Rethinking the fiscal compact

EDITORIAL: The federal government’s steadily diminishing fiscal space, the persistent failure of the provinces to develop their own sources of revenue, the lack of financially empowered local governance and the National Finance Commission Award’s inequitable horizontal distribution formula have together created a fiscal arrangement that is increasingly misaligned with the country’s evolving governance needs.Against this backdrop, the recently held Pakistan Governance Forum — bringing together representatives of provincial governments and the Centre — stressed the need to recalibrate the federal fiscal compact.As Planning Minister Ahsan Iqbal highlighted at the forum, the federal government faces a precarious fiscal position, where nearly half the tax revenue at its disposal goes towards debt repayments and another quarter to defence spending, forcing it to borrow heavily to fund other vital obligations, and intensifying an already crippling debt burden.Of the roughly Rs14 trillion in tax and Rs5 trillion in non-tax revenues, around Rs8.2 trillion is transferred to the provinces under the NFC Award, leaving the Centre with just Rs11 trillion to cover expenditures approaching Rs17.5 trillion.After covering debt, defence and non-development outlays, such as salaries and pensions, as well as managing the finances of Azad Jammu and Kashmir, Gilgit-Baltistan and Islamabad, only then can the Centre focus attention on development projects and social protection schemes, not just for federally administered areas, but in many cases also for the provinces, despite the devolution of social sector functions to provincial domains under the 18th Amendment.Moreover, the provinces’ chronic inability to generate meaningful revenue of their own — less than one percent of GDP — has left them heavily reliant on federal transfers.A lack of political will to tax under-taxed segments has been compounded by entrenched inefficiencies, underfunded local governments and frequent reckless use of public finances undermining the impact of these transfers, leaving much-needed development and social spending at the grassroots largely unrealised.To tackle these systemic gaps, Iqbal has underscored the need for creating Functional Financial Provincial Commissions, which would allocate each province’s resources at the district level, targeting social sector priorities and poverty in under-developed areas. It is worth noting that Article 140-A obliges provinces to devolve political, administrative and financial authority to local governments, but it offers no formula-based or legally binding framework for this, enabling provincial administrations to neglect the vital task of establishing an effective, empowered governance structure at the grassroots.Instituting such commissions through a constitutional amendment, then, could legally mandate the creation of a financially empowered local governance system, ensure more strategic, impactful use of provincial funds, relieve the Centre of direct social sector spending and provide impetus to both provincial and local governments to develop new revenue sources.Such proposals, however, often face strong provincial opposition, as they are seen as encroaching on provinces’ domain. But if these commissions were established with provinces fully controlling their composition and allocation formulas, with all resources being spent locally under a democratic, accountable framework, it is hard to see how these objections would hold.Another critical flaw in the federation’s fiscal compact that has been repeatedly highlighted in this space is the outsized role population plays in the NFC Award formula, commanding 82 percent weightage while poverty, revenue generation and inverse population density carry only marginal weight. This skew has discouraged provinces from controlling population growth, and even the minimal emphasis on poverty in the formula can perversely reduce incentives for meaningful action on poverty alleviation.The solution then is clear: a comprehensive overhaul of the formula that drastically reduces population’s influence and places factors such as poverty alleviation, human development, climate resilience and population stabilisation at its core.Without such reforms, all federating units will remain trapped in a misaligned fiscal framework, perpetuating inefficiency, inequity and constrained national development.Copyright Business Recorder, 2026

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