The federal government, alongside at least three provincial administrations, has conditionally agreed to a new National Fiscal Pact aimed at fulfilling a crucial requirement set by the International Monetary Fund (IMF). This development follows substantial revisions to the original contract, crafted to alleviate concerns raised by the provinces about their fiscal responsibilities and allocations.
The finance ministry had not confirmed whether the government of Sindh had granted its consent to the National Fiscal Pact, which is intended to serve as an alternative to the National Finance Commission (NFC).
Notably, despite a public stance suggesting otherwise, the government of Khyber Pakhtunkhwa (K-P) has exhibited maturity by agreeing to the pact, albeit with certain conditions. Sindh’s objections to the initial draft necessitated significant changes, highlighting the complexities of intergovernmental negotiations.
Finance Ministry spokesman Quamar Abbasi did not respond to inquiries regarding whether all provincial governments had signed the agreement. He also remained silent on whether any changes had been made to the memorandum of understanding (MoU) that had been established with the provinces in July to address their concerns.
In an effort to build consensus, the finance ministry decided against including the requirement for provinces to share expenses related to the Benazir Income Support Programme (BISP). Additionally, the ministry relaxed the conditions surrounding the transfer of federally funded projects to provincial control, stipulating that any such transfer would now require the consent of the National Economic Council (NEC).
In a significant concession to Sindh, any reduction in the size of the federal government will now be contingent upon reaching a consensus at the Council of Common Interests (CCI), which is the constitutional forum responsible for making decisions that affect both federal and provincial governments.
Finance ministry officials reported that the governments of Punjab, Khyber Pakhtunkhwa, and Balochistan had conditionally agreed to the National Fiscal Pact. However, there were no official announcements regarding Sindh’s signing of the pact, which was set as a deadline for all five governments.
Under the previous NFC agreement, the share of provincial governments in federal taxes was increased to 57.5%. However, the federal government did not completely relinquish its responsibilities in sectors such as provincial road infrastructure, health, and education.
The new National Fiscal Pact prohibits provincial governments from determining agricultural support prices. It also mandates that they amend agriculture income tax laws to align the tax rates for small farmers with federal personal income tax rates and set agriculture corporate income tax rates equivalent to federal corporate tax rates.
With federal personal income tax rates reaching as high as 50% and corporate rates at 29%, excluding the super income tax, the provinces are now expected to shoulder some expenditure responsibilities, although these do not fully align with the IMF’s initial expectations. The clarity on whether the IMF will accept this toned-down pact remains uncertain, especially given that it does not fully address concerns regarding expenditures on BISP and development projects.
As part of the IMF’s broader strategy to expand Pakistan’s narrow tax base and alleviate the expenditure burden on the federal government, a significant condition has been placed: all five governments must sign the National Fiscal Pact by September 30, 2024 and communicate this agreement to the IMF headquarters by the same date.
The National Fiscal Pact is intended to replace the National Finance Commission, which the government is hesitant to amend, even though there is consensus between military authorities and the federal government that the current NFC framework contributes to persistent federal fiscal imbalances.
While the government seeks to amend the Constitution to alter the judiciary’s framework for political advantages, it appears reluctant to redefine the NFC for the sake of Pakistan’s economic stability. The provinces of Punjab and Sindh, being major beneficiaries of the federal government’s expenditures, raised objections to the initial draft of the fiscal pact.
To address their concerns, the finance ministry made significant amendments to the draft on 25 September2024, coinciding with the IMF’s approval of Pakistan’s $7 billion bailout package, which is contingent on implementing crucial structural reforms.
Previously, Punjab, Sindh, Khyber Pakhtunkhwa, and Balochistan had signed an MoU in July regarding the sharing of fiscal responsibilities. The IMF has urged provinces to increase their contributions toward higher education, health, social protection, and regional public infrastructure investment schemes.
Simultaneously, provincial governments are expected to enhance their tax collection efforts, particularly targeting sales tax on services, property tax, and agricultural income tax. However, the absence of specific targets in the agreement renders the National Fiscal Pact somewhat generic in its objectives.
Muzzammil Aslam, Finance Adviser to the K-P chief minister, noted that the K-P cabinet had raised over five questions regarding the amendments, which were subsequently clarified by the federal finance ministry. Muzzammil Aslam emphasized that the K-P government is committed to the fiscal pact in the national interest but reserves the right to take corrective actions if there are any deviations from the clarifications provided by the Finance Division.
A primary concern for K-P is any potential restriction on the movement of wheat from Punjab. Should such restrictions be imposed, the K-P government is prepared to initiate wheat procurement operations independently.
Key Agreements Reached
Under the new agreement, provincial governments are to amend their Agricultural Income Tax (AIT) regimes to fully align with federal personal income tax rates for small farmers and corporate income tax rates for commercial agriculture by the end of October 2024. The collection of agricultural income taxes under this new regime is set to begin on January 1, 2025, with revenues from the second half of FY 2024-25 to be collected in July 2025.
Provincial governments are also expected to transition the sales tax on services from a positive list approach to a negative list approach to combat tax evasion, effective from the start of the next fiscal year. They will aim to collectively enhance revenues from corporate tax in agriculture and the goods and services tax (GST), in addition to expanding revenue collection efforts in other areas.
At least three provincial governments have committed to developing and implementing a common approach to property taxation. They will also undertake the necessary administrative reforms to narrow the tax compliance gap, including efforts related to GST.
Importantly, the terms of reference for the National Tax Council will be broadened to encompass the design of relevant tax measures, including property tax, alongside the legal and administrative changes needed for their implementation.
The agreement stipulates that the provinces will discontinue the announcement of support prices for raw commodities and cease procurement operations altogether.
Compromised Consensus
Initially, the finance ministry proposed that provinces provide additional contributions for higher education and to social protection programs supported by federal initiatives such as the Higher Education Commission (HEC) and the BISP.
However, in response to objections from Sindh, the finance ministry excluded the terms “social protection” and “BISP” from the provinces’ obligations. The agreement now requires provincial governments to contribute additionally for the HEC, while both federal and provincial administrations will gradually restore spending on health and education programs as a percentage of GDP.
Commitments related to the BISP are now stated generically, indicating that the federal government, in collaboration with provincial governments, will review social protection programs and identify overlaps to ensure fiscal prudence.
A specific exception has been made concerning the full transfer of the Public Sector Development Program (PSDP) projects, mandating that provinces will cover all PSDP expenditures benefiting solely one province, along with any federal spending in areas allocated to provinces under the 18th Amendment, subject to exceptions determined by the NEC.
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According to another compromise, the federal government will reduce its involvement in line with the 18th Amendment; however, matters requiring federal and provincial consensus will be referred to the forums of the CCI or the NEC.
