Fiscal decentralisation necessarily involves the transfer of taxing and spending powers to sub-national levels of government—in our context, local governments that are still deprived of devolution of political, administrative and fiscal powers despite unambiguous command contained in Article 140A of the Constitution of Islamic Republic of Pakistan.
With the completion of process of general elections for national and provincial assemblies on February 8, 2024, one hopes the issue of implementation of Article 140A of the Constitution in letter and spirit will be taken up seriously and urgently by all the elected members, no matter to which party they belong. Article 140A, inserted through the 18th Amendment, remains unimplemented even after lapse of almost 14 years!
Article 140A requires, “Each Province shall, by law, establish a local government system and devolve political, administrative and financial responsibility and authority to the elected representatives of the local governments”. Elections to the local governments is the duty of the Election Commission of Pakistan (ECP).
The local government system under the constitutional scheme of governance is the dire need of the country, as it emphasizes fiscal decentralisation. Presently major fiscal powers are concentrated in the hands of federal government. On the one hand, federal government has usurped the right of provinces to levy sales tax on goods within their respective territories. On the other, the provinces have shown apathy to devolve political, administrative and fiscal powers to local governments. Resultantly democratic polity has failed to take roots in Pakistan.
We can learn a lot from countries that have successfully achieved the goal of fiscal decentralization. For example, municipalities in Finland enjoy complete fiscal independence through their elected residents.
At present, all broad-based and buoyant sources of revenue lie with the federal government, contribution of provinces in total tax revenues is just 8.3%, and in the overall national revenue base (tax and non-tax revenue) just 8.5%. This has made them heavily dependent on federal government for transfers from divisible pool.
We can learn a lot from countries that have successfully achieved the goal of fiscal decentralization. For example, municipalities in Finland enjoy complete fiscal independence through their elected residents. These municipalities have the right to levy municipal tax in accordance with the Local Government Act 1995. Local authorities perform the functions, assigned for by virtue of their autonomy under the law. This type of local self-governance is totally missing in Pakistan in violation of Article 140A of the Constitution.
In Finland, extensive functions that fall within the specific sphere of local self-governance include education, health care and social welfare services. Furthermore, the municipalities are responsible for matters related to the residents’ free time, recreation, housing, and management and maintenance of their living environment (i.e. roads, streets, water supply and sewerage), as well as land-use planning and functional municipal structures.
Tax revenues play a critical role in municipal finances in Finland that are conspicuous by their absence in our model. The power to levy and collect taxes is one of the cornerstones of municipal self-governance. It ensures that the municipalities can manage the functions that they have undertaken to execute or which they are responsible for by law. The most important is municipal tax. In 2023, the municipal tax rates ranged between 4.36% and 10.86% in mainland Finland. The average municipal tax rate was 7.38%. Total collection in 2023 of municipal tax was €16 billion. Corporate income tax amounts to a little over €6 billion, and real estate tax raises almost €4 billion. This is more than Pakistan’s total tax collection by the Federal Board of Revenue (FBR) of Rs. 7.169 billion in fiscal year 2022-23!
One of the central constitutional principles regarding municipal self-governance in Finland is that, when allocating new functions to municipalities, the State has also to ensure that they have the necessary resources for them. Finland has a well-functioning relationship between the State and the local authorities, as well as a state-subsidy system that ensures municipal resources and residents’ equal access to services.
In Pakistan, unfortunately, the Federal Government has been shamelessly encroaching upon the rights of the provinces by levying presumptive taxes on services camouflaged under the Income Tax Ordinance, 2001, sales tax on gas, electricity and telephone services and excise duty on a number of services.
We can learn from Finland’s great innovation. It can change the fate of Pakistan in a short span of time. We have resources but system for self-governance as in vogue in Finland and elsewhere is non-existent. Resultantly, power vests with the privileged classes instead of the people. Like Finland, we must move to welfare state model, largely based on the idea of the municipalities being the producers and providers of services.
In Pakistan, unfortunately, the Federal Government has been shamelessly encroaching upon the rights of the provinces by levying presumptive taxes on services camouflaged under the Income Tax Ordinance, 2001, sales tax on gas, electricity and telephone services and excise duty on a number of services.
Federal injustice in tax matters has denied the provinces their constitutional rights besides crippling them financially—even 7th National Finance Commission (NFC) Award has not solved the issue of dependence on Islamabad as FBR has miserably failed to collect projected taxes. We need to introduce harmonized sales tax (HST) on goods and services as is in vogue in Canada and India, federations like us. The distribution of taxes should be fairly and justly under Article 160 of the Constitution.
