Pakistan has made “meaningful” progress on fiscal federalism since 2010; however, deviations from “international norms” and “good practices” remain, including in the current federal–provincial transfer arrangements, the World Bank said in a report released on Tuesday.
In its report titled “ Strengthening Fiscal Federalism in Pakistan ”, the WB highlighted four critical dimensions in which Pakistan lacked in terms of fiscal federalism.
“First, expenditure assignments remain incompletely implemented and inadequately defined in some areas,” the report said and highlighted that the government continued to “operate” in constitutionally devolved areas despite the 18th Constitutional Amendment.
It added that the involvement had caused waste and blurred “accountability”, while local governments lack clearly defined or adequately resourced functional mandates.
It also pointed out that the 18th Amendment had caused “fragmentation” of the tax system.
“While the Amendment strengthened provincial tax authority, particularly over General Sales Tax (GST) on services, it also split the tax base between five competing jurisdictions,” the report added, adding that complexity led to higher compliance costs, discouraged inter-provincial trade and constrained aggregate revenue performance.
It noted that tax bases, especially agricultural income and property, remained “significantly underutilised”.
The report pointed out that the existing federal–provincial transfer arrangements, such as the National Finance Commission (NFC), had failed to achieve “important policy objectives”.
It noted that while the NFC provided “predictability and protected provincial revenue shares”, this financing had not translated into functional outcomes.
“The current framework reduced federal resources without a commensurate adjustment in expenditure responsibilities, driving a structural federal fiscal deficit,” the report read.
The report maintained that NFC’s horizontal distribution had not achieved “genuine fiscal equalisation”.
It further added that the formula provided “no meaningful incentives for provincial revenue effort or service delivery performance”.
“Current arrangements arguably also deter federal revenue effort, with a large share of revenues automatically transferred to provinces.”
Highlighting the final area, the report said that despite the recognition of Article 140A — which stipulates that each province shall, by law, establish a local government system and devolve political, administrative and financial responsibility and authority to the elected representatives of the local governments — local government continued to be “fiscally dependent, institutionally unstable, and effectively subordinate to provincial discretion”.
“Provincial Finance Commission (PFC) awards are infrequent and non-binding, transfers are ad hoc, and own-source revenue is minimal,” it said, stressing that proposed devolution had not “extended meaningfully below the provincial tier”.
The report further noted that deviations from good practices had also led to negative outcomes, including a structural federal fiscal deficit, weak revenue performance, limited impact on aligning public spending and service delivery with needs, and a failure to safeguard the performance of the fiscal federalism system.
“Provincial revenues, including federal transfers, rose from less than 4 per cent of gross domestic product (GDP) to an average of 6.5pc over fiscal year 2010 (FY10) to FY24, but federal expenditures did not adjust commensurately,” the report read.
It continued: “The loss in federal revenues from transfers (1.9pc of GDP) was roughly equivalent to the increase in federal primary deficits post-devolution (1.7pc of GDP).”
The report added that “misalignment” between federal financing and functional needs had contributed to “Pakistan’s fiscal deficit and accumulation of public debt”.
On weak revenue performance resulting from the existing fiscal federalism framework, the report said: “Fragmentation of the tax base across five jurisdictions has misaligned incentives, raised compliance costs, and created opportunities for avoidance.
“Federal revenues have continued to significantly underperform. Despite the expanded provincial revenue assignments, own-source tax revenue has barely increased.”
It noted that agricultural income tax was “largely uncollected”, even though the sector accounted for over 20pc of the country’s GDP.
“Urban immovable property tax generates only 0.13pc of GDP, far below comparator country norms of 0.3 to 0.6pc,” it read.
Additionally, the WB report highlighted that fiscal federalism has had a “limited impact in aligning public spending and service delivery with needs, which is contrary to the expected outcomes of the devolution.
“While provinces have increased spending on basic services since the 18th Constitutional Amendment, the largest single increase has been in administrative expenses,” the report stated.
According to the report, about 80pc of the total provincial expenditure went to “recurrent costs, with the largest share of incremental spending absorbed by general public services and administrative costs rather than education or health”.
“Spending has also remained geospatially inequitable, with district allocations driven by historical precedent rather than poverty levels or service delivery gaps,” it added.
For local government, the total government spending fell from 10pc in 2005 to 4.7pc in 2024, the report said.
It also observed that the institutions responsible for ensuring fiscal federalism had failed to safeguard the performance of the system through effective monitoring and coordination.
“The institutional framework underpinning fiscal federalism has underperformed,” it said, elaborating that the “Council of Common Interests (CCI) held only 11 meetings between 1973 and 2010 despite a constitutional requirement for quarterly meetings and a successor NFC Award has now been delayed for over a decade and a half”.
The report outlined key priorities for reforms aimed at a more suitable fiscal federalism framework.
First, it stressed the need to address the existing misalignment between the financing and functions of federal and provincial governments.
