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FISCAL DEFICIT AND THE PRODUCTIVITY OF THE NIGERIAS

TAX SYSTEM (1970 2010)

BY

IBOMA GODWIN E PG/08/09/167291

A dissertation submitted to the Post Graduate School, Department of Economics, in partial fulfilment of the Requirements for the Award of the Master of Science (M.Sc) Degree in Economics of the Delta State University, Abraka, Nigeria

FEBRUARY 2012

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Abstract

This study evaluates the link between fiscal deficit and the productivity of the Nigeria tax

system between 1970 - 2010 using tax buoyancy and elasticity as indexes. It also

examines some major tax reforms within the period. Overall, the analysis shows that for

most of the tax sources, the elasticity indexes were significantly less than 0.5 while for 3

out of the 10 equations the elasticity fell between 0.5 and 0.9. This indicates a relatively

weak productive tax system. The study also indicates that unlike the overall equation the

result for the oil boom period, the elasticity of petroleum profit tax was unity. The other

results followed the general results. The results for the period of the Structural

Adjustment Programme (SAP) were not significantly different from those of the oil

boom and the entire period. The study concludes that administrative lags may have

affected the remittance of tax revenues to government which may be responsible for the

low productivity observed. We therefore recommend that government should broaden the

tax base and improve on administration of tax collection.

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CHAPTER ONE INTRODUCTION

1.1 Background to the Study

Tax structure and regulations in Nigeria have undergone tremendous changes since the

colonial period. These changes were propelled by the inconsistencies and visible

confusions in the operation of various tax systems in the country. These inconsistencies

and confusion led to the establishment of the Raisman Fiscal Commission of 1958.

According to Aluko (2004), the Commission was mandated to apply uniform basic

principle for taxing incomes throughout the country. This recommendation was embodied

in the Nigerian Independence Constitution Order in Council 1960, which resulted

eventually in the enactment of the 1961 Income Tax Management Act (ITMA). ITMA

1961 was the forerunner of the Companies Income Tax (CIT) Acts 1961, 1979 and 1990

as well as the Personal Income Act 1993 as amended.

The structure of the Nigerian tax reflects the nature of the business in the economy.

Depending on the type of business, taxes are levied on businesses on an annual basis.

This implies that all businesses, organizations and taxable persons are obligated to make

a tax return to the Inland Revenue (State of Federal). Profits arising from transactions of

companies constitute taxable income following their assessment to tax. This also

includes personal income tax, which is duly imposed on individuals by the relevant tax

authority in the territory where the company has its principal office, or the place of

business on the first day of the year of assessment or year of commencement of business.

The state Board of Internal Revenue is responsible for the administration and collection

of the relevant tax in while the Federal Inland Revenue is charged with the responsibility

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of the company and other related taxes. These structures are governed by the Personal

Income Tax Act (PITA, 1993) and Company Income Tax Act (CITA, 1994) respectively

(Anyaduba, 2004).

Therefore, the Nigerian tax system is prudently organized in order to effectively enhance

the collection of taxes and reduce the incidence of tax evasion and the subsequent loss of

revenue to the government. The tax laws therefore provides for the collection of taxes at

source of the taxpayers income. This is achieved through the withholding tax system,

which allows taxes to be deducted at the source of income. This is provided in sections

63 of CITA and 72 of PITA; where the laws recommends that income tax assessable on

any company, whether or not an assessment has been made, shall if the Board (the

relevant tax authority) so directs, be recoverable from any payments made by any person

to such company.

Taxation is a dynamic subject, which grows with the constant changes in the economic

environment in which it operates, hence the need to review the regulating instruments

from time to time. As a result, there had been amendments to the various tax laws to

reflect the intention of the government. Usually, tax policies announced in a budget

speech by government become legally operational on the 1st day of the next budgetary

year. This creates time lag in implementation and administration of tax policies. The

main purpose for reviewing the regulating instruments and changes in tax policies is to

create avenue for increased revenue from taxation. In spite of these reforms and the

visible increase in revenue from taxation, the federal and state governments have on a

regular basis engaged in fiscal deficit.

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Fiscal deficit arises because public expenditure rises while revenue remains unchanged,

or tax revenue falls while public spending remains unchanged, or tax revenue falls while

public spending rises. A commonly observed phenomenon in most developing countries

like Nigeria is that, the public sector plays a dominant role in initiating and financing

economic growth. The resultant growth in public expenditure is expected to be financed

by public revenues from taxes and non-tax sources but the revenues always lag behind

the level of public expenditure, leaving large deficits in the focus.

