ISLAMABAD: Pakistan has made “meaningful” progress on fiscal federalism since the landmark 18th Constitutional Amendment of 2010, yet significant deviations from international norms and good practices persist, the World Bank said in a report released Tuesday.
The report warns that current arrangements are fueling a structural fiscal deficit, undermining revenue collection, and failing to improve public service delivery.
Titled “Strengthening Fiscal Federalism in Pakistan,” the report scrutinizes the country’s intergovernmental fiscal framework. It found that while the devolution of powers to provinces was a historic step, the full promise of bringing government closer to the people has not been realized, with critical flaws in expenditure assignments, tax administration, and local governance.
Misaligned Finances and a Structural Deficit
The World Bank identified a fundamental misalignment between the financing and functions of federal and provincial governments. Following the 7th National Finance Commission (NFC) Award, provincial revenues rose from less than 4% of GDP to an average of 6.5% between fiscal years 2010 and 2024. However, the report notes that federal expenditures did not adjust commensurately .
“The loss in federal revenues from transfers (1.9% of GDP) was roughly equivalent to the increase in federal primary deficits post-devolution (1.7% of GDP),” the report states.
The lender argues that this “misalignment” has contributed to Pakistan’s fiscal deficit and the accumulation of public debt.
While the NFC provides predictability for provincial shares, the report criticizes the framework for reducing federal resources without a corresponding reduction in expenditure responsibilities.
Fragmented Tax System and Weak Revenue Performance
The report highlights that the 18th Amendment, while strengthening provincial tax authority, has caused a “fragmentation” of the tax system, particularly by splitting the General Sales Tax (GST) base between the federal government and four provinces.
This complexity, the World Bank explains, leads to higher compliance costs, discourages inter-provincial trade, and constrains aggregate revenue performance .
Furthermore, the report points to significantly underutilized tax bases, including agricultural income and property taxes. Despite agriculture accounting for over 20% of the country’s GDP, agricultural income tax remains “largely uncollected.”
The urban immovable property tax generates only 0.13% of GDP, far below comparator country norms of 0.3 to 0.6%. The bank calls for harmonizing GST definitions and place-of-supply rules to address these issues.
Declining Role of Local Government
A third critical dimension identified is the failure to effectively devolve power to the local government tier. Despite Article 140A of the Constitution requiring provinces to establish local government systems, the World Bank notes that local governments remain “fiscally dependent, institutionally unstable, and effectively subordinate to provincial discretion.”
The report observes that Provincial Finance Commission (PFC) awards are infrequent and non-binding, while transfers are ad hoc. Consequently, the share of total government spending allocated to local governments has plummeted from 10% in 2005 to just 4.7% in 2024 .
The report warns that spending has also remained geospatially inequitable, with district allocations driven by historical precedent rather than poverty levels or service delivery gaps.
Recommendations and Path Forward
To address these challenges, the World Bank outlines a series of key reforms. It urges the government to prioritize the ongoing federal rightsizing exercise to eliminate wasteful spending that overlaps with provincial mandates.
To improve revenue, the report recommends a “transparent fiscal gap approach” for horizontal distribution of resources to replace the current complex formula, which would allocate funds based on expenditure needs and revenue capacity .
The World Bank also calls for full reunification of the GST base under a centralized administration or, alternatively, incentivizing harmonization through a shared negative list and a unified digital filing system. Empowering local governments through clear transfer systems and performance-based grants is also a top priority.
The report concludes by urging the revival of fiscal federalism institutions like the Council of Common Interests (CCI) and the NFC, noting that a successor NFC award has been delayed for over a decade and a half.
