The World Bank has acknowledged that Pakistan has made meaningful progress on its fiscal federalism system since constitutional reforms in 2010, but warns that significant deviations from international norms and good practices persist across four critical dimensions. The report, titled 'Strengthening Fiscal Federalism in Pakistan,' was released on Monday and provides a detailed assessment of the country's intergovernmental fiscal arrangements.
Key Findings of the World Bank Report
According to the executive summary of the report, Pakistan's 2010 constitutional reforms substantially increased the provincial share of federal revenues and devolved major service delivery responsibilities to provinces. Provinces are now responsible for vital sectors such as health care, education, local infrastructure, and law and order. However, the federal government continues to operate in constitutionally devolved areas, causing waste and blurring accountability. Local governments lack clearly defined or adequately resourced functional mandates.
The report notes that the National Finance Commission (NFC) Award determines how tax revenues collected by the federal government are distributed among Pakistan's four provinces. While the system has improved provincial fiscal autonomy, the fragmentation of the tax system has created new challenges.
Tax Fragmentation and Revenue Underperformance
The World Bank points out that the 2010 reforms further fragmented the tax system by splitting the tax base between five competing jurisdictions. While provincial tax authority was strengthened, particularly over General Sales Tax (GST) on services, the resulting complexity imposes high compliance costs, discourages interprovincial trade, and has constrained aggregate revenue performance. 'Large potential tax bases, particularly agriculture income and property, remain significantly underutilized,' the report states.
The federal government's revenues have continued to underperform, and agriculture income tax remains largely uncollected despite the sector accounting for more than 20 percent of the country's Gross Domestic Product (GDP). The fragmentation of the GST between goods and services results in multiple collection agencies applying different rates, definitions, withholding rules, input adjustment mechanisms, and refund systems. This is identified as a primary constraint on revenue performance and should be treated as a 'first-priority reform.'
Subnational Finance Systems and Local Government Empowerment
The report highlights that improved outcomes from devolving powers depend on subnational finance systems, and Pakistan's provinces exhibit mixed performance in the strength of their public finance systems. Key shortcomings include weak predictability of resource availability, large and unpredictable in-year reallocations, limited performance orientation through the budget cycle and across levels of government, and constrained local discretion to manage effective resource use.
To address these issues, the World Bank recommends that the federal government's ongoing rightsizing exercise—aimed at reducing redundancies through downsizing, merging, and privatizing federal ministries and state-owned enterprises—should be prioritized. Once achievable savings are realized, a federal revenue potential assessment should determine whether further vertical rebalancing is needed and to what degree.
The report also suggests that the NFC could incentivize harmonization of the GST base through common definitions based on a shared negative list, harmonized place-of-supply rules, expedited rollout of a unified digital filing and payment system, and comprehensive data-sharing arrangements. Additionally, NFC agreements could establish clear guidelines for local government structures and minimum standards for the devolution of administrative and financial decision-making. Increased local level allocations should target key national priorities including health and education, and performance-based grants should incentivize improved service delivery and local revenue generation.
