Budget 2027 & challenges—III Death of fiscal federalism under IMF tutelage

The second part of this series, “Budget 2027 & challenges—II: IMF, petroleum levy & constitutional theft”, examined how the petroleum levy regime has effectively become a mechanism for constitutional bypass, allowing the federation to appropriate revenues outside the divisible pool mandated under Article 160 of the Constitution of Islamic Republic of Pakistan [“the Constitution”].

Recent developments now confirm that this is no longer merely a legal or academic concern. Pakistan’s fiscal federalism itself is collapsing under the combined weight of International Monetary Fund (IMF)-driven conditionalities, federal extractionism, and systematic constitutional erosion.

The latest reports reveal that the federal government is facing an alarming revenue shortfall of nearly Rs. one trillion because of the failure of Federal Board of Revenue (FBR) to achieve even the downward revised target. To conceal this structural collapse, the federation is compensating through three coercive mechanisms: excessive petroleum levy collection, drastic cuts in federal development expenditure, and pressure on provinces to generate larger cash surpluses.

According to reports, provinces are now being urged to raise an additional Rs. 400 billion in taxes while simultaneously maintaining higher cash surpluses to protect the federally negotiated IMF primary surplus target. This is not cooperative federalism. This is fiscal commandeering of federating units by an over-centralized state acting under external financial supervision.

The tragedy is that the Constitution (Eighteenth Amendment) Act, 2010 [Eighteenth Amendment]—celebrated as the restoration of parliamentary democracy and provincial autonomy after decades of centralized authoritarianism—is now being dismantled not through martial law proclamations but through fiscal manipulation, IMF conditionalities, executive notifications, and budgetary coercion.

The constitutional framework after the Eighteenth Amendment was crystal clear. Provinces were to become financially autonomous units with expanded legislative competence and constitutionally protected revenue rights. Article 160(3A) of the Constitution explicitly prohibited reduction in provincial shares under the National Finance Commission (NFC) Award. The federation was constitutionally obligated to respect fiscal decentralization as part of Pakistan’s democratic restructuring. What has happened instead is precisely the opposite.

The federation increasingly relies upon non-divisible pool revenues—particularly petroleum levy collections—to bypass constitutional revenue-sharing obligations. The petroleum levy has become the single largest instrument of fiscal centralization.

Unlike General Sales Tax (GST) on petroleum products, which would enter the divisible pool under Article 160, the petroleum levy remains exclusively with the federation. The constitutional effect is devastating: provinces are systematically deprived of billions of rupees that constitutionally belong to them. This is why the petroleum levy issue is not merely a taxation dispute. It is fundamentally a federalism dispute, which is now challenged before the Federal Constitution Court (FCC) of Pakistan.

The constitutional fraud becomes even more apparent when one examines how GST on petroleum products was reduced to zero from March 1, 2022 through an executive instrument, while petroleum levy rates were simultaneously escalated to unprecedented levels. The economic substance remains taxation of petroleum consumption, but the constitutional form is deliberately altered to deprive provinces of their lawful share. This is classic colourable legislation.

The Supreme Court in multiple judgments has consistently held that constitutional interpretation must examine substance over form. One cannot achieve indirectly what the Constitution prohibits directly. Yet successive governments, with IMF blessings, have converted petroleum pricing into a mechanism for constitutional circumvention. The irony is painful. Provinces are constitutionally entitled to fiscal autonomy, but they are now being transformed into surplus-generating agents for federal IMF compliance.

The federal government’s insistence on provincial cash surpluses exposes the complete distortion of constitutional federalism. Provincial governments are being forced to suppress their own development expenditures, delay infrastructure spending, reduce social sector allocations, and maintain artificial surpluses merely so the federation can satisfy IMF primary balance conditions. This is economic extraction disguised as macroeconomic stabilization.

Under genuine federalism, provinces should independently determine their developmental priorities based on local needs. Instead, provincial fiscal policy is increasingly subordinated to federal debt management objectives negotiated with international lenders. The Constitutional Political Economy (CPE) perspective reveals the deeper structural crisis behind this arrangement.

