Pakistan's IMF Bailouts Demand Fiscal Centralisation, Not Devolution

The Problem, Stated Plainly

Pakistan stands at a precipice, once again negotiating with the International Monetary Fund (IMF) for financial succour. This cycle of dependency is not an act of God, nor solely the result of external shocks. It is, in large part, a self-inflicted wound exacerbated by a flawed fiscal architecture that emerged from the 18th Amendment. Celebrated as a triumph of democratic federalism, the amendment's decentralisation of fiscal powers has, in practice, created a system where provinces wield significant spending authority without the corresponding responsibility to generate revenue. This imbalance has led to unchecked provincial expenditure, ballooning deficits, and an ever-deepening reliance on federal transfers and external borrowing, ultimately undermining national economic stability. The narrative that further devolution is the answer to Pakistan's economic woes is not just misguided; it is actively dangerous, pushing the nation further into the debt trap.

The 18th Amendment's Fiscal Paradox: Autonomy Without Accountability

The 18th Amendment to Pakistan's Constitution, enacted in 2010, is widely lauded for its role in strengthening parliamentary democracy and devolving power to the provinces. It significantly expanded provincial autonomy, transferring control over numerous subjects and a larger share of national revenue. The National Finance Commission (NFC) Award, a cornerstone of this devolution, allocates a substantial portion of the divisible pool of federal taxes to the provinces. As of the latest NFC Award, provinces receive approximately 40% of the federal government's tax revenue. This increased financial muscle was intended to empower provinces to deliver better services and tailor development to local needs. However, the practical implementation has revealed a critical flaw: the devolution of expenditure responsibilities has not been matched by a commensurate devolution of revenue-raising powers, particularly in direct taxation. Provinces have become heavily reliant on their share of federal taxes, often referred to as "divisible pool" taxes, which are collected by the federal government. While provinces have some limited tax bases (e.g., property tax, services tax), their capacity to generate significant independent revenue, especially through progressive direct taxes like income tax or corporate tax, remains underdeveloped. This structural imbalance creates a perverse incentive. Provinces are incentivised to increase spending, as they can rely on federal transfers, without facing the direct political consequences of raising taxes from their own electorates. This leads to fiscal indiscipline, inefficient resource allocation, and a growing dependence on the federal government, which then must borrow heavily or seek external bailouts to meet its obligations, including its commitments to the provinces. Consider the situation in recent fiscal years. While the federal government struggles with a widening revenue gap, provinces often exhibit significant deficits in their own accounts, which are then covered by federal transfers or provincial borrowing. The Pakistan Economic Survey 2023-24 highlighted that provincial governments collectively incurred a fiscal deficit of approximately PKR 3.5 trillion in the fiscal year 2023-24. This deficit is often financed through borrowing from the State Bank of Pakistan or commercial banks, adding to the national debt burden. The limited tax-to-GDP ratio at the provincial level, estimated to be between 10-15% and highly variable across provinces, underscores this revenue generation challenge. This contrasts sharply with the federal government's own tax revenue, which constitutes around 60% of the total tax collection, primarily from indirect taxes and income/corporate taxes. The 18th Amendment, therefore, has inadvertently created a fiscal dependency that is unsustainable.

The IMF's Dilemma: Demanding Reforms Pakistan Won't Make

The IMF's engagement with Pakistan is a recurring narrative, often characterised by stringent conditions aimed at fiscal consolidation and structural reforms. However, the Fund's typical prescriptions, while sound in principle, often fail to account for the political economy of Pakistan's federal structure. The IMF rightly pushes for increased tax-to-GDP ratios and reduced fiscal deficits. Yet, its engagement often focuses on federal revenue measures, implicitly accepting the existing provincial fiscal arrangements. This is a critical oversight. Without addressing the fiscal imbalance at the heart of the federal-provincial relationship, any reforms at the federal level are akin to treating symptoms while ignoring the disease. The core of the problem lies in the fact that provinces, empowered by the 18th Amendment, have become major spending entities but lack the independent revenue-generating capacity to match their expenditure. They receive a large share of federal taxes, but the political cost of raising provincial taxes is often deemed too high. This creates a situation where provinces can demand more funds from the centre, but the centre, in turn, must borrow or cut its own development spending to meet these demands. This dynamic is unsustainable and directly contributes to Pakistan's chronic balance of payments crises and its reliance on IMF bailouts. For instance, the IMF consistently advocates for broadening the tax base and improving tax administration. While crucial at the federal level, this prescription needs to be extended to the provincial level. Provinces should be incentivised and empowered to collect a larger share of taxes, particularly direct taxes, thereby increasing their fiscal autonomy and accountability. The current system, where provinces are largely recipients of federal transfers, breeds inefficiency and a lack of ownership over fiscal outcomes. The IMF's conditionalities, therefore, must explicitly address the need for a recalibration of fiscal federalism, pushing for a more equitable distribution of revenue-raising powers and responsibilities.