Onwioduokit (1999) The growth and persistence of fiscal deficits in both the

industrialized and developing countries in recent times have brought the issue of fiscal

deficits into sharp focus. The issues surrounding fiscal deficits are certainly not new, but

the economic development of the past decade has rekindled the interest in fiscal policy

issues. In the advanced countries, the growth of United State Federal deficit provided the

impetus for a reassessment of the effect of fiscal deficits on economic activities (Islam

and Wetzel, 1991). In the less developed countries including Nigeria, fiscal deficits have

been blamed for much of the economic crisis that beset them in the 1980s: over

indebtedness and the debt crisis; high inflation and poor investment performance; and

growth. Attempts to regain stability at the macro-level through fiscal adjustment achieved

uneven success, raising questions about the macroeconomic consequences of public

deficits and fiscal deterioration or fiscal stabilization (Easterly and Schmidt-Hebbel,

1993).

The growth in public revenue through taxation in developing countries is restricted by

many factors such as low per capita income, limited base on which direct taxes can be

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imposed, income tax exemptions in the form of tax holidays, accelerated depreciation

rates and tax credits usually provided to the manufacturing sector, and deficiencies in tax

administration. On the other hand, public expenditure continues to grow due mainly to

mismanagement/high rate of corruption; high cost of running public administration due to

the type of political system, the level of government participation in production and

control of economic variables; and sheer inability to control spending by public office

holders (Financial Indiscipline). In addition, increasing population, insecurity and the

political system are also responsible for increase in public expenditure.

1.2 Statement of the Problem

Over the years, huge amounts of revenue have accrued to the federal, state and local

governments from taxation. In a research conducted by Ariyo and Aaheem (1991), it was

confirmed that budgetary allocation does not necessarily exceed the expected revenue.

Yet, the government on regular basis embark on extra budgetary activities indicating the

non-sustainability of the tax revenue.

On the basis of the above, there has been a growing concern over the use of fiscal deficit

as an option in accelerating economic growth and development especially in developing

countries like Nigeria. This situation arises from the ever-increasing magnitude of deficit

by the government of most developing countries. It was on this ground that Ariyo,

(1993) points out the implications of fiscal deficits on growth and economic reforms in

these countries. Chibber and Khalizadeh, (1988), have also suggested that economic

reforms should cover not only the size and financing pattern of government deficits, but

also the structure of taxation and the level and composition of public expenditure.

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Studies conducted by different scholars suggest the need for concerned attention about

the problem of fiscal deficit in Nigeria. A study by Ariyo and Raheem, (1990) reports

that fiscal deficit has become a recurring feature of Nigerias fiscal policy and notes the

absence of any identifiable macroeconomic objective to justify this deficit-prone

behaviour. In same vein, Onwioduokit (2002) opined that Government expenditure in

Nigeria has consistently exceeded revenue for most of the years beginning from 1980 and

that the symptoms of such fiscal imbalance are, of course, budget deficits. While budget

deficits are nothing new in the countrys history, the recent size of the deficit has been a

cause of concern to many people including academics, policy makers, and investors. It is,

however, pertinent to note that much of the debates over the deficits have been more

related to the effects of unacceptably large deficits rather than with the causes of the

deficits

Furthermore, Ariyo, (1993) reports that the level of fiscal deficit in Nigeria has become

unsustainable since 1980. When a country experiences non-sustainable fiscal deficit,

there are three options opened to the government for addressing the problem. These

options according to Zee, (1988) are determination of the optimal tax rate for a given

level of expenditure; determination of the optimal level of expenditure for a given tax

rate; and simultaneous determination of the optimal level of expenditure and tax rate.

This study therefore focuses on the first option to enable us to determine a sustainable

level of revenue as a basis for evolving sustainable deficit profile in Nigeria. This choice

is influenced by the following considerations. Firstly, this research is essentially a

follow-up of related studies by Ariyo and Raheem, (1990) and Ariyo, (1993), which

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indicate that the level of fiscal deficit in Nigeria is no longer sustainable and it is not

desirable to continue to incur budget deficit for financing public expenditure. Rather,

efforts should be made to reduce expenditure or raise additional revenue by expanding

revenue sources and by exercising some financial discipline.

Second, it is preferable to focus on revenue enhancement tax policy in view of the current

situation in Nigeria. Most development policies in the country today are geared toward

rebranding Nigerians, fighting corruption and implementing the Vision 2020. This as we

know requires large financial outlay on activities that are not directly productive in the

short, a situation that is expected to continue for some years. Therefore, a significant

reduction or switching of public expenditure into directly non-productive real sectors of

the economy is not a viable proposition in the short run in the phase of high rate of

unemployment, youth restiveness, insecurity and unresolved political crisis.

