Impact of Fiscal Decentralization on Economic Growth

Impact of Fiscal Decentralization on Economic Growth CHAPTER-1 INTRODUCTION INTRODUCTION Fiscal decentralization and its impact on economic growth have turned into an interesting subject until today since studies regarding fiscal decentralization are not only considered from the economic viewpoint, but also another perspective such as politics, graphic, and other subjects. The reason conduct of this study about fiscal decentralization and its impact on economic growth is that because sometimes the findings do not give the same conclusions among the researchers about the effect above topic. It is believed that Fiscal decentralization has positive impact on economic stability and growth because it supports in better and appropriate execution of public policies. In decentralized system the government is in great position to know about the essential requirements and problems of societies. It has no any issue in collecting the useful data for mapping out any results oriented policies for backward areas and societies. The â€Å"Decentralization Theorem† maintains that i f there are different preferences for public goods between jurisdictions of uniform provision of these goods by central government will generally achieve lower level of efficiency than one that can be attained by a decentralized provision that allows for differences across jurisdictions (Oates, 1972). Fiscal decentralization cab be handy in shaping out suitable policies, strategies and can get rid of needless activities of federal governments. In the words of Bird and Smart (2002), â€Å" for services to be effectively provided, those receiving transfers need a clear mandate, adequate resources and sufficient flexibility to make decisions†. Fiscal decentralization is a process through which the responsibilities as well as resources from national to provincial governments are devolved (Rondinelli, 1981). Thus decentralization, federal government empowers the provincial governments in such a manner that can help in better use of resources, improve public living standards and at the same time to share the work load (Gordin, 2004). Nevertheless from financial point of view, decentralization may pose danger if it is weakly design so that provinces are able to externalize their costs to others (Rodden et al, 2002; Von Hagen et al, 2000). Our country is federal country with centralized taxation procedure. The central authority collects the bulk of income and then redistributes it between the federal and provinces to correct both the vertical and horizontal differences. The financial resources allocation scheme in Pakistan is fortified with rule and an independent organization, National Finance Commission (NFC), subsequent to every five years, to make sure the fair and careful resource division. However, at times different issues perturb the method and existing economic resources sharing and that could not prove productive. Deadlocks were practiced time to time and therefore National Finance and horizontal resource sharing breaches. Further this study intention to discover the strengths and weaknesses of the present financial resource allocation structure in Pakistan, in the course of the compilation of its past trends. The accurate and suitable information about the existing resource sharing is supposed to result in improved strategy formulation and therefore would eventually assist the nation to grab the growth path faster. In this regard, it is very essential to check out the impact of present resources distribution on economic expansion of nation. So the present study assists in identifying the scale of financial sovereignty of the provincial governments and increase its long run returns. History of Resource allocation in Pakistan Pakistan is a country that has powerful central control system. Two levels of government are working in Pakistan .i.e. the national and sub national (provincial). The resources distribution system all the time remained under discussion due to the competence and sharing issues. -In the observation of Jaffery and Sadaqat (2006), the resource sharing system goes through the four levels. The first level the National Finance Commission (NFC) awards decides the revenue division among the central government and provincial governments. At the second level, Provincial Finance Commission (PFC) delegates funds from provincial to local levels. At the third stage transfers are made from central to local levels and lastly the vertical resources distribution takes place at local levels .i.e. from district government to Tehsil Municipal Administration. On the converse, the random transfers take the shape of particular grants, discretionary resources for administrative, the parliamentarian developmen t funds and the same. This fraction summarizes all the awards offered during the course of time after getting the independence. The overtime development is then discussed on the foundation of chronological investigation. 