Pakistan’s ruling elites have gradually transformed the federation into a centralized extraction apparatus primarily designed to secure debt servicing capacity rather than citizen welfare or constitutional governance. Revenue collection is no longer directed toward productive transformation, industrialization, education, healthcare, technological advancement, or social justice. Instead, fiscal policy is overwhelmingly dominated by one objective: maintaining external creditor confidence.

This explains why indirect taxation, petroleum levies, electricity tariffs, gas surcharges, and withholding taxes continue expanding while politically connected sectors remain substantially undertaxed. The IMF itself repeatedly acknowledges that agriculture, real estate, wholesale trade, retail, and elite wealth remain under-taxed. Nevertheless, instead of confronting entrenched elite structures, the state intensifies extraction from fuel consumers, salaried classes, documented businesses, and formal sectors.

Petroleum levy collections now function as a regressive transfer mechanism from ordinary citizens to debt-servicing obligations. The common citizen pays at the fuel pump so the state may preserve macroeconomic indicators acceptable to external creditors. The provinces are simultaneously instructed to produce cash surpluses so the federation may artificially manufacture primary surpluses.

Federal development expenditure is slashed because debt servicing consumes the overwhelming share of federal revenues. This is not fiscal reform. It is the financialization of governance itself. The federation today increasingly resembles what constitutional theorists describe as a “debt-administering state”—a state whose primary policy function becomes management of creditor obligations rather than advancement of public welfare. The consequences for democracy are profound.

Once fiscal sovereignty shifts from Parliament and federating units toward externally monitored quantitative targets, democratic accountability itself weakens. Budgetary priorities increasingly reflect lender conditionalities instead of constitutional commitments or electoral mandates.

The Eighteenth Amendment envisaged decentralization of power. IMF-driven fiscal governance is producing recentralization through financial dependence. The contradiction is now irreconcilable.

How can provinces meaningfully exercise constitutional autonomy when their fiscal space is effectively controlled through federally negotiated surplus requirements?

How can Article 160 retain substantive meaning when petroleum taxation is shifted outside the divisible pool? How can Parliament claim supremacy when core fiscal decisions increasingly emerge from IMF staff-level agreements? How can social justice emerge when regressive indirect taxation substitutes structural taxation of wealth and privilege? Pakistan’s fiscal crisis is, therefore, not merely economic. It is fundamentally constitutional.

The continuing bypass of NFC principles, concentration of fiscal authority through petroleum levies, suppression of provincial fiscal autonomy, and prioritization of creditor-oriented governance collectively represent the gradual death of federal fiscalism envisioned under the Constitution.

The recent petition before the FCC challenging the petroleum levy correctly identifies this crisis as one involving parliamentary supremacy, constitutional federalism, and distributive justice.  The real issue before Pakistan today is no longer, whether the federation can temporarily satisfy IMF review conditions. The real question is whether the constitutional structure created after the Eighteenth Amendment can survive the emerging regime of centralized fiscal extraction.

A federation cannot survive permanently if federating units are treated merely as instruments for balancing federal accounts. Nor can democracy survive if budgets cease to be instruments of public welfare and instead become accounting exercises designed exclusively for debt sustainability metrics.

The Constitution of 1973 envisioned a participatory federal republic based on distributive justice, parliamentary supremacy, provincial autonomy, and welfare-oriented governance. What is emerging instead is a centralized debt-management regime where constitutional federalism is subordinated to externally supervised fiscal compression. That is why the present crisis is far larger than petroleum levy or IMF conditionalities alone.

It is about whether Pakistan shall remain a constitutional federation—or gradually transform into a fiscally centralized extraction state where the spirit of the Eighteenth Amendment exists only ceremonially while its substance stands systematically dismantled.

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Dr. Ikramul Haq, Advocate Supreme Court, Adjunct Faculty at Lahore University of Management Sciences (LUMS), member Advisory Board and Visiting Senior Fellow of Pakistan Institute of Development Economics (PIDE), holds an LLD in tax laws. He was full-time journalist from 1979 to 1984 with Viewpoint and Dawn. He also served Civil Services of Pakistan from 1984 to 1996.