Third, Lipumba and Mbelle, (1990) indicate that increasing revenue and reducing

expenditure are some of the most important fiscal challenges facing a government

entangled in the budget deficit problem. Ndekwu, (1991) also noted that more than ever

before, there is now a great demand for the optimization of revenue from various tax

sources in Nigeria. This probably influenced the decision of the Federal Government of

Nigeria (FGN), which in 1991 set up a Study Group on the Review of the Nigerian Tax

System and Administration.

Finally, an accurate estimation of the appropriate level of optimal rate that will match the

required level of expenditure requires the knowledge of the productivity of the tax

system. This will assist in identifying a sustainable revenue profile for the country. It will

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also help in determining appropriate modifications to the existing tax structure and rates

as well as areas for improving tax administration.

It should be noted that the advent of the oil boom in the 1973 and 1974 fiscal year

encouraged over-reliance on oil revenue to the neglect of the traditional revenue sources.

As a result, some non-oil revenue sources were either, abandoned or became of less

concern to the government, and no attention was paid to assessing the optimal revenue

derivable from these non-oil sources. Further, there were episodic jumps in the countrys

total annual revenue and hence budget deficits (Ariyo and Raheem, (1990). This is a

reflection of the vagaries of the oil market whose fortunes fluctuate widely and

unpredictably.

This research work therefore appraises fiscal deficit and the productivity of the Nigerian

tax system. This will assist in an objective assessment of the countrys sustainable level

of revenue as a basis for determining an optimal level of expenditure. It will also

facilitate the design of fiscal policies to overcome the deficit problem in the long run.

1.3 Research Questions

Given the magnitude of the fiscal deficit problem in Nigeria and the length of the period

of time under consideration, fundamental questions are raised for this dissertation.

Amongst these fundamental questions are:

1. What is the relationship between government total tax revenue (GTR) and the

Gross Domestic Product (GDP) in Nigeria?

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2. Does an increase in government tax revenue (GTR) lead to the same proportionate

increase in Gross Domestic Product (GDP) in Nigeria?

3. What are the impacts of the non-oil revenue (NOR) on the non-oil gross domestic

product (NGDP) in Nigeria?

4. Is there any relationship between the custom and excise duties (CEXD) and the

gross domestic product (GDP) in Nigeria?

5. Does the petroleum profit tax (PPT) have any significant impact on the total oil

revenue (TOR)?

6. What is the impact of the petroleum profit tax (PPT) on the gross domestic product

(GDP) in Nigeria?

7. Does the company income tax (CIT) have any effect on the gross domestic

product (GDP) in Nigeria?

8. Does the company income tax (CIT) have any effect on the non-oil gross domestic

product (NGDP) in Nigeria?

1.4 Objectives of the Study

The main objective of this study is to examine the productivity of the Nigerian tax system

with a view to determining whether it is adequate in meeting budget proposals without

recourse to budget deficits as an option in budget finance, knowing well that taxation is

one of the major sources of government revenue. The specific objectives are as follows.

1. To examine the relationship between government total revenue and the gross

domestic product in Nigeria.

2. To investigate the impact of increasing government tax revenue on the Gross

Domestic Product (GDP) in Nigeria.

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3. To examine the index of tax buoyancy in Nigeria from 1970 2010

4. To investigate the relationship between non-oil revenue and the gross domestic

product in Nigeria.

5. To empirically establish the relationship between petroleum profit tax and the total

oil revenue as well as the GDP.

6. To investigate the impacts of the total oil revenue on the gross domestic product of

Nigeria.

7. To investigate the impact of custom and excise duties on the non-oil gross

domestic product in Nigeria.

8. To examine the relationship between the company income tax and the GDP and

NGDP.

1.5 Research Hypotheses

The hypothesis formulated for this dissertation is meant to test relationship between

government tax revenue, tax sources and tax productivity. These hypotheses are

formulated in null form.

Hypothesis 1

Ho: There is no significant relationship between the federal government tax (GTR)

revenue and gross domestic product (GDP) in Nigeria.

Hypothesis 2

H1: There is no significant relationship between the non-oil revenue (NOR) and the

NGDP in Nigeria.

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Hypothesis 3

H1: There is no significant relationship between the petroleum profit tax (PPT) and

total oil revenue (TOR).

Hypothesis 4

H1: Company Income tax does not significantly affect the GDP and the NGDP in

Nigeria.

Hypothesis 5

H1: Revenue from total export (TEXP) does not have any significant effect on the

gross domestic product (GDP).

