Fiscal federalism

PAKISTAN has recently constituted its 11th National Finance Commission (NFC) to develop a new Award for the sharing of divisible resources between the centre and the provinces. Fiscal federalism arrangements were last significantly reformed over 15 years ago and are overdue for an update.

Fiscal federalism arrangements determine how public money is raised, divided and spent across federal, provincial and local governments. They directly shape whether schools have teachers, whether health clinics have medicines, whether each tier of government is adequately resourced, and whether the 3.5 million Pakistanis entering Pakistan’s labour force annually can find productive work.

The 2010 reforms (the 18th Constitu­tional Amendment and the 7th NFC Award) were a step forward, shifting significant resources and responsibilities to the provinces. But as discussed in our new World Bank report, Strengthening Fiscal Federalism in Pakistan, they have not delivered as intended. The report provides recommendations to address these issues.

First, financing has not followed function. The federal government transferred a larger share of revenue to the provinces but did not reduce its own spending commensurately. The loss in federal revenues from transfers (around Rs2 trillion today) was roughly matched by the increase in federal primary deficits post-devolution. The result has been a structural federal fiscal deficit, contributing directly to Pakistan’s cycle of debt accumulation and macroeconomic vulnerability.

Pakistan’s fiscal federalism needs urgent reform.

To address this critical issue, the federal government should reduce spending in areas that are constitutionally the provinces’ responsibility; and eliminate duplication and waste through a thorough spending review. The remaining federal financing gap could be addressed through divisible pool deductions for key national priorities. Allocating resources based on an assessment of expenditure needs and revenue capacity would improve the current system.

Second, the tax base has fragmented without generating more revenue. The 2010 reforms split GST collection across five competing jurisdictions, raising compliance costs and creating opportunities for avoidance. As a result, Pakistan continues to suffer from a chronically low tax-to-GDP ratio. Agriculture accounts for over 20 per cent of GDP, but agricultural income tax remains largely uncollected. Urban property tax generates just 0.13pc of GDP, well below the 0.3pc to 0.6pc norm in comparable countries. Devolution of tax authority has not translated into tax effort.

Fragmentation of sales tax between goods and services, with agencies operating under different rules, must be resolved. At a minimum, this requires harmonisation of the tax base, common definitions and a unified digital filing and payment system. Beyond GST, the NFC could advance implementation of provincial agricultural income tax regimes and support harmonisation of all immovable property-related levies through a common valuation system.

Third, provincial spending has shifted away from service delivery needs. Since 2010, the largest single increase in provincial spending has been on administrative costs, not education or health. Around 80pc of consolidated provincial expenditure continues to be absorbed by recurrent costs. District allocations follow historical precedent rather than poverty levels or service delivery gaps. Local governments have seen their share of total public spending fall from around 10pc in 2005 to under 5pc to­­day. The devolution envisaged in 2010 has not extended meaningfully below provinces.

To address this is­­sue, incentives must shift towards accoun­tability and service delivery. Conditional transfers tied to mea­surable service delivery outcomes in education and health would redirect pro­­vin­-cial spending towards services. The NFC could also establish minimum standards for what provinces devolve to the local level, with transfers that are predictable, objective and regularly updated.

The current NFC process requires consensus on any new Award, and broad ag­­re­ement will be required on wider reforms. The technical arguments are clear. But to overcome current economic and service-de­­livery challenges, the conversation must shift from a zero-sum competition over resources towards finding solutions to development challenges. Better-designed fiscal federalism arrangements align incentives behind revenue collection, direct spending towards human capital, and close the accountability loops that underpin current gaps between public finances and public needs. These are the principles that should guide the next generation of fiscal federalism reforms in Pakistan.

The writer is World Bank country director for Pakistan.

Published in Dawn, July 6th, 2026

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