" Assessing the Effectiveness and Equity of the National Finance

Commission (NFC) Award: A Comprehensive Analysis of Resource

Distribution, and Regional Development."

MPA Session: (2023-25)

Submitted By:

Muhammad Sadiq

MPA-IAS-013-R-F23

Submitted To:

Dr. Ayesha Serfraz

Economics of Public Policy

Institute of Administrative Sciences

University of the Punjab

Lahore
Contents
Background.................................................................................................................................................3
Current Trend..............................................................................................................................................3
Motivation...................................................................................................................................................4
Introduction.................................................................................................................................................4
Revenue Sharing Criteria.............................................................................................................................4
Vertical Revenue sharing.........................................................................................................................4
Horizontal Revenue Sharing....................................................................................................................5
Factors of Revenue Distribution..................................................................................................................5
Population................................................................................................................................................5
Inverse Population Density (IPD)............................................................................................................6
Poverty/backwardness.............................................................................................................................6
Revenue Generation and Revenue Collection..........................................................................................7
Economic & Social Long/Short-term Impact..............................................................................................9
Short-term Impacts..................................................................................................................................9
Long-Term Impacts.................................................................................................................................9
Recommendation as Policy Maker............................................................................................................10
References.................................................................................................................................................11
Background
The National Finance Commission (NFC) award of Pakistan provides the framework for fiscal
federalism and is designed to address the equitable distribution of resources vertically between
the center and provinces and horizontally between the provinces. Article 160 of the constitution
of Pakistan allows the president of Pakistan to form the Commission every five years. The
finance minister of the center would be the Chairman and representatives of the provinces would
be Chief Ministers of the provinces any other members from the provinces will be added by
consultation with the Governor of the Provinces. The National Finance Commission (NFC) is
revised periodically after five years to adapt to address the changing economic landscape and
needs of provinces.
The National Finance Commission award has played a crucial role in allocating resources based
on factors such as population, revenue generation capacity, inverse population density, and
development needs of each province. The central areas of concern and investigation are the
effectiveness and equity of the distribution process, prompting the need for a comprehensive
analysis. The National Finance Commission award ensures the efforts of the nation in the
effective and efficient distribution of financial resources between the federation and provinces.
The fair and just distribution of resources among provinces is the foundational principle of the
National Finance Commission award. The share of each province is determined by the formula
which includes population size, revenue contributions, inverse population density, and
development needs, which are the critical factors in assessing the fairness of the allocation
process. The NFC Award, intended to promote balanced regional development, raises questions
about its actual impact on narrowing regional disparities. A comprehensive analysis is needed to
evaluate whether the financial allocations effectively contribute to fostering economic growth,
infrastructure development, and social progress in each province.

Current Trend
National Finance Commission (NFC) awards were established to distribute equitable resources
between provinces after the 18th amendment the power was transferred to provinces and
provinces became autonomous in making their own decisions. Currently, the provinces do not
agree on the formula of the National Finance Commission (NFC) award and there is a deadlock
between the provinces on the distribution of the resources. The deadlock is prompting the
federation to revise and have a fresh look at the divisible pool and to improve both the vertical
and horizontal distribution of the resources. The National Finance Commission's prime focus
was population the pre-dominant criteria of resource distribution which is against the prime
objective of the NFC award to remove the imbalances between the provinces. The Indian
National Finance Commission reduced the population to 25-pc and in Pakistan, there are 80-pc
for a population which is injustice to low-population provinces.
In the previous NFC award, a consensus was not made between provinces due to different issues.
The Khyber Pakhtunkhwa wants a share in hydel power revenues and demands the share of
newly merged Districts of the Federally Administrative Tribal Area in Khyber Pakhtunkhwa.
The Baluchistan demanded the Gas surcharge and a huge share in the Reko-diq and Saindak
projects

Motivation
The study will investigate the equitable distribution of resources in Pakistan vertically among
federating units and the federal government and horizontally between the provinces. Will discuss
the factors in which the resources are distributed. The study will assess the effectiveness of
achieving equitable distribution among the provinces. Understanding whether the allocation
mechanisms are fair and just is crucial for fostering national unity and addressing regional
disparities. Investigating how the NFC Award contributes to or hinders regional development.
Understanding the impact of financial allocations on economic growth, infrastructure
development, and social progress in different provinces can guide policy decisions.

Introduction
The NFC award aims to redistribute the divisible pool among the provinces, encompassing
customs taxes, GST on commodities, personal and corporate income tax, and others. The NFC's
main objective is to suggest the following:
The allocation of certain levies and tariffs among member states and regions.
The distribution of funds to regional administrations.
The federal and provincial borrowing authorities administrations.
Any further financial issue that has been referred to the Commission.

