VZCZCXRO5976
RR RUEHLH RUEHPW
DE RUEHIL #2829/01 3271358
ZNR UUUUU ZZH
R 231358Z NOV 09
FM AMEMBASSY ISLAMABAD
TO RUEHC/SECSTATE WASHDC 6116
INFO RHEHNSC/NSC WASHINGTON DC
RUEATRS/DEPT OF TREASURY WASHINGTON DC
RUCPDOC/DEPT OF COMMERCE WASHINGTON DC
RUMICEA/USCENTCOM INTEL CEN MACDILL AFB FL
RUEAIIA/CIA WASHINGTON DC
RUEHNE/AMEMBASSY NEW DELHI 5788
RUEHBUL/AMEMBASSY KABUL 1197
RUEHLO/AMEMBASSY LONDON 1850
RUEHLH/AMCONSUL LAHORE 8191
RUEHKP/AMCONSUL KARACHI 2591
RUEHPW/AMCONSUL PESHAWAR 7238

UNCLAS SECTION 01 OF 02 ISLAMABAD 002829 
 
SIPDIS 
SENSITIVE 
 
E.O. 12958: N/A 
TAGS: ECON ETRD EFIN EAID PGOV PREL PK
SUBJECT: DIVVYING UP THE TAX REVENUE PIE 
 
REFTEL:  A) PESHAWAR 214 
 
1.(SBU) Summary: Pakistan's constitutionally mandated National 
Finance Commission (NFC) is tasked with meeting every five years to 
formulate the distribution of revenue between the federal and 
provincial governments.  For the first time since 1997, this body 
has convened and is currently wrangling over the degree to which 
factors like a province's population, revenue collection, and level 
of development should determine the portion of tax revenue that 
provinces receive.  The provinces are taking advantage of the 
opportunity the NFC provides to pursue unrelated financial 
grievances against the federal government, such as profits from 
hydropower owed the provinces by the federal government.  While this 
has slowed the process, members of the Commission are optimistic 
they will come to the required unanimous agreement before the next 
budget cycle begins in the spring.  End Summary. 
 
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What is the NFC? 
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¶2. (SBU) Taking action overdue by more than seven years, the GOP in 
July convened the National Finance Commission (NFC), a body charged 
with formulating the distribution of revenue between the federal and 
provincial governments.  Revenue from most taxes, including income 
tax, sales tax, customs duties and excise duties broadly make up 
what is known as the "divisible pool" - the revenue pie that the 
federal and provincial governments must divide.  As directed by 
Article 160 of the Pakistani Constitution, the Minister of Finance 
chairs the NFC and each province is represented by both its 
Provincial Finance Minister, and a private, non-statutory member. 
Article 160 also stipulates that the NFC re-examine the distribution 
of the divisible pool at least every five years, although this 
exercise has not been completed since 1997.  The NFC was convened 
once in the intervening years, in 2003, but the Commission was 
unable to come to consensus on the division of revenue between the 
provinces.  Since that time, the division has been carried out by 
Executive Ordinance. 
 
¶3. (SBU) The NFC must come to a consensus on four matters in order 
to complete its task and have the resulting agreement take effect 
for the next five years: the exact composition of the divisible 
pool; what percentage of the pool will go to the federal government; 
what percentage of the remaining pool each province will receive; 
and a number of small, peripheral issues that the NFC is tasked with 
regulating that are related to taxation policy, but that are not 
relevant to the divisible pool. 
 
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Vertical Distribution 
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¶4. (SBU) Since the last NFC in 1997, the provinces have received 
less than 50 percent of the divisible pool, but in this NFC round 
the Federal Government has publicly indicated that it will likely 
agree to give the provinces more than half.  In late October, the 
federal government announced that it would give the "maximum 
resources possible" to the provinces, but that the current fiscal 
situation would keep the provinces' total share to less than 60 
percent of the entire pool.  According to Mian Mohammad Yousaf, 
Secretary of the NFC, the provinces will receive 52 percent of this 
NFC's divisible pool. 
 
