Institutional Decentralization, Fiscal Decentralization, and Sales Tax on Services Collection: Evidence from Khyber Pakhtunkhwa, Pakistan

In the complex machinery of a modern nation, the government needs money to build roads, run schools, and keep the lights on. This money comes largely from taxes, and how a country decides who collects those taxes and who keeps the money is a question of deep importance. In a large country like Pakistan, the question is whether the central government should collect all the taxes and hand out shares to the regions, or if the regions should be trusted to collect their own taxes and keep what they earn. This is the heart of fiscal decentralization, a concept where local governments are given more power and money to manage their own affairs. The theory suggests that when local leaders are closer to the people they serve, they can design better tax rules that fit local needs, leading to more trust and more money collected. However, there is a second, often overlooked piece of the puzzle: the people and the offices actually doing the collecting. Giving a region the right to collect taxes is one thing; giving it a skilled, well-equipped, and independent office to do the job is another. Without the right tools and trained staff, even the best laws can fail to bring in the revenue a region needs to thrive.

A recent study focused on the Khyber Pakhtunkhwa province of Pakistan to see how these two ideas—giving a region the right to keep its tax money and building a strong local office to collect it—work together in the real world. The researchers looked at a specific type of tax called the sales tax on services, which is charged on things like electricity bills, restaurant meals, and professional fees. For many years, the federal government collected this tax on behalf of the provinces. But in 2010, the country's constitution was changed to give the provinces the right to collect this tax themselves. Then, in 2013, the Khyber Pakhtunkhwa province took a further step by creating its own dedicated tax office, the Khyber Pakhtunkhwa Revenue Authority, to handle the job. The researchers wanted to know if simply giving the province the right to collect the tax was enough, or if the creation of this new, specialized office was the real key to success. They analyzed twenty-five years of financial records, from the year 2000 to 2025, to trace how tax collection changed over time as these reforms were put into place.

The study found that the creation of the specialized tax office was a major turning point. After the new authority began its work in 2013, the amount of sales tax collected by the province grew significantly. The researchers observed that this new office did more than just collect money; it expanded the list of services that could be taxed, improved the way people registered for taxes, and used modern technology to make it easier for citizens to pay what they owed. The presence of this dedicated, capable institution made a clear and lasting difference in the province's ability to gather revenue. The data showed that when a local government has a strong, professional team to manage the tax system, the results are much better than when the system is run by a distant central authority that may not understand local conditions.

However, the study also uncovered a surprising and counterintuitive result regarding the idea of fiscal autonomy. The researchers measured how much of a province's total money came from its own tax collection versus how much came from transfers from the central government. They found that as the province became more dependent on money sent from the central government, its own ability to collect taxes actually weakened. This does not mean that receiving money from the central government is bad, but rather that it can create a situation where the local government feels less pressure to build a strong system for collecting its own taxes. The study suggests that if a province relies too heavily on handouts from the center, it may lose the motivation to develop the tough, efficient systems needed to gather its own revenue. In other words, having the right to collect taxes is not enough if the local government is not financially independent enough to feel the need to do the hard work of collection.

The researchers concluded that the most effective path forward for the province is not just to have the legal right to collect taxes, but to invest heavily in the people and systems that do the collecting. They argued that simply handing over the responsibility of tax collection without building a capable, independent, and well-trained local authority would not lead to success. The study points out that the province needs to continue modernizing its tax office, training its staff, and using data to find and fix problems. It also suggests that the province should work to reduce its heavy reliance on central government transfers, as this dependence can dull the incentive to improve local tax collection. By strengthening its own institutional capacity and ensuring its tax office is run by experts rather than temporary staff, the province can secure a more stable and growing source of income for its future. The findings serve as a reminder that in the world of public finance, the strength of the institution matters just as much as the law that creates it.