The Case for Temporary Fiscal Centralisation

The argument for temporarily centralising fiscal authority, particularly tax policy, is not a call for rolling back the 18th Amendment entirely, but a pragmatic response to an existential economic crisis. The current system, where provinces have significant spending power but limited revenue-generating capacity, is fiscally unsustainable. This imbalance has led to a situation where Pakistan is perpetually on the brink of default, requiring repeated IMF interventions. A temporary centralisation of key tax policy decisions, especially concerning direct taxes like income and corporate taxes, would allow the federal government to implement a coherent, national revenue strategy. This would enable Pakistan to meet IMF conditions more effectively, broaden the tax base, and reduce the overall fiscal deficit. This temporary centralisation would involve the federal government taking the lead in setting tax policies, rates, and administration for major revenue streams. Provinces would continue to manage their devolved expenditures and could retain some of their existing tax bases, but the primary responsibility for generating substantial revenue would rest with the centre. This approach would ensure that tax policies are designed with a national perspective, considering the overall economic health of the country rather than narrow provincial interests. It would also streamline tax administration, reduce compliance costs for businesses operating across provinces, and enhance Pakistan's ability to meet its debt obligations. Furthermore, such a measure would provide much-needed fiscal space for the federal government to invest in critical national infrastructure, social safety nets, and defence. It would also allow for a more equitable distribution of resources, ensuring that less developed regions receive adequate support without creating fiscal burdens on the more prosperous ones. The key is that this centralisation must be explicitly temporary, with a clear roadmap for its eventual unwinding once fiscal stability is achieved and provinces are better equipped to manage their own revenue generation. This is not about undermining provincial autonomy in the long run, but about ensuring the survival of the state in the short to medium term.

The Counterargument — Political Instability and Federal Overreach

Opponents of fiscal centralisation argue that any attempt to claw back provincial tax powers would be met with fierce political resistance, potentially destabilising the fragile federal structure. They contend that the 18th Amendment is a hard-won democratic achievement, and any move to reverse its fiscal implications would be seen as a betrayal of provincial autonomy and a return to the centralising tendencies of the past. This perspective highlights the legitimate concerns of provinces about maintaining their financial independence and their ability to cater to local development needs. Furthermore, critics might argue that such a move would be politically unfeasible, leading to gridlock, constitutional challenges, and public unrest, thereby exacerbating the very instability it seeks to resolve. They might point to the historical context of Pakistan, where a strong centre has often been perceived as overbearing, and the 18th Amendment was a necessary corrective. The argument is that provinces, having gained significant autonomy, will not willingly cede fiscal powers. Moreover, they might suggest that the solution lies not in centralisation, but in strengthening provincial revenue-raising capacities and improving fiscal discipline at the sub-national level. This could involve capacity-building for provincial tax authorities, exploring new provincial tax bases, and implementing stricter fiscal rules for provincial governments. The fear is that centralisation, even if temporary, could set a dangerous precedent and erode the spirit of federalism, leading to a more authoritarian state structure. This viewpoint also often invokes the principle of subsidiarity, arguing that decisions and revenue collection should be as close to the people as possible. Centralising tax policy, it is argued, would distance governance from the citizenry and reduce the responsiveness of the state to local needs. The potential for the federal government to misuse its centralised tax powers for political leverage or to favour certain provinces over others is also a significant concern raised by this perspective. Therefore, the opposition frames any move towards centralisation as a threat to democracy and a step backward for Pakistan's federal experiment.

Dismantling the Opposition: The Pragmatic Imperative

While the concerns about political instability and the sanctity of the 18th Amendment are valid and must be acknowledged, they cannot be allowed to paralyse Pakistan into economic oblivion. The argument that further devolution is the only path forward ignores the stark reality of Pakistan's fiscal situation. The current model of devolution, as implemented, has created a fiscal dependency that is actively harming the nation. Provinces are not demonstrating the capacity to generate sufficient revenue to match their expenditure, leading to a perpetual reliance on federal transfers and borrowing. This is not autonomy; it is fiscal irresponsibility masquerading as federalism. The fear of political resistance is real, but it is a challenge that must be managed, not a reason to abandon necessary reforms. The federal government, with the backing of institutions like the IMF and international development partners, can negotiate a phased and carefully managed approach to temporary fiscal centralisation. This could involve a constitutional amendment for a limited period, or a new NFC Award that rebalances revenue-sharing mechanisms and empowers the federal government to lead on direct taxation. The key is to frame this not as a rollback of the 18th Amendment, but as a temporary emergency measure to ensure the survival of the state, with a clear commitment to restoring a more balanced federal fiscal structure once stability is achieved. Moreover, the argument that provinces can simply improve their revenue generation is often overstated. While capacity building is essential, the fundamental issue is the lack of political will and the absence of a strong incentive structure for provinces to undertake potentially unpopular tax reforms. The federal government, with its broader mandate and greater capacity for direct taxation, is better positioned to implement the tough, but necessary, revenue-enhancing measures required to pull Pakistan out of its debt trap. The principle of subsidiarity is important, but it cannot supersede the fundamental requirement of national economic solvency. A bankrupt state cannot empower its provinces; it can only drag them down with it.

Conclusion

Pakistan's economic survival hinges on a difficult but necessary recalibration of its fiscal federalism. The 18th Amendment, while a democratic milestone, has inadvertently created a system of fiscal dependency that is pushing the nation towards ruin. The allure of provincial autonomy cannot blind us to the reality of fiscal unsustainability. A temporary centralisation of tax policy is not a step backward, but a strategic manoeuvre to secure the nation's economic future. It is a pragmatic, albeit politically challenging, solution that prioritises national solvency over an unsustainable interpretation of federalism. The time for incremental adjustments is over; Pakistan needs bold, decisive action to break free from the cycle of debt and IMF dependency. The choice is stark: embrace necessary fiscal discipline, or face the abyss of economic collapse.