Fiscal federalism by workaround

Pakistan’s forthcoming budget is being assembled through a familiar combination of arithmetic constraint and political improvisation. The federal government faces a substantial revenue shortfall, rising expenditure pressures and limited room to borrow. Its proposed answer is to persuade the provinces to surrender part of the increase in their constitutionally determined transfers.

The mechanism is designed to preserve the appearance of compliance with the National Finance Commission framework. Provincial shares would be transferred in full, after which participating provinces would return the amount exceeding their current-year receipts. Formally, the distribution formula would remain untouched. Economically, the Centre would retain revenue that would otherwise fund provincial governments.

This is an ingenious accounting device, but not a durable fiscal settlement. The seventh NFC Award gives the provinces the larger share of the divisible pool, while the federal government continues to carry debt servicing, defence, pensions, subsidies and much of the cost of macroeconomic stabilisation. That mismatch has become increasingly difficult to manage. Yet the answer cannot be an annual series of negotiated exceptions.

Freezing provincial transfers in nominal terms also amounts to a real cut. Inflation, population growth and higher wage and pension costs mean that unchanged receipts buy fewer services. Provinces will therefore have to cut development projects, restrain salaries, defer expenditure or raise more revenue themselves. The burden will fall most heavily on infrastructure, health, education and local services, because these are easier to compress than salaries and pensions.

The proposed reduction in federal and provincial development programmes illustrates the broader weakness of Pakistan’s budget process. Development spending remains the first casualty whenever tax collection disappoints or politically protected expenditure rises. This may help meet a primary surplus target, but it weakens long-term growth and ensures that fiscal adjustment remains contractionary rather than reformist.

The political structure of the agreement is equally revealing. Punjab and Sindh appear central to the arrangement, while Khyber Pakhtunkhwa and Balochistan remain outside it. This may be sufficient to generate cash, but it does not amount to a credible federation-wide compact. Nor does it resolve longstanding disputes over expenditure responsibilities, merged districts, population shifts and provincial revenue effort.

Pakistan has achieved a degree of macroeconomic stabilisation, but stability without fiscal capacity is fragile. The Centre lacks sufficient revenue, the provinces resist surrendering autonomy, and neither tier has built a tax system capable of financing the state’s obligations.

The next budget may balance on paper through expenditure cuts and provincial cooperation. But unless Pakistan produces a new NFC settlement, reforms pensions and subsidies, and broadens taxation beyond the already documented sectors, the same crisis will return. Fiscal federalism cannot indefinitely be managed through temporary transfers, political bargains and deferred development.