It may be recalled that right to levy sales tax on goods was with the provinces at the time of independence. Despite federal highhandedness in levying unjust taxes and denying the provinces their legitimate shares, the Federal Government has miserably failed to reduce the burgeoning fiscal deficit that will reach the horrifying mark of Rs. 8 trillion at the end of the current fiscal year.
The centrist mind since independence has never allowed provinces to generate their own resources through sales tax on goods. It has resulted in a chaotic economic mess. We could avert it by adopting a rational and growth-oriented tax policy with federalised system of collection. The FBR has the audacity to claim that provinces lack infrastructure to efficiently collect sales tax—an attitude that is reflective of colonial legacy.
On the one hand, we denied the provinces autonomy over their resources and on the other money that belonged to them—collected fraudulently as federal taxes e.g. presumptive taxes and federal excise duty on services—is given to them as act of benevolence under NFC Award.
It is like adding insult to injury. This is a considered policy of control by Islamabad for maintaining hegemony over federating units. The provinces should have exclusive right to levy indirect taxes on goods and services generated within their boundaries and they must devolve fiscal powers to local governments for meeting the universal entitlements of local residents.
Performance of provinces in collecting agricultural income tax is extremely poor. This is a common issue both at federal and provincial level arising from absence of will to collect income tax from the rich and mighty—the meagre collection of agricultural income tax despite the existence of relevant provincial statutes should be a serious cause of concern.
The failure of the FBR to tap the country's real tax potential is the real dilemma of Pakistan. The poor performance of the FBR adversely affects the provinces as they are wholly dependent on what the federal government collects and transfers to them from the divisible pool.
It is imperative that right to levy tax on income, including agricultural income, should be with the Federal Government.
The federal government has miserably failed to tap the real revenue potential, which is not less than Rs. 20 trillion at federal level alone. FBR even failed to collect Rs. 7200 billion last year—the original target assigned in the budget.
The failure of the FBR to tap the country's real tax potential is the real dilemma of Pakistan. The poor performance of the FBR adversely affects the provinces as they are wholly dependent on what the federal government collects and transfers to them from the divisible pool. The federal government is unwilling to grant the provinces their legitimate taxation rights while it collects too little to meet their overall financial demands. The size of the cake—divisible pool—is so small that nothing substantial can be done to come out of debt enslavement and to spend adequately for the welfare of the people, no matter in which part of the country they live.
The track record of the FBR shows remote possibility of collecting even Rs. 15 trillion in the next three years to give enough fiscal space both to the federation and the provinces to come out of the present economic mess, thus providing some relief to the poor as well as trade and industry. Under the given scenario, federation-provinces tax tangle will continue unchecked and further taxation through local governments would not serve any useful purpose—there will be no relief to the people, rather tax burden will increase manifold.
Pakistan will remain in debt enslavement, and more and more people will be pushed below the poverty line. If we want to overcome this crisis, the Parliament will have to reconsider the prevailing social contract between federation and the provinces. Provincial autonomy and local self-governance without taxation rights and equitable distribution of income and wealth is meaningless.
We cannot overcome perpetual economic and political crises unless the provinces are given true autonomy; ownership of all resources; generation of own revenue and exclusive right to utilise it for the welfare of their denizens. Fiscal decentralisation and municipal self-rule should essentially be linked with a social policy based on the principle of universal entitlements for all residents in terms of access to social benefits and social services. Taxation without representation also means denial of spending for the essential entitlements guaranteed in the Constitution.
The principle of universal entitlements, as practiced in Finland through municipalities, is worth studying. The provincial parliaments in Pakistan should be pressurized by civil society to enact laws as ordained under Article 140A of the Constitution on the basis of social policy discussed above—they have so far just copied the previous outdated ones with patch work here and there. The ruling classes do not want to empower people through self-governance. They want to enjoy total control over resources. The local governments will not be meaningful unless entitled, within national economic policy, to have adequate financial resources of their own, of which they may dispose freely within the framework of their powers and for public welfare.
Concisely, for achieving the goal of fiscal decentralization, local governments’ financial resources must be commensurate with the responsibilities provided for by the Constitution and the law to ensure the welfare of the people and ensure sustainable growth at the grassroots level. Part of the financial resources of local authorities shall derive from local taxes, and they will in turn spend for providing universal entitlements and development. Pakistan must follow the model of welfare states like Finland where resources available to local governments are based on a sufficiently diversified and buoyant nature to enable them to keep pace with the real evolution of the cost of carrying out their tasks.