Revenue Sharing Criteria

Vertical Revenue sharing
To develop the national resource picture for the vertical sharing of the Divided Pool Taxes, the
1996 NFC Award used a method that included all of the resources available at the federal and
provincial levels with the debt taken on to close the acceptable/targeted national budget deficit.
Next, the current and future development expenses for both the federal and provincial
benchmarking were used to evaluate and determine governments. In evaluating the necessary
spending, top priorities, like debt servicing and defense and spending in the social sector were
safeguarded. Taking into consideration the needs of the portion of the Divisible Pool Taxes
received by the federal and local governments It was decided by the federal and provincial
administrations.
The methodology adopted by the seventh NFC is established for the reason that the vast majority
of the advancement work should be started at the common level to guarantee results at the
grassroots level. Besides, the obligation of giving social areas benefits likewise rests with the
commonplace legislatures. As such, the requirements of the areas should be tended to first.
The Commission was additionally aware of the consistent assessment that the vertical projects of
the National Government were not giving the ideal outcomes and ought to be in this way
decreased. Rather, more prominent assets ought to be put at the disposal of the common state-run
administrations. The Commission was likewise of the view that there is a duplication of
capabilities; for example, similar capabilities were being performed by offices of the
administrative and common states, bringing about the wastage of government assets.
Consequently, rather than deciding the uses prerequisite of the government what's more,
commonplace legislatures at the same time, in the main occurrence, the necessities of the
commonplace legislatures would be evaluated and worked out, and the portion of the areas in the
Distinct Pool Expenses Net would not be entirely settled. In the wake of setting Aside from the
common offers, government consumptions would be changed by keeping up with the getting
level at an acceptable level.
Horizontal Revenue Sharing
The NFC is now debating two primary issues: one of them is the horizontal distribution of
Divisible Pool Taxes. The provinces' resource share is as follows, according to the interim
agreements made in 2006:

● The provincial portion less the sum equal to one-sixth of the sales tax is dispersed
according to each province's population ratio.
● 50% of the amount equal to one-sixth of the sales tax is distributed. on the population
ratio and 50% on the Octroi and Zilla tax ratios audited the collection for the 1998–1999
fiscal year.
● Punjab, Sindh, NWFP and Baluchistan provinces receive grants-in-aid at the ratios of
11%, 21%, 35%, and 33% correspondingly.
Following a lot of deliberation, the provinces decided to employ a variety of metrics for the
horizontal allocation of resources. Nonetheless, based on the revised sharing agreements, it was
essentially agreed that no province would profit less in absolute terms. The metrics on which all
were agreed upon for use in the resource distribution process.

Factors of Revenue Distribution

Population
The National Finance Commission (NFC) Award uses population as a key metric, which plays
an important role in deciding how financial resources are distributed among Pakistani provinces.
This is justified by taking into consideration the different needs and developmental requirements
that provinces have according to the size of their populations. Greater population density is
reflected in the proportionately higher share given to provinces, which is intended to
accommodate the increased demand for infrastructure and public services in densely populated
areas. Since it is assumed that larger populations inevitably require more resources, using
population as a criterion raises questions about justice even as it guarantees that the scope of
needs is taken into account. This NFC Award indication must be balanced to guarantee a fair
allocation of resources that satisfies the diverse needs of all provinces.
The province-wise ratios of the population as per the 1998 Census are as follows:
Table: Province-wise Population (1998 Census)
Punjab Sindh NWFP Baluchistan Total
Population 73,621,290 30,439,893 17,743,645 6,565,885 128,370,713
57.36% 23.71% 13.82% 5.11% 100.00%
Source: Report of the National Finance Commission

Inverse Population Density (IPD)

