A new World Bank report, Strengthening Fiscal Federalism in Pakistan, asserts that improving how public resources are shared across Pakistan’s federal, provincial, and local governments is critical to sustaining macroeconomic stability, enhancing public services, and meeting the demands of a rapidly growing population. The report acknowledges that the landmark 2010 reforms—the 18th Constitutional Amendment and the 7th National Finance Commission (NFC) Award—represented a major step forward by devolving major service delivery responsibilities to the provinces and significantly increasing their revenues. However, structural weaknesses in the system continue to pose challenges for fiscal discipline, constrain revenue mobilization, and affect the quality of services reaching citizens.
Key Factors Behind Fiscal Deficit
The report identifies two main factors behind the widening federal fiscal deficit: an increase in transfers following the 7th NFC Award that was not matched by adjustment in federal expenditures, and stagnant revenue collection. Provincial revenues rose from less than 4 percent of GDP to an average of 6.5 percent over 2010-2024, yet federal expenditures did not decline commensurably. The division of the tax base across five jurisdictions has raised compliance costs and constrained revenue. At the same time, agricultural income remains largely untaxed despite the sector accounting for more than 20 percent of GDP.
Expert Views on Devolution
“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,” said Bolormaa Amgaabazar, World Bank Country Director for Pakistan. “Aligning financing with responsibilities, broadening the tax base, and ensuring that resources reach schools, clinics, and local communities are essential to sustaining stability and delivering better services to Pakistan’s growing population.”
Limited Impact on Spending Alignment
The report also finds that devolution has so far had limited impact in aligning public spending with needs. The formula for distributing resources across provinces does not provide allocations in line with fiscal needs or create strong incentives for provincial revenue effort and service delivery performance. Much of the increase in provincial spending since the 7th NFC Award was absorbed by administrative expenses rather than education or health, with more than 80 percent of expenditure in FY23 used to meet recurrent costs. Spending across districts has continued to track historical precedent rather than poverty levels or service delivery gaps. The share of total government spending undertaken by local governments has fallen from around 10 percent in 2005 to under 5 percent in 2024.
Opportunity for Reform
“The structure of fiscal federalism shapes whether children attend functioning schools and whether health facilities are stocked with medicines,” said Tobias Haque, World Bank Lead Country Economist and lead author of the report. “A planned new NFC Award offers an important opportunity to recalibrate incentives - rewarding provinces that strengthen their own revenue effort and improve service delivery, while directing more resources to where needs are greatest.”
Menu of Reform Options
Rather than a single prescriptive agenda, the report presents a menu of reform options that could be pursued through a new NFC Award and broader measures within Pakistan’s existing constitutional framework. These include aligning federal financing with responsibilities; strengthening domestic revenue mobilization; empowering local governments with more predictable transfers; and improving coordination across different levels of government. The report notes that ensuring reliable, regular NFC Awards would itself be a major reform: predictable revisions lower the stakes of any single negotiation and create space for the dialogue and consensus-building that lasting reform requires.