“The ongoing federal rightsizing exercise (reducing wasteful spending that overlaps with provincial mandates) should be prioritised regardless of broader reforms,” it suggested, further stating that global precedents should be utilised.
“Once achievable savings are realised, a federal revenue potential assessment should determine whether further vertical rebalancing is needed and to what degree,” the report read.
It added that the rest of the gaps should be addressed via mechanisms including: “Function-specific deductions from the divisible pool could share the burden of continued federal expenditure on national public goods such as national transport infrastructure, certain security expenditures, debt servicing, social protection, environmental programs, strategic interprovincial water infrastructure, and national policy coordination.”
Secondly, the report suggested that to address the issue of horizontal distribution, a solution which “achieves equalisation while generating positive fiscal incentives” should be adopted.
“A transparent fiscal gap approach — replacing the current complex multi-factor formula — would allocate divisible pool resources based on standardised assessments of expenditure needs versus own-source revenue capacity, eliminating disincentives to revenue effort and avoiding penalties on provinces for fiscal efficiency.”
The report added that such an approach would “preserve provincial fiscal autonomy”, citing examples of several countries adopting similar models, including Australia, Canada, China, Nigeria, and South Africa.
“This equalisation framework could be complemented by conditional transfers tied to measurable service delivery outcomes in devolved sectors such as education and health, with disbursements verified by an independent third party and supported by strengthened federal and provincial statistical systems.”
The report further suggested national priorities such as revenue collection, environmental goods, governance, and effective local government could similarly be linked to conditional transfers.
It said that the existing formula can also be improved with greater weight given to poverty, backwardness, and inverse population density indicators to strengthen redistribution; rewarding provinces for closing gaps between potential and actual own-source revenue collection, including underutilised property and agricultural taxes; and linking a share of divisible pool transfers to investments in critical public services, fiscal discipline and budget transparency, climate adaptation, disaster preparedness, and further devolution to local governments, rather than a full overhaul.
Another key priority highlighted by the World Bank called for addressing “specific problematic revenue assignment issues”.
“Fragmentation of GST between goods and services results in multiple collection agencies applying different rates, definitions, withholding rules, input adjustment mechanisms, and refund systems,” which it said was a “primary” constraint on revenue performance and called for it to be treated as a “first priority reform”.
The international lender suggested that the NFC should be able to “incentivise harmonisation of the GST base through common definitions based on a shared negative list, harmonised place-of-supply rules, expedited rollout of a unified digital filing and payment system, and comprehensive data-sharing arrangements”.
It further recommended, “Alternatively, the NFC could pursue full reunification of the GST base under centralised administration, with constitutional revenue-sharing provisions implemented through an agreed allocation formula”.
On agricultural income, the report suggested that “NFC could also promote the implementation of provincial agricultural income tax regimes recently amended to align with the federal system, and establish automatic information exchange arrangements where differences remain to prevent evasion,” it added.
To deal with property, the report recommended that NFC can support the “harmonisation of all immovable property-related levies — taxes, duties, fees, and charges — through a common valuation system and uniform methodology applied consistently across instruments”.
It further recommended the establishment of a framework for sharing the fiscal burden of social protection, which it said can be carried out through “either agreed deductions from the divisible pool or through proportionate provincial budgetary grants to federal social protection institutions”.
Fourth, the report called for empowering the local government, suggesting that clear guidelines be established for “local government structures and minimum standards for the devolution of administrative and financial decision-making, while protecting provincial autonomy through differentiated approaches”.
The report underscored the value of “transparent, objective, and regularly updated” PFC transfer systems, which can ensure allocation of resources based on defined expenditure needs and revenue capacity.
Within these local resource allocations, the report recommended that key national priorities such as health and education should be considered.
“Performance-based grants should incentivise improved service delivery and local revenue generation,” it added.
The report, in its recommendations for reforms, also emphasised that local government representatives should be made to “meaningfully” engage in the PFC process.
However, it pointed out that empowering local government would require broader reforms, including “reviewing existing governance tiers and their jurisdictional design, strengthening the role of metropolitan centres, streamlining municipal oversight of autonomous bodies, clarifying respective roles and tenures, elaborating fully aligned revenue and expenditure assignments, and mandating consistent provincial–local transfer frameworks that close resource gaps and strengthen horizontal equalisation”.
In its final reform recommendation, the World Bank report called for efforts to revive fiscal federalism institutions, stating that a revised NFC “could reinvigorate coordination bodies, clarify their mandates and functions, and create incentives for active participation”.
It added that the reform was achievable through policy decisions and legislation.
As per the report, “more ambitious future reforms could establish binding mandates to ensure role clarity, reduce overlaps in existing functions, and set minimum standards for resourcing and representation”.
Lastly, it observed that the convening of the NFC was “in itself an important reform objective”, highlighting that regular revisions would “lower the political stakes of any single negotiation, reduce perceptions of irreversibility, and create ongoing opportunities for dialogue, experimentation, and consensus-building on important fiscal federalism issues”.