Regarding the National Finance Commission (NFC) Award in Pakistan, inverse population
density is an important variable that affects how financial resources are distributed across the
provinces. Lower population density provinces, which are usually defined by more rural or
sparsely inhabited areas, have unique difficulties when it comes to service delivery and
infrastructure development. For provinces with sparse populations to get sufficient funding to
meet the particular demands of distant communities, the NFC Award's inverse population density
factor is crucial. This method acknowledges that to address issues with accessibility,
development, and public service delivery, areas with lower population densities frequently need
to get proportionately larger funding allocations. Encouraging equitable and inclusive growth in
all of Pakistan's provinces requires balancing the distribution of resources to consider inverse
population density.
Based on the 1998 Population Census, province-wise ratios of IPD are worked out as follows:
Table: Province-wise Inverse Population Density
Punjab Sindh NWFP Baluchistan Total
Area (in sq. 205,345 140,914 74,521 347,190 767,970
km)
As % of 26.74% 18.35% 9.70% 45.21% 100.00%
total
Population 73,621,290 30,439,893 17,743,645 6,565,885 128,370,713
Population 358.52487 216.01752 238.10262 18.91150 831.56
density
Inverse 0.0028 0.0046 0.0042 0.0529 0.0645
population
density
As % of 4.32% 7.18% 6.51% 81.99% 100.00%
 total
Source: Report of the National Finance Commission
Poverty/backwardness
In Pakistan, the National Finance Commission (NFC) Award helps to alleviate poverty and
backwardness by ensuring an equitable distribution of financial resources among provinces.
Recognizing the unique challenges that less developed regions face, the NFC Award allocates
funds based on population, revenue generation capacity, and development needs. This strategic
approach aims to help poor provinces by encouraging inclusive growth and closing the economic
gap. The NFC Award significantly contributes to poverty alleviation efforts and promotes a more
balanced and sustainable development trajectory for the nation by directing resources toward
backward areas.
There is a lack of trustworthy data on poverty or the HDI. The PRSP Secretariat of Finance
Division's 2003 report, Poverty Reduction Strategy Paper-I (PRSP-I), titled "Accelerating
Economic Growth and Reducing Poverty: the Road Ahead," showed the poverty levels in each
province's rural and urban regions separately using data from the Household and Income
Expenditure Survey, 1998–1999, as follows:
Table: Incidence of Poverty in Provinces 1998-99
Provinces Urban Rural
Punjab 26.50% 32.40%
Sindh 19.00% 29.20%
NWFP 31.20% 44.30%
Baluchistan 28.40% 24.60%
Source: Report of the National Finance Commission
Since the PRSP report lacks aggregate data, the data has been compiled using the percentage of
the 1998 census's population that lived in urban and rural areas. It should be noted that the 1998
data was used to calculate the poverty level mentioned above. The combined standing is as
follows:
Table: Working on Province-wise Poverty
Incidence Population Incidence Population Aggregate Poverty
of Urban urban of Rural Rural Poverty translating
Poverty proportion poverty proportion into a
[PRSP-1] [1998 [PRSP-1] [1998 percentage
census] census]
Punjab 26.50% 31.27% 32.40% 68.73% 30.56% 25.0%
Sindh 19.00% 48.75% 29.20% 51.25% 24.23% 19.8%
 NWFP 31.20% 16.87% 44.30% 83.13% 42.09% 34.4%
Baluchistan 28.40% 23.90% 24.60% 76.10% 25.51% 20.8%
Source: Report of the National Finance Commission
Revenue Generation and Revenue Collection
It was difficult to find reliable revenue generation data. While the other three provinces insisted
on using income generation as an indicator, Sindh supported the use of revenue collecting.
Following careful consideration, the Commission chose to employ both, assigning each indicator
a 50% weight. Due to a lack of a method for gathering data on a generation basis, the Federal
Board of Revenue (FBR) demonstrated its incapacity to provide statistics on revenue creation. It
was determined that one possible stand-in for revenue creation would be the withholding tax paid
on power consumption.
Table: Province-wise Tax Collection/Generation Rs. billion
Punjab Sindh NWFP Balochistan Total
Total Tax 214,564 558,948 21,452 8,360 803,324
Collection
27% 70% 3% 1% 100%
excluding
Islamabad
in 2007-08
Withholdin 3,320 1,455 370 111 5,257
g Tax on
Electricity
excluding
Islamabad
in 2007-08
Giving 63.0% 28% 7% 2% 100%
weight 50%
44% 50% 5% 1% 100%
of each of
the above
Source: Report of the National Finance Commission
In response to Baluchistan's unique needs, the Federation, along with the provinces of Punjab,
Sindh, and North Western Frontier Province, decided to allocate Rs. 83 billion (9.09%) of the
provincial pool to the region in the first year of the Award. The Federal Government would use
its resources to make up any shortfall in this amount. Based on yearly budgetary projections, this
arrangement for Baluchistan would also be safeguarded for the remaining four years of the
Award.
As per the arrangement, the following multiple indicators have the following weights:
a) population (82.0%);
b) poverty/backwardness (10.3%);
c) revenue collection/generation (5.0%);
d) inverse population density (IPD) 2.7%.
Following the implementation of the aforementioned multiple indicators and consideration of
Baluchistan’s unique needs, the provinces' final percentage share will be as follows:

