World Bank urges Pakistan to revamp NFC Award to strengthen economy

Pakistan needs to strengthen the way public resources are shared among the federal, provincial and local governments to safeguard macroeconomic stability, improve public services and meet the needs of its rapidly growing population, the World Bank said in a report released on Wednesday.

In its report, "Strengthening Fiscal Federalism in Pakistan," the World Bank said the 18th Constitutional Amendment and the 7th National Finance Commission (NFC) Award, introduced in 2010, marked a historic shift by devolving key service delivery responsibilities to the provinces and significantly increasing provincial revenues. However, structural weaknesses continue to undermine fiscal discipline, limit revenue mobilization and reduce the effectiveness of public spending.

Federal deficit driven by higher transfers, weak revenue collection

The report said the federal fiscal deficit widened largely because transfers to the provinces increased sharply after the 7th NFC Award without a corresponding reduction in federal spending, while revenue collection remained stagnant.

According to the World Bank, provincial revenues increased from less than 4% of gross domestic product (GDP) before the reforms to an average of 6.5% of GDP between 2010 and 2024. However, federal spending did not decline proportionately despite the transfer of responsibilities.

The report also said Pakistan's fragmented tax system, divided across five tax jurisdictions, has increased compliance costs and constrained revenue collection. It noted that agricultural income remains largely untaxed despite agriculture contributing more than one-fifth of the country's GDP.

World Bank Country Director for Pakistan Bolormaa Amgaabazar said, "Pakistan took a historic step in 2010 by bringing government closer to its people, but the full promise of devolution has yet to be realized."

She said aligning financing with government responsibilities, broadening the tax base and ensuring resources reach schools, health facilities and local communities would be critical to maintaining economic stability and improving service delivery.

Spending fails to reflect development needs

The report said devolution has achieved only limited success in aligning public spending with citizens' needs.

It found that the formula for distributing resources among the provinces does not adequately reflect fiscal needs or encourage provinces to improve tax collection and public service delivery.

More than 80% of provincial expenditure in fiscal year 2023 was absorbed by recurrent costs, primarily administrative spending, leaving relatively limited resources for development sectors such as education and health.

The report also said spending across districts continues to follow historical patterns rather than poverty levels or service delivery gaps.

Meanwhile, the share of total government spending managed by local governments declined from about 10% in 2005 to less than 5% in 2024.

Tobias Haque, the World Bank's lead country economist and the report's lead author, said, "The structure of fiscal federalism shapes whether children attend functioning schools and whether health facilities are stocked with medicines."

He said the planned new NFC Award presents an opportunity to redesign incentives by rewarding provinces that improve revenue collection and service delivery while directing more resources to areas with the greatest needs.

Reform options for a new NFC Award

Rather than prescribing a single solution, the report outlines a range of policy options that could be implemented through a new NFC Award within Pakistan's existing constitutional framework.

The proposed reforms include:

• Aligning federal financing with constitutional responsibilities.
• Strengthening domestic revenue mobilization by broadening the tax base.
• Empowering local governments through more predictable fiscal transfers.
• Improving coordination among federal, provincial and local governments.

The World Bank also recommended reducing overlapping federal expenditures, assessing revenue potential at both the federal and provincial levels, and considering function-specific deductions from the divisible tax pool to fund national priorities, including debt servicing, infrastructure, social protection, security, environmental programs and intergovernmental coordination.

The report added that holding regular and timely NFC Awards would itself constitute a major reform by making fiscal arrangements more predictable and creating greater scope for consensus-building on future reforms.