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Horizontal Distribution 
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¶5. (SBU) The sharing out of the divisible pool between the 
provinces, known as the "horizontal distribution," has historically 
been based solely on population.  The more people in a province, the 
larger its portion of the pool.  However, this formula favors the 
already developed and more financially stable Punjab and has for 
years been a source of irritation.  Secretary Yousaf said that in 
recent meetings the provinces have agreed in principle to use 
multiple criteria, specifically revenue generation, geographical 
area, and backwardness as elements to be included in the formula for 
resource distribution.  The Secretary estimated, however, that about 
60 percent of the resources given to the provinces would continue to 
be distributed based on population. 
 
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ISLAMABAD 00002829  002 OF 002 
 
 
Varying Provincial Agendas 
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¶6. (SBU) Dr. Gulfaraz, the non-statutory NFC member from 
Balochistan, spoke frankly with EconOffs about the motivations of 
the four provinces regarding the horizontal distribution.  His own 
belief is that the NFC should aim to equalize revenue distribution 
among and within the provinces and ensure the equalization of public 
service provision in each province.  Balochistan, Gulfaraz said, 
would like the NFC to consider the problem of inverse population 
density, which increases public service costs in a large, sparsely 
populated province like Balochistan.  Sindh, however, would like the 
revenue generation of a province to be a primary factor in the 
distribution of the divisible pool.  In Pakistan, revenue generation 
is credited to the headquarters of a company, no matter where it is 
truly generated, meaning that Karachi - as home to most Pakistani 
company headquarters - receives credit for generating revenue, even 
if the transactions do not take place in Sindh. 
 
¶7. (SBU) Representatives from the Northwest Frontier Province (NWFP) 
are taking yet another tactic, pushing the other NFC members to 
consider the effects of war in their province and also stressing 
their lower level of development.  The NWFP representatives to the 
NFC argue that revenue distribution should be used to bring the NWFP 
up to the same standard of development as the other provinces, as 
well as mitigate the effects of conflict.  Abdul Ghafoor Mirza, the 
non-statutory NFC member from Punjab and former Finance Secretary, 
told EconOffs that the break in the traditional horizontal 
distribution was not certain and that the standard practice of using 
population as the sole criterion is the most agreeable formula for 
Punjab - Pakistan's most populous province. 
 
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Peripheral Issues Equal Leverage 
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¶8. (SBU) Mirza said the NFC has already resolved some of the more 
critical peripheral issues.  Primary among these is the NFC decision 
that the General Sales Tax on Services (GST) will not be included in 
the divisible pool and will instead be distributed proportionally 
back to the provinces from which it was generated.  For the last 
several years the GST has been collected by the federal government, 
as the provinces themselves - although statutorily responsible for 
collecting the tax - lacked the technical means to do so.  The 
federal government charged a five percent service fee for 
collection, and then included the collected funds in the divisible 
pool for distribution to the provinces.  Given that the divisible 
pool has been distributed based on population, more populous 
provinces such as Punjab have gotten more of the GST than other 
provinces, such as Sindh that generates more of the GST.  The 
federal government has also agreed to reduce the service fee it 
charges from five percent to two to three percent. 
 
¶9. (SBU) Article 161 of the Pakistani Constitution mandates that net 
profits from hydro-electric power generation should be paid back to 
the province in which the power was generated, rather than disbursed 
through the NFC or retained by the federal government.  Just as with 
the GST, however, these power dues were retained by the federal 
government in recent years.  The NWFP delegation threatened to 
boycott the Karachi round of NFC negotiations after a promised first 
$120 million traunch of back hydro-electric payments was delayed by 
more than two weeks.  Both Punjab and the NWFP received a portion of 
the power dues owed them on the eve of the negotiations, however, 
and the Karachi round began as planned on November 18. 
 
¶10. (SBU) Comment: As the most recent round of negotiations in 
Karachi began, members of the Commission were unwilling to predict 
whether the NFC would come to a consensus before February.  However, 
both Gulfaraz and Mirza were sanguine about the Commission coming to 
the required unanimous agreement and that the NFC's work would be 
done before the next federal budget begins to take shape in May. 
End comment. 
 
 
PATTERSON