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Old Monday, August 17, 2009
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Default NFC Awards:Introduction and explanation

NFC is composed under constitution of 1973 for the smooth and judicious resource redistribution between federal and provincial governments. Under article 160 of 1973 constitution, it is made obligatory for the federal government to form an NFC after every five years time. The commission is headed by the federal finance minister, while the provincial finance ministers are its members. In addition to this each province can nominate one additional member; similarly the President may also appoint any expert as well.
Pakistan is a federation comprising four provinces, federally administered areas and Islamabad Capital Territory. Being central type of government bulk of fiscal revenue is collected by the centre. A certain percentage is then redistributed among the lower tiers of government.

Specifically when we talk of fiscal resources distribution among the governments; it mainly takes place in two ways. Firstly revenues are distributed between the upper and lower tier of government ie the federal and provincial governments, it is called vertical distribution.

As far as horizontal distribution is concerned, it is the percentage allocation among different provinces according to some specified criteria. Further there is another critical classification of resource distribution in Pakistan ie the revenue transfers could be categorised as "Systematic" and "Random" Transfer. Under systematic a certain specified percentage of revenues are transferred from federal to provincial governments as their right of share of revenues collected and on the other hand random transfers consist of internal and external grants, executive discretionary rites, parliamentarians funds and likewise.

In Pakistan systematic revenue sharing has four stages. Firstly, revenues are transferred from federal to provincial governments through the National Finance Commission (NFC). Secondly, resource distribution takes place from provincial to local governments and is done through Provincial Finance Commission (PFC). Thirdly, the federal government allocate specified amount of money to local governments and lastly revenues are distributed among the local government ie from district government to tehsil municipal administration.

The transfers made between federal and provincial governments includes revenue shares out of the divisible pool, grants, straight transfers (royalties) and loans. Divisible pool (as of now) consists of all taxes collected by the federal government eg sales tax, income tax, excise duty, custom duty, etc.

The history of resource distribution in Pakistan goes back to 1947 when Niemeyer award (given under 1935 act) was followed for this purpose. This award was exercised till March 1952 with some adjustments. After independence Sir Jeremy Raisman was assigned the task to devise an amicable resource distribution formula between the federal and provincial governments. Thus Raisman award was adopted later on 1st April 1952 although it was given in December 1947.

Following that two awards of year 1961 and 1964 were given at the time when West Pakistan was declared as one unit. Thus resources at that time were distributed only amongst East and West Pakistan. The next National Finance Committee (not a commission) was for year 1970.

With the implementation of 1973 constitution, the first award was that of year 1974. After this two commissions were constituted (1979 and 1985) but it failed to suggest any recommendations. Thus after a pause of almost 12 years the 1990 NFC award was announced with some modifications in the divisible pool. The 1996 NFC award was announces by the caretaker government of Malik Meraj Khalid. Current NFC award for year 2006 was implemented through an ordinance after the commission failed to achieve consensus.

The judicious and equitable financial resource distribution is imperative for development. The NFC has dynamically evolved to its current state over a period of time. Improvements have been made from time to time. However, in Pakistan fiscal decentralisation remained the basic issue of confrontation. After 1973 constitution, out of total of seven awards, only four have resulted with some tangible results to improve the distribution of resources between federal and provincial governments.

Currently the federal government collects around 93 percent of the total tax collection while its share in total expenditure is only 72 percent. The federal government presents the argument of equity, efficiency, economy and ability to levy and collect for higher revenue collection. But as a result provinces are left with exhausted resources. They collect only 7 percent of total tax collection although the provincial governments account for around 28 percent of total expenditure. This creates dependency of provinces on the centre for resource transfer. Major tax heads ie income, corporation, wealth and property taxes are with federal government (Table 1).

When we talk of NFC one thing is very prominent and is worth mentioning ie the adoption of sole criterion for resource distribution among the provinces. In Pakistan, population only is used to determine the share of the provinces out of the divisible pool which is not the case anywhere else in the world. Even in India in recent past 11 different criteria were being used to determine the share of the provinces. Throughout the world various factors like revenue generation, poverty, population density, income distribution, backwardness, etc are used to disaggregate the federal tax revenues.

This shows the stagnancy and lack of adaptation in our policy making. Thus over a period of time there is no serious shift in resource distribution among the provinces despite vast differences in the living standards of the people in different areas of the country.

