Repair provincial finances

Much of the discussion and discourse on public finances has remained centered on the federal government and the RBF. The analysis of provincial finances has been sketchy and superficial, although it should feature prominently in the wake of the 18th Amendment and the National Finance Commission’s 7th award.

For a decade now, the provincial governments have enjoyed administrative, legal and political autonomy and a significant injection of financial resources from the divisible fiscal pool.

Compared to the period before 2009-2010, when the provinces were entitled to a relatively small share and the federal government a larger share, the new provisions have considerably increased the share of the provinces, which rose to almost 60 % (57.5% of the divisible pool and the remaining amount in the form of direct transfers to various accounts and recurrent and development grants). This has favored the provinces – and rightly so, since the main services that citizens expect from the state are all provided by local and provincial governments. It is another story that local governments have in fact been weakened and the delegated functions and responsibilities as well as the necessary financial resources which were granted in 2001 have been removed.

There are many compelling reasons why the current decentralization should be taken to its logical endpoint – at the third level of government. It is interesting to know how the increased amount of resources available to the provinces over the past decade have been utilized and what impact they have created on human capital formation, infrastructure development and connectivity and productive sectors. And what repercussions has this had on the general state of public finances at the national level, in particular on the budgetary situation of the federal government.

In 2009-2010, the four provincial governments collectively employed 1.8 million people and their payroll amounted to 340 billion rupees, an average salary of 189,000 rupees per year. In the same year, the federal government employed 928,000 people and paid them 89 billion rupees, an average of 96,000 rupees.

In 2019-20 – a decade later – the number of provincial government employees had increased by 28% to 2.3 million and the annual payroll had reached 1.548 billion rupees. The average salary had risen to Rs673,000. The number of federal government jobs was 981,000 with a payroll of Rs 260 billion. The average salary was 265,000 rupees during the same period.

Not only was there a net addition of half a million new employees or a 28% increase in provincial government staff, but the average salary also increased by multiples of 3.6 times. In contrast, the increase in employment in the federal government was limited to 6% and the average salary increased 2.8 times. The annual rate of inflation over the period averaged about 8-9% and thus there was a significant increase in real wages for federal and provincial government employees.

The total payroll of the provincial governments increased by a factor of 4.2 during this decade while that of the federal government increased by a factor of 2.8, which means that the growing share of the divisible fiscal pool of the federal governments was used primarily for the benefit of provincial government employees. In the provinces, three departments – education, health and police – employ 75% of the total workforce, with education and health accounting for more than half of the total workforce. The same formula applies to the breakdown of payroll.

Spending on education and health in provincial budgets remained within the 35-39% range, but the impact on outcomes – school enrollment rates, adult literacy rates, average year of schooling, out-of-school children , learning ability and health indicators – has been minimal. Governance and management of these sectors have been below average; most of the money is spent on poorly trained teachers and basic infrastructure in schools is lacking. Therefore, those who argue for increased allocation for social sectors in the absence of governance and improved quality of education risk wasting money after the harm.

One of the pernicious side effects of a large dose of the divisible federal fiscal fund, injected into provincial finances, has been that the provinces have been slow to mobilize their own revenues. The provinces only contribute 1% of GDP to national taxes. Indian state governments contribute 35% of total tax revenue, or 6-7% of GDP. Pakistan’s provinces together spend 40% of total consolidated expenditure while collecting only 10% of total national tax revenue.

When replete with such exceptional liquidity, the political will and bureaucratic efforts to exploit the GST on services, the property tax and the farm income tax have been found to be absent, regardless of party in power. power. Our elected officials consider taxation and tax collection to be an unpopular task when their spending needs can be easily met through federal transfers. They don’t feel much pressure to opt for digitized cadastral surveys of the property; revaluation of existing properties bringing them into line with market prices; remove exemptions, concessions and discretionary prices set by tax officials; the introduction of electronic record keeping and an automatic invoicing system; updating registration through GIS system mapping, including newly urbanized areas in the tax base.

The property tax ratio is 0.03% of GDP while the average for developing countries is 0.6%. The total collection from all cities in Pakistan is 20 billion rupees while the Mumbai Municipal Corporation collects 120 billion rupees. The Pakistani property market is estimated to have an asset value of $400-700 billion. Studies have shown that Pakistan can collect at least 400 billion rupees per year from property tax if the above mentioned reforms are implemented and responsibility for assessment, collection and l he application of the property tax is transferred only to the metropolitan corporations and the municipal corporation.

The agricultural income tax brings in a negligible amount of Rs 3 billion per year, while the gross value added from agriculture in 2020-21 was Rs 15 trillion. Non-farm income tax collection amounts to Rs 1.7 trillion. Of the total agricultural area of ​​21.4 million hectares in Pakistan, land ownership of 10 hectares and more by the richest four percent of farmers constitutes 35% (the richest 1% owns 22%). If a quarter of agricultural GVA can be attributed to this top four percent category of owners, their contribution would be at least Rs 3.75 trillion. Applying an average tax rate of 10% (with a sliding sliding scale), we should expect the farm income tax to bring in 375 billion rupees or 0.5% of GDP.

This farm income tax application would also end non-farm income tax evasion, as the Federal Income Tax Order of 2001 exempts farm income from federal income tax. Income. Taking advantage of this loophole, federal income tax filers inflate their true farm income by including sources of income from other non-exempt sectors of the economy. Thus, the FBR also suffers losses in the collection of income tax.

All provinces have made considerable efforts to collect GST on services that were previously the domain of RBF. In fact, it has become the largest source of provincial tax revenue – 293 billion rupees or 58% of provincial tax revenue. However, the gross value added in the service sector that can potentially contribute to GST is estimated at Rs 3.8 trillion. An average tax rate of 16% is expected to generate 600 billion rupees a year, twice as much as is currently collected. The new bodies – provincial revenue authorities – set up for this purpose have the capacity to achieve this objective.

There are a number of other revenue items in provincial budgets that can also be rationalized, but they have not been included in this analysis. By cleaning up provincial finances, it has been shown that at least 1.6% of GDP in the form of additional taxes can be generated, bringing the national tax-to-GDP ratio to 12%, thereby reducing budget deficits and primary. and repay and thereby reduce the national debt burden. For this, the scope of local government finances must be widened.

The writer is the author of ‘Governing the ungovernable’.