1.3 Niemeyer Award In the light of the 1935 Act of United India, the Niemeyer Award was followed for resource allocation between the federal and provinces. According to this award, a major tax i.e. sales tax was levied and collected by the provincial government. While the fifty percent of income tax of the total collection was redistributed to the provinces. When Pakistan came into being, the similar provisions were carried out up to March 1952, though a few adjustments were chart out in railway budget and distribution of earnings and sales tax (Government of Pakistan, 1991). 1.4 Raisman Award In December, 1947 the Raisman award was presented (Government of Pakistan, 1991). The particular provisions were made to cover up the fragile financial situation of the central government. The federal government was authorized of fifty percent of sales tax revenue as an ad hoc measure. The remaining fifty percent was given to provinces, out of which five percent was allocated to provinces, Punjab, Sindh, NWFP, Bhawalpur, Khairpur Mir’s, Balochistan states union and residual as 27,12,8,4,0.6,0.6 and 2.8 percent respectively and 45 was given to East Pakistan (Government of Pakistan, 1991). 1.5 Revenue Sharing Under One Unit In 1955, all the four provinces of West Pakistan were combined and stated as a one unit during the implementation phase of the Raisman Award. Consequently, later than 1955 the entire country was acknowledged two identities merely .i.e. West Pakistan and East Pakistan. In the period of One Unit, two awards were presented .i.e. of year 1961 and 1965. 1.5 (I).The First Award 1961 In the light of this first award the 70 percent of sales tax and other taxes from divisible pool were assigned to East Pakistan and West Pakistan. The share of East Pakistan and West Pakistan was 54% and 46% respectively. While the remaining 30 percent of sales tax was assigned to the provinces on the basis of collection in their respective areas. The remaining duties on agricultural land and capital value tax on immovable property were given to the units as per their collection (Pakistan 1991). 1.5 (II). The Second Award 1965 The 1965 National Finance Commission was designed under the article 144 of the 1962 constitution of Pakistan. The divisible pool comprised of collection from income tax, sales tax, excise duty and export duty. However 30% of sales tax was distributed in accordance with its collection in each province. The respective share out of divisible pool between Centre and Provinces were decided 35:65 percent respectively. The share of East Pakistan and West Pakistan remained untouched at 54% and 46%. However, on 1st July 1970 the West Pakistan was disband into four provinces Sindh, Punjab, Baluchistan and NWFP, thus its share 46 percent was distributed as 23.5, 56.5, 23.5, 4.5 and 15.5 percent respectively among the new provinces of West Pakistan. (Pakistan 1991). 1.6 National Finance Committee 1970 In April 1970, this was first time a committee was made to chart out acceptable resource allocation among the federating units under the supervision of federal finance minister. The committee gave a new resource division mechanism. The resources pool was vertically divided between federal and provincial government 20:80 percent respectively. The thirty percent of the allotted sales tax was redistributed among the provinces according to the collection from the respective areas. Table No: 01, Provincial Share under National Finance Committee 1970 Sindh Punjab Baluchistan NWFP 23.50%56.50% 4.50% 15.50% Source: Pakistan 1991 1.7 Financial Arrangements in 1973 Constitution The 1973 new constitution was accepted in the majority by National Assembly either government member or opposition members. The particular provisions were charted out for the revenue allocation mechanism smooth and suitable in the new constitution of 1973. The federal government was made obligatory to constitute the NFC following every five years in the 1973 constitution. The commission was authorized to propose and asses the resource allocation process in country. So with the new and strong position, efforts were made to make sure an undisputed revenue allocation 1.8 The FirstNational Finance Commission (NFC) Award 1974 In the light of new constitution the first National Finance Commission was constituted in 1974. The DP consisted of merely sales tax, income tax and export duty on cotton under this new commission. This commission made the population only decisive factor for horizontal income sharing among the federating units. The vertical division of resources remained unchanged. Because of population as the only standard for the resource division, the