87101 Public Disclosure Authorized Public Disclosure Authorized Fiscal Implications of the 18th Amendment: The Outlook for Provincial Finances Aisha Ghaus Pasha Public Disclosure Authorized World Bank Policy Paper Series on Pakistan PK 02/12 November 2011 Public Disclosure Authorized The Outlook for Provincial Finances 2011 The Policy Research Working Paper Series disseminates the findings of work in progress to encourage the exchange of ideas about development issues. An objective of the series is to get the findings out quickly, even if the presentations are less than fully polished. The papers carry the names of the authors and should be cited accordingly. The findings, interpretations, and conclusions expressed in this paper are entirely those of the authors. They do not necessarily represent the views of the International Bank for Reconstruction and Development / World Bank and its affiliated organizations, or those of the Executive Directors of the World Bank or the governments they represent. 2 The Outlook for Provincial Finances 2011 Fiscal Implications of the 18th Amendment: The Outlook for Provincial Finances Aisha Ghaus Pasha I would like to acknowledge the kind cooperation shown by a number of federal and provincial officials. Also, I thank Jose R. Lopez Claix and Hanid Mukhtar for their continuous guidance and support and all the participants at the World Bank workshop on the 18th Amendment held last June for their useful comments. 3 The Outlook for Provincial Finances 2011 ACRONYMS ADP Annual Development Programme AIT Agricultural Income Tax CAD Capital Administration and Development Division CCI Council of Common Interests CDL Cash Development Loans CDWP Central Development Working Party CGT Capital Gains Tax CVT Capital Value Tax DP Divisible Pool EAD Economic Affairs Division ECNEC Executive Committee of the National Economic Council EOBI Employees Old-Age Benefits Institution FATA Federally Administered Tribal Areas FBR Federal Board of Revenue FY Fiscal Year GDP Gross Domestic Product GDS Gas Development Surcharge GST General Sales Tax HEC Higher Education Commission IC Implementation Commission ICT Islamabad Capital Territory IMF International Monetary Fund IPC Inter-Provincial Coordination IPD Inverse Population Density JPMC Jinnah Postgraduate Medical Centre KPK Khyber Pakhtunkhwa LGO Local Government Ordinance MDGs Millennium Development Goals MMBTU British Thermal Units, in Millions MQM Motahida Quami Movement MTDF Medium Term Development Framework NEC National Economic Council NFC National Finance Commission O&M Operation and Maintenance OGDC Oil & Gas Development Company Limited P&D Planning and Development PASSCO Pakistan Agricultural Storage and Services Corporation PFRA Provincial Fiscal Responsibility Act PIC Provincial Implementation Committees PML Pakistan Muslim League PPL Pakistan Petroleum Limited PPP Pakistan Peoples Party PSDP Public Sector Development Program PWP Peoples Works Programme RGST Reformed General Sales Tax SBA Standby Facility SBP State Bank of Pakistan SNE Schedule of New Expenditure SNGPL Sui Northern Gas Pipelines Limited SSGCL Sui Southern Gas Company Limited TCP Trading Corporation of Pakistan UIPT Urban Immovable Property Tax VAT Value Added Tax WWF Worker Welfare Fund 4 The Outlook for Provincial Finances 2011 Contents ACRONYMS ................................................................................................................................................... 4 Executive Summary ....................................................................................................................................... 7 CHAPTER 1 .................................................................................................................................................. 13 Overview of the 18th Amendment and Its Major Fiscal Implications on Provincial Governments ......... 13 1.1 New Functional Responsibilities and Institutions ................................................................... 13 1.2 Federal Expenditure on Devolved Ministries/ Divisions ......................................................... 18 1.3. Financing of New Responsibilities ................................................................................................ 20 1.4 Political Economy of the 18th Amendment and its Fiscal Implications ................................... 21 1.5 Reflection of the 18th Amendment in the Federal Budget 2011-12 ....................................... 24 CHAPTER 2 .................................................................................................................................................. 27 OUTLOOK FOR PROVINCIAL FINANCES ................................................................................................... 27 2.1 Trends in Provincial Fiscal Variables ............................................................................................. 27 2.2. Broad Fiscal Implications of the 7th NFC Award ........................................................................... 29 2.3. Raising Provincial Resources ........................................................................................................ 34 2.4. Borrowing and Debt Levels .......................................................................................................... 39 2.5. Alternative Scenarios for Provincial Finances .............................................................................. 40 CHAPTER 3 .................................................................................................................................................. 44 POTENTIAL FOR A NEW REVENUE SHARING SYSTEM ............................................................................. 44 AND NEW FISCAL RULES ......................................................................................................................... 44 3.1. New Revenue Sharing Arrangements .......................................................................................... 44 3.2. Exploring Fiscal Rules for Provincial Governments ...................................................................... 45 CHAPTER 4 .................................................................................................................................................. 48 EMERGING ISSUES .................................................................................................................................. 48 4.1. Devolution of the Health Division ................................................................................................ 48 4.2. Devolution of the Food and Agriculture Division ......................................................................... 48 4.3. Devolution of Labor and Manpower Division .............................................................................. 49 4.4. Sharing of Natural Resources ....................................................................................................... 50 4.5. Borrowing Powers of Provinces ................................................................................................... 51 4.6. Impact of 18th Amendment on Federal Entities ........................................................................... 51 4.7. 18th Amendment and Local Governments ................................................................................... 52 4.8. Decentralization and Growth ....................................................................................................... 53 5 The Outlook for Provincial Finances 2011 4.9. Monitoring the Devolution Process ............................................................................................. 53 REFERENCES ................................................................................................................................................ 57 6 The Outlook for Provincial Finances 2011 Executive Summary 1. Following the transition to democracy in 2008, two very important political developments took place. These were the announcement of the 7th National Finance Commission (NFC) Award, which was agreed upon in December 2009 in Lahore, and the unanimous ratification by Parliament of the 18th Amendment to the Constitution in April 2010. Both developments have the potential of fundamentally restructuring the way Pakistan is governed in the future. The Eighteenth Amendment 2. The 18th Amendment brought important institutional changes. It abolished the Concurrent Legislative List (CLL) of the Constitution and made some changes in the Federal Legislative List (FLL), sections I and II. The CLL has been transferred to the provinces, with the only major exception of electricity which has been brought under FLL-II. As a result, fifteen Ministries/seventeen Divisions of the federal government are being devolved to the provinces. Furthermore, the fiscal powers of the provinces have also simultaneously been enhanced. And some functions of ministries which remain at the federal level are also being transferred, making them a joint responsibility of the federal and provincial governments. As a result, the 18th Amendment will lead to a more balanced and decentralized structure of government of Pakistan and to an enhanced empowerment by the provinces. 3. The devolution process under the 18th Amendment was implemented in three phases. Phase-I was completed in December 2010 when five Divisions—Special Initiatives, Zakat and Ushr, Youth Affairs, Population Welfare, Local Government and Rural Development—were devolved. In