This is obvious from the diagram that although there is a rise in resource pie over the period of time but there is no significant change in the percentage allocation to the provinces (Figure 1).

When we critically analyse the history of NFC we can notice that major shift in government policy towards fiscal decentralisation came after the 1996 NFC award. Here all the taxes were included in the divisible pool. This has resulted in greater transparency, simplicity and predictability. In addition to that incentives of matching grants (up to a certain limit) were given to the provinces if they achieve the revenue growth target of 14.2 percent. But all efforts were hampered by the sudden and radical change in the share of the provinces out of the divisible pool. Earlier it was 20:80 for federal and provincial government which was then shifted to 62.5:37.5 in this award. This was such a drastic shift in the resource allocation that provinces fell into acute shortage of resources.

The current NFC for year 2006 has been announced by the President after the commission failed to achieve consensus among the members since year 2000. This award seems to be a better one. The provincial demands are accommodated by revising the federal/ provincial share to 55:45 percent out of the divisible pool with subsequent increase of 1 percent per annum till it reaches to 50 percent.

Along with this for the first time grants are incorporated into the provincial shares. This would help the provinces with greater predictability and to devise their indigenous development plans with more ease.

But the core problem still remained the same as there is no diversification in the resource distribution criteria. It is astonishing that all the provinces are using more than one criterion while announcing PFC's but fail to achieve any consensus while sitting in the NFC to diversify the criteria for just revenue distribution of resources. It is indicative that certain elements are giving higher preference to their own preferences rather than the national unity and needs of the other federating units.

If we critically analyse the situation, federal government has been more centralised rather than devolving the finance and expenditure side to the lower tier of the government. This has created a negative impact on the performance of the provincial governments and created disincentive. With the passage of time federal government has overstretched itself by taking different aspects into account. Certain tasks like roads, irrigation, some aspects of agricultural sector (like quality control), culture and tourism, youth affairs, and rural development can be given to the provincial governments which would reduce both administrative and financial burden from the federal government. This would also save time and money resources.

This relates to the issue of political economy. We have such an electoral process that leads us to a situation where due to majority seats in the National Assembly the federal government is hijacked by the larger federating unit. Although, in the Senate all provinces have equal representation but they only have power to discuss, not to formulate any feasible resource distribution mechanism. In addition to that the centre does not want to reduce its functions of doing the business of the government.

That's the reason that since independence, 10 awards for formula based justified resource sharing have so far been constituted, out of which only two (1974, 1999) came from the elected governments. Among the other two, 1996 award was announced by a caretaker government, while the year 2006 award was announced by the uniform President after NFC failed to achieve consensus among the members on an amicable resource distribution mechanism.

The issue of resource distribution is very complex one and it never proved to be simple. But when we go through the history of NFC it becomes clear that it is never taken seriously.

No measure has been taken despite its failure again and again. The uni-variable criterion for resource distribution is neither optimal nor judicious. There is little encouragement for the provinces to generate their own resources but with a less systematic approach to decentralize and capacitate them. There is a need for the elimination of administrative and financial dependence on the centre. There is a definite need for the diversification of the resource distribution criteria.

Different provinces are demanding for adoption of various criteria in this context. Sindh is emphasising on revenue generation, Balochistan has the stance for area and backwardness while NWFP is demanding for inclusion of poverty and infrastructure while announcing NFC awards. Hence proper weightage be given to important factors in order to address provincial grievances.

Even the ministry of inter-provincial coordination has suggested for the inclusion of two more elements (poverty and backwardness) in revenue distribution criteria. This will empower and capacitate the provinces.

There is a need to incorporate international experience in this context. The factors that can be included are backwardness and development gap, inverse income distribution (rural urban income disparity), natural resource endowment/degradation, revenue generation/revenue collection, population density, poverty, area, non-formula transfers and environmental consideration. In addition to that there should be a permanent body of NFC comprising of professionals to regularly monitor and evaluate the equitable utilisation of the award.

The members should pay visits to different areas and stakeholders be consulted to have a real look of the situation prevailing in different areas. The federal government assignment be gradually minimised and provinces be trusted more. Thus, we should be optimistic that in the near future government will pay more attention to this serious problem and would try to solve it amicably according to the needs and requirements of the provinces, along with technical considerations.

Link:Pakistan Institute of Development Economics
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