provincial share of Punjab increased to 60.25 percent of the total provincial share. As a result with the non-diversification of principle, the smaller provinces were badly affected. Table No: 02, Provincial Share under National Finance Commission 1974 Sindh Punjab Baluchistan NWFP 22.50%60.25% 3.86% 13.39% Source: Pakistan 1991 1.9 The Second National Finance Commission (NFC) Award 1979 In 1979 the government of President General Zia-ul-Haq set up the second national finance commission award. This commission gave the resource distribution formula between provinces as the following i.e. Punjab 57.97, Sindh 23.34, NWFP 13.39 and Baluchistan 5.30 respectively. Table No: 03, Provincial Share under National Finance Commission 1979 Sindh Punjab Baluchistan NWFP 23.34%57.97% 5.30% 13.39% Source: Pakistan 2000 1.10 The third National Finance Commission (NFC) Award 1985 The third National Finance Commission could not give any recommendation for resource distribution mechanism. The revenue was distributed in the light of the first NFC award with the amended provisional population. Table No: 04, Provincial Share under National Finance Committee 1970 Sindh Punjab Baluchistan NWFP 23.50%56.50% 4.50% 15.50% Source: Pakistan 1991 1.11 The Fourth National Finance Commission (NFC) Award 1991 Under the shelter of democratic government of Mr. Muhammad Nawaz Sharif the Fourth National Finance Commission was shaped in 1990. This Fourth NFC achieved the success after the break of sixteen years so this award was considered a significant attainment. The numbers of constructive suggestions were the elements of this award. In the light of this fourth NFC award the horizontal resource share of the provinces registered the significant expansion of 17 percentage points which increases form 28% to 45% of federal tax revenue, (Ghaus and Phasha, 1994). The population was the only base for resource distribution among the provinces which is given below. Table No: 05, Provincial Share under National Finance Committee 1991 Sindh Punjab Baluchistan NWFP 23.28%57.88% 5.30% 13.54% Source: Pakistan 1991 1.12 The Fifth National Finance Commission (NFC) Award 1997 In this award the DP was extended with the addition of all duties and taxes. Capital value tax, wealth tax, income tax, sales tax, excise duties, export duties, custom duties (other than duty on gas that is charged at wellhead), and each and every other taxes that were collected or levied by central government. The net development surcharges on natural gas and the royalties on crude oil were extended to the provinces in the form of straight transfers. The each province was given the share from divisible pool as under. Table No: 06, Provincial Share under National Finance Committee 1997 Sindh Punjab Baluchistan NWFP 23.28%57.88% 5.30% 13.54% Source: Pakistan 1996 1.13 The sixth National Finance Commission (NFC) Award 2000 General Pervaiz Musharraf came into power and gave the Sixth NFC in which the federal government was insisting 45% out of DP but the provinces were demanding 50% of the share and this NFC completed its term without any achievement. 1.14 The Seventh National Finance Commission (NFC) Award 2010 The long standing problem of allocation of resources between provinces and federal has been set on by the momentous announcement of the 7th National Finance Commission Award on 18th March 2010. In this National Finance Commission Award the share of the provinces in vertical allocation has been enlarged from 49 percent to 56 percent for the period of the 2010-11 and 57.5 percent for the duration of the remaining years of the award. The multiple criteria formula for the horizontal resource distribution among the provinces has been applied instead of traditional population criteria which was the only base for resource distribution in Pakistan. In the light of this new multiple criterion for resource distribution among the provinces, 82 percent allocation was made on population, 10.3 percent on poverty and backwardness, 5 percent on revenue collection or generation and 2.7 percent on inverse population density (IPD). According to the 7th NFC award Federal Government had reduced its colle ction charges from 5 percent to 1 percent, which would mainly benefit to the provinces. Realizing the position of Province Khyber-Pakhtunkhwa in the war on terror 1 percent of the net divisible pool was assigned to this province. According to this new formula of resource allocation Baluchistan would get 9.09 percent from divisible pool, Khyber-Pakhtunkhwa 14.62 percent, Sindh 24.55 percent and Punjab 51.74 percent. Table No: 07, Provincial Share under National Finance Committee 2010 Sindh Punjab Baluchistan Khyber-Pakhtunkhwa 24.55%5174% 9.09% 14.62% Source: Pakistan 2006 Briefly, the record of National Finance Commission indicates the resource allocation in Pakistan