Hypothesis 6

H1: There is no significant relationship between custom and excise duties and the non-

oil gross domestic product (NGDP) in Nigeria.

1.6 Scope and Delimitation of the Study

This research work examines fiscal deficit and the productivity of the Nigerias Tax

System (1970 2010). It covers the structure of the Nigerian tax system and justifies the

productivity of the system. The researcher obtained data, which cover a period of 40

years after independence (1970 2010). It examines sources of revenue, tax elasticity

and buoyancy, fiscal federalism, the impact of the oil boom and government expenditure

in general.

1.7 Significance of the Study

Successive governments in developing countries have expressed concern about the level

of fiscal indiscipline and the low level of the productivity of the tax system especially in

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developing countries and Nigeria in particular. Therefore, this research work is relevant

to all the three tiers of government as the research is concerned with the examination of

the link between fiscal deficit and the productivity of the Nigerias tax system and draw

attention to how this should be curtailed in Nigeria.

The dissertation also assist in identifying a sustainable revenue profile for the

country thereby helping to determine appropriate modifications to existing tax structure

and rates as well as improving tax administration. Significantly also, this work

contributes to knowledge as it improved upon the work of previous studies such as the

work of Ariyo, (1997), Ariyo, (1993), Ariyo and Raheem (1991, and 1990) by adding

more variables and extension of the period of study to 40 years.

1.8 Limitations of the Study

The major hindrance to this study is the dearth of adequate research materials such as the

accurate data on GDP, Custom and Excise Duties, Company Income Tax, etc necessary

for a smooth research work. However, these problems were resolved through the use of

published data from the Central Bank of Nigeria (CBN), the Federal Office of Statistics

(FOS), and The National Bureaux of Statistics (NBS). The problem encountered in the

use of these secondary data, was that there were slight variation in the data published by

the different agencies.

1.9 Organization of the Study

The research work is organized in five (5) chapters where chapter one discusses the

preliminary task of the research. It is sub-divided into nine sub-units. Chapter two

concentrates on the review of related literature and theoretical framework. Chapter three

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discusses research methodology while four is concerned with data presentation and

analysis of results. The last chapter which is chapter five focuses on summary,

recommendations and conclusion.

1.10 Definition of Terms

To enhance a proper understanding of this dissertation, some of the terms used in this

work are defined and explained below:

Fiscal Deficit:- According to Alade, (2003) Fiscal deficit is the amount by which

government spending exceeds government revenue and it is usually considered

expansionary, while the World Bank (1988) refers to fiscal deficit as the excess of public

sectors spending over its revenue.

Deficit Financing:- This is an economic phenomenon which shows that government

expenditure surpasses the total revenue in the country.

Convection Fiscal Deficit:- This is the measure of the difference between total

government outlays and receipt, excluding changes in debts, which can be measured in

cash or actual basis.

Tax Productivity:- Tax productivity relates to the concept of efficiency in tax

administration and collection. Therefore, a tax system is said to be productive if and only

if the revenue generated is able to achieve the purpose for which the tax is being

collected.

Tax Elasticity:- This is the ratio between the percentage change in revenue and the

percentage change in the base year.

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Fiscal Indiscipline:- This is a sheer inability of public office holders and policy makers

to control expenditure. It is the inability to adhere strictly to the expenditure as stipulated

budget allocation. Off time, they exceed what is allocated for a particular project or

sector. It is a phenomenon that arises due to the high level of corruption in an economy.

Tax Buoyancy:- T his is the measure of the total response of tax revenue to changes in

income. In fact, Ariyo (1997) opines that, tax buoyancy is the changes in tax revenue due

to changes not only in income but also in other discretionary changes in tax policy.

Laffer Curve:- According to Newberry and Stern (1987), Laffer curve is a theoretical

representation of the relationship between government revenue raised from taxation and

all possible rates of taxation. It is used to illustrate the concept of taxable income

elasticity. The Laffer curve assumes that at 0% tax rate no revenue is generated and at

100% tax rate, no revenue is also generated.

Dependency Syndrome:- An attitude and belief that a group (country) cannot solve its

own problems without seeking external help especially from other countries.

Dutch Disease Syndrome:- This is a concept that purportedly explains the apparent

relationship between the increase in exploitation of natural resources and a decline in the

manufacturing sector. In this research, it is used to refer to the relationship between the

increase in tax revenue and a decline in private sector benefits accruing from the tax

revenue.

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Crowding Out of Private Sector:- This is when there is decline in investment resulting

from the effect of the fiscal policy expansion in private expenditure or investment.

