costs and created opportunities for tax avoidance.
Federal revenues continued to significantly underperform. Despite the increase in provincial revenue allocations, own-source tax revenues have barely increased. Agricultural income tax remains largely uncollected, although this sector represents more than 20% of GDP. The urban real estate property tax generates only 0.13% of GDP, well below comparator country standards of 0.3% to 0.6%.
Third, the provisions of fiscal federalism have had, at best, a limited impact on aligning public spending and service delivery with needs. In theory, decentralization should reduce accountability loops and better align spending with public needs. Although provinces have increased their 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 the largest share of additional spending going to general public services and administrative costs rather than education or health. Spending also remained geographically inequitable, with allocations to districts determined by historical precedent rather than poverty levels or gaps in service delivery. Local authorities have seen their share of total public spending increase from around 10% in 2005 to around 4.7% in 2024.
The WB recommends adopting a horizontal distribution solution that makes it possible to achieve equalization while generating positive tax incentives. A transparent budget gap approach – replacing the current complex multifactor formula – would allocate common divisible resources based on standardized assessments of spending needs relative to own revenue capacity, thereby eliminating disincentives to revenue effort and avoiding penalties to provinces for fiscal efficiency. Using needs and capacities rather than actual spending or collections avoids penalizing provinces that perform well.
Unconditional transfers under this approach preserve the fiscal autonomy of the provinces. 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 service delivery outcomes in decentralized 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 administration – could also be linked to conditional transfers. Without a complete overhaul, the existing formula could be improved by giving greater weight to indicators of poverty, backwardness and inverse population density in order to strengthen redistribution; reward provinces that close the gaps between potential and actual collection of own-source revenues, including underutilized property and agricultural taxes; and link a share of divisible transfers to investments in essential public services, fiscal discipline and budget transparency, climate adaptation, disaster preparedness, and increased decentralization to local governments.
The WB recommends that the NFC pursue full reunification of the GST base under centralized administration, with constitutional revenue sharing provisions implemented through an agreed allocation formula.
On income tax, the NFC could advance the implementation of recently amended provincial farm income tax regimes to align with the federal system, and establish automatic information exchange agreements where differences remain to prevent evasion.
In the real estate area, the NFC could support the harmonization of all real estate-related levies – taxes, duties, fees and charges – through a common assessment system and a uniform methodology applied consistently to all instruments.
Originally published in The News