generally has been ineffective. It has the both the shades of failure as well as certain achievements. On the positive side the NFC all the stake holders are kept on board and decides the resource allocation among them. Further, with the passage of time more financial resources autonomy has been delegated to the provinces and there is more realization of fiscal decentralization especially in past three NFC awards of 1997, 2006 and 2010. The resource share of provinces has been improved either due to inclusion of taxes in the DP or due to the higher provincial share in the comparison that of central since 1991 NFC award. Further the increased grants and straight transfers are channelized to the provinces. Similarly, the incentive of matching the grants motive the provinces, inviting them to enhance efficiency, have their own resource generation and obtain financial autonomy ( Ahmed et al, 2007). On the other hand, on its negative side, various deadlocks and long breaks were exercised very often due to non-harmony among the provinces and between the provinces and center. Every one of the provinces has contrary characteristics and offers different monetary opportunities to its citizens. Different importance of the provinces destabilized their bargaining authority. For instance, Punjab insisted for the agriculture yield and population as only criterion to share out the funds, while Sindh has emphasized on the revenue generation criterion, Baluchistan demanded for area and Khyber-Pakhtunkhwa advocated for backwardness. Consequently, owing to the absence of consensus and failure in agreement, provinces retreat to the adoption of a single criterion, which is sub-most favorable. In last the institutional system of NFC has remained unsuccessful in amicably moving towards the progress, development and tackling the very crucial hitch of fiscal allocation and transference. The second part of this empirical work is the comparison between the local governments’ and non-local governments’ economic performance. The GDP growth rate has been compared. The first phase of local governments starts from the government of General Ayoub Khan and Yahya Khan from 1960 to 1971, second phase of the local government starts in the government of General Zia-ul-Haq from 1978 to 1987 and third phase of local government starts in the government of General Musharraff from 2001 to 2008. The total time period of local government remained 30 years so other remaining years of non-local government performance have been compared which starts form 1957 to 1959, 1972 to 1977, 1988 to 2000 and 2009 to 2012. GDP growth rate during the local and non-local government in Pakistan year wise is given bellow. Table No: 08, GDP growth rate during non-local governments in Pakistan for thirty years. Year GDP Growth Rate Year GDP Growth Rate 1954 10.2 1991 5.6 1955 2.0 1992 7.7 1956 3.5 1993 2.3 1957 3.0 1994 4.5 1958 2.5 1995 4.1 1959 5.5 1996 6.6 1972 2.3 1997 1.7 1973 6.8 1998 3.5 1974 7.5 1999 4.2 1975 3.9 2000 3.9 1976 3.3 2009 1.6 1977 2.8 2010 3.8 1988 6.4 2011 4.4 1989 4.8 2012 4.5 1990 4.6 2013 5.0 Source Economic Survey of Pakistan and Handbook of Statistics on Pakistan Economy Graph No: 01 GDP growth rate during non-local governments in Pakistan Table No: 09, GDP growth rate during local governments in Pakistan for thirty years. Year GDP Growth Rate Year GDP Growth Rate 1960 10.2 1981 5.6 1961 2.0 1982 7.7 1962 3.5 1983 2.3 1963 3.0 1984 4.5 1964 2.5 1985 4.1 1965 5.5 1986 6.6 1966 2.3 1987 1.7 1967 6.8 2001 3.5 1968 7.5 2002 4.2 1969 3.9 2003 3.9 1970 3.3 2004 1.6 1971 2.8 2005 3.8 1978 6.4 2006 4.4 1979 4.8 2007 4.5 1980 4.6 2008 5.0 Source Economic Survey of Pakistan and Handbook of Statistics on Pakistan Economy Graph No: 02, GDP growth rate during local governments in Pakistan. Graph No: 03, GDP growth rate during the local and non-local governments for the selected thirty years in Pakistan. In this graph of GDP growth rate during Local and Non-local Governments, the green colour bars show the GDP growth rate during Local Governments and while the purple colour bars show the GDP growth rate during the Non-local Governments in Pakistan for the selected years. The green colour bars which depict the growth rate during local governments are generally higher than others that represent the growth rate during Non-local Governments for nominated years in Pakistan. Further we have compared the Average GDP growth rate of both types of governments. First GDP growth rates of Non-local Governments of Pakistan for given time periods 30 years have been summed and divided by 30 thirty years and same for Local Governments. So the average GDP growth rate during Non-local Governments has remained 4.41% and while the GDP growth in the period of Local Governments has remained 6.11%, which is much higher than Non-local governments.