● Punjab 51.74%

● Sindh 24.55%

● NWFP 14.62%

● Baluchistan 9.09%

Economic & Social Long/Short-term Impact

Short-term Impacts
Economic Stability: An NFC Award's capacity to promote economic stability is what gives it its
immediate impact. Financial resources are distributed fairly and in response to urgent economic
needs by being distributed among federal and provincial entities.
Regional Development: One of the short-term effects is an increase in regional development,
especially in those provinces that are currently experiencing severe economic hardship. These
areas can now carry out crucial infrastructure projects thanks to the funding infusion, which
promotes economic growth.
Employment Opportunities: There is a temporary creation of employment opportunities as a
result of increased economic activity from NFC-funded projects. This helps local livelihoods and
offers a prompt way to lower unemployment rates.
Improvement of Social Services: Provinces with larger allotments can improve social services,
like healthcare and education, fast. The population's well-being benefits from this quick upgrade
to the social infrastructure.
Long-Term Impacts
Long-term Sustainable Economic Growth: The NFC Awards support long-term sustainable
economic growth. Provinces can lay the groundwork for sustained economic prosperity by
addressing regional disparities and promoting development.
Poverty Alleviation: A decrease in the long-term poverty rate is one of the effects. A persistent
decrease in poverty rates could result from uplifting marginalized communities as economic
development becomes more evenly distributed throughout regions.
Long-term human capital development is the consequence of improved social services,
particularly in education. A population with higher levels of education and health can make a
substantial contribution to the nation's overall socioeconomic development.
Better Governance: The constitution's requirement that the NFC Awards be applied consistently
encourages good governance practices. It ensures the effective use of resources, lessens
corruption, and creates a framework for transparent fiscal federalism.
Infrastructure Development: Building a strong infrastructure is one of the long-term effects.
Provinces can make investments in long-term initiatives that enhance transportation,
communication, and connectivity, setting the stage for long-term economic growth.
Equal Opportunities: Over time, the NFC Awards seek to establish equal development
opportunities for all provinces. This fosters inclusivity and lessens regional disparities, which
strengthens national cohesion and shared prosperity.

Recommendation as Policy Maker

Benchmarks established by other nations in this area should be included in academic discussions
to bring back the shortcomings in a federation's resource distribution. Resources should be
distributed among federation units; this is a recognized intellectual tenet. However, the political
will to understand the available formulas used by others needs to be proven and institutionalized
in our system. To give the sub-national units of the federation more provincial autonomy, India's
province share increased from 32% to 42%. Similarly, under the seventh NFC, the Pakistani
government has tipped the scales in favor of federating units. Baluchistan is one of Pakistan's
provinces that is the most economically isolated. Punjab had a solid foundation on which to
expand to raise the standard of living for its people.
The poverty criterion must be used to address the disparity between Central Punjab and the rest
of the province. In particular, a higher share needs to be obtained for the people living in South
Punjab. The backwardness of this neglected region must be given the proper consideration and
share of the credit when the NFC award criteria are expanded to include poverty as one of the
factors.
Under the NFC award formula, it is imperative to guarantee the transfer of funds to regions like
Gilgit Baltistan and Azad Jammu Kashmir.
These regions undoubtedly have provincial status, but they are still a part of Pakistan's republic.
To ensure that the federal government doesn't fall behind in funding these regions, there needs to
be strong controls in place.
The NFC formula should incorporate a positive reward criterion to enhance social variables.
Additionally, efforts to improve social variables such as healthcare and education should be
encouraged and included, as well as provincial per capita income. Bonus points or base points
ought to be given to provinces that make an effort to improve, such as KPK and Baluchistan. The
goals of the points are to incentivize Boluchistan's participation and to give KPK credit for
competing with Punjab.
To improve the Federal government's performance through the NFC award, an external
monitoring and evaluation mechanism needs to be developed. Baluchistan and other remote
regions ought to receive development funds on a priority basis in this manner. The province-to-
province development gap might be closed by this urgency.
Pakistan has been developing different regions through a top-down approach. For the provinces,
this centralized fabric has not produced much. Greater momentum for the provinces' executive
and fiscal autonomy is urgently needed. The provinces would be encouraged to develop a
healthy rivalry under corporate culture if they were given more authority.
International experiences need to be taken into account when creating the resource distribution
model. The government should appropriately consider the following factors that are used
throughout the world when announcing the NFC award.
(1) The gap in development and backwardness.
(2) Inverse income distribution (disparity in income between rural and urban areas).
(3) Endowment of natural resources.
(4) Generating and collecting revenue.
(5) Density of population.
(6) Poverty.
(7) Area.
(8) Transfers without a formula.
(9) Take into account environmental factors.

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