The report identified two main factors behind the widening federal fiscal deficit: increased transfers following the 7th NFC Award without corresponding adjustments in federal expenditures, and stagnant revenue collection.

Faisal Sheikh

                ISLAMABAD: The World Bank on Wednesday, in its report titled “Strengthening Fiscal Federalism in Pakistan,” stressed the need to reform the country’s system of resource distribution among federal, provincial and local governments.

It warned that stronger fiscal coordination was essential to sustain economic stability, improve public service delivery and effectively respond to the demands of a rapidly growing population.

The report mentioned that the landmark 2010 reforms,  the 18th Constitutional Amendment and the 7th National Finance Commission (NFC) Award, marked a major step forward by devolving key service delivery responsibilities to provinces and significantly increasing their revenues.

However, it highlighted that structural weaknesses continued to challenge fiscal discipline, limit revenue mobilization and affect the quality of services delivered to citizens.

The report identified two main factors behind the widening federal fiscal deficit: increased transfers following the 7th NFC Award without corresponding adjustments in federal expenditures, and stagnant revenue collection.

While provincial revenues rose from less than 4 percent of GDP to an average of 6.5 percent during 2010–2024, federal expenditures did not decline accordingly.

It also pointed out that the division of the tax base across five jurisdictions has increased compliance costs and constrained revenue growth, while agricultural income remains largely untaxed despite contributing over 20 percent to GDP.

“Pakistan took a historic step in 2010 by bringing government closer to its people, but the full promise of devolution has yet to be realized,” World Bank Country Director for Pakistan Bolormaa Amgaabazar said while launching the report.

“Aligning financing with responsibilities, broadening the tax base, and ensuring that resources reach schools, clinics and local communities are essential to sustaining stability and delivering better services to Pakistan’s growing population,” she added.

The report further observed that devolution has had limited success in aligning public spending with actual needs.

It noted that the formula for distributing resources among provinces does not adequately reflect fiscal needs or incentivize stronger provincial revenue efforts and improved service delivery.

A significant portion of increased provincial spending since the 7th NFC Award has been absorbed by administrative expenses rather than priority sectors such as education and health, with more than 80 percent of expenditure in FY2023 allocated to recurrent costs.

Spending across districts, the report added, continued to follow historical patterns instead of being guided by poverty levels or service delivery gaps.

Meanwhile, the share of total government spending undertaken by local governments has declined from around 10 per cent in 2005 to less than 5 per cent in 2024.

“The structure of fiscal federalism shapes whether children attend functioning schools and whether health facilities are stocked with medicines,” World Bank Lead Country Economist and lead author of the report Tobias Haque said.

“A planned new NFC Award offers an important opportunity to recalibrate incentives – rewarding provinces that strengthen their revenue efforts and improve service delivery, while directing more resources to where needs are greatest,” he added.

Rather than prescribing a single reform path, the report presented a range of policy options that could be implemented through a new NFC Award and within Pakistan’s existing constitutional framework.

These include better alignment of federal financing with responsibilities, stronger domestic revenue mobilization, more predictable transfers to local governments, and improved coordination among different tiers of government.

It also emphasized that ensuring timely and regular NFC Awards would itself constitute a major reform, as predictable revisions would reduce the stakes of negotiations and create space for sustained dialogue and consensus-building necessary for long-term fiscal stability.