According to Jhingan, (2005), it is the reduction in private expenditure or investment

caused by any increase in government expenditure through deficit budget via a tax cut

increase in money supply or bond issue.

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CHAPTER TWO

LITERATURE REVIEW AND THEORETICAL FRAMEWORK

2.0 Introduction

This Chapter is concerned with a review of literature on fiscal deficit and the productivity

of the Nigerian tax system from 1970 2010. It is structured into five sections some of

which are further divided into sub-sections. The first section examines the overview of

the Nigerian tax system with fiscal deficit in Nigeria while the second deals with the

sustainability of the Nigeria tax system. The second comprises of two sub-sections such

as fiscal deficit in Nigeria and monetary impacts of fiscal deficit. The third section

discusses Nigerian Fiscal Federalism, which is also sub-divided into two sub-sections

Revenue Profile of the Federal Government of Nigeria and the Structure of Tax-Based

Revenue in Nigeria. In section four, the Current Legal Framework is examined. This is

made up of Tax Reforms in Nigeria, taxes collectible by the federal government,

taxes/levies collectible by state governments and taxes/levies collectible by local

governments. The last section of this chapter discusses the Concept of Productivity of a

tax system with sub-sections as, theoretical framework, the tax buoyancy, tax elasticity

and Tax Stability

2. 1 Overview of the Nigerias Tax System

Taxation is not new to the country. Prior to independence, taxes existed in the form of

direct taxes which were introduced into the Northern part of the country by Lord Lugard

in 1904 and later to other parts of the country specifically, Western Nigeria in 1917 and

Eastern Nigeria in 1928. After the independence, the need to collect personal income tax

from the entire country led to the promulgation of a uniform tax law, which gave birth to

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the Income Tax Management Act (ITMA) of 1961, which was enforceable in the

federation.

Prior to the advent of oil in 1971, revenue from the traditional sources, such as tax on

export products like cocoa, groundnut and palm kernel provided adequate revenue for the

needs of the public sector. In addition, most people outside the tax net used to pay the

poll tax. Following the oil boom, however, little attention was paid to these non-oil

revenue sources. Consequently, there arose over-dependence on oil revenue as the anchor

for public expenditure programming thus, a structural change in the federal tax sources.

According to Ariyo (1997) the relative contribution of oil revenue increased from 18.9%

in 1970 to 80.7% in 1974, rising further to 82.2% in 1989. This trend continues in 1990

and rose to 84% in 1993. (See table above).

Given the fragile nature of the oil market, the countrys revenue profile has been

subjected to wide fluctuations over the years. This, in addition to overambitious

expenditure programmes resulted in episodic jumps in the countrys budget deficits.

Ijewere, (1991) and Ndekwu, (1991) noted that successive governments have expressed

concern about the low level of productivity of the Nigerian tax system. This has been

attributed largely to the deficiencies in the tax administration and collection system,

complex legislation, and apathy, especially on the part of those outside the tax net.

In view of this, the Federal Government of Nigeria (FGN) in 1991 set up a study group

on the review of the Nigerian tax system management and administration. A behavioural

explanation for this fiscal stance had been elaborated upon by Olopoenia (1991) in his

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discussion of the impact of a sudden surge in oil revenue in the context of the Dutch

disease syndrome (Corden and Nealy, 1982; Herberger, 1983). He explained how the

confidence of wealth effect influences governments expenditures and non-oil revenue

efforts. With respect to the latter, he indicated that the government may want to pass on

some of its oil revenues to the private sector indirectly in the form of lower non-oil tax

rate and levels.

Aghevli and Sassanpour (1982), Veez-Zedeh (1989) and Ezeabasili and Mojekwu, (2011)

also noted that the level of non-oil revenue is influenced by the level of economic activity

in the non-oil sector as well as by the oil wealth effect. Specifically, the extent to which

the government withdraws resources from the non-oil sector may depend on its

perception of the oil wealth. If oil wealth is perceived to be permanent, there may be a

desire by government to transfer some of the wealth to the private non-oil sector through

a reduction in non-oil tax burden. This orientation negatively affects the productivity of

the non-oil tax sources in particular and the tax system in general. However, there is

paucity of comprehensive research on the productivity of the Nigerian tax system. Rather,

most research has focused only on a single aspect of the tax sources. For example,

Idachaba (1984) assessed the tax-to-base elasticities of import and export duties in terms

of total imports and exports. Similarly, Diejomaoh (1986) estimated the income

elasticities of import volume over the period 1954-1964.

The Nigerian tax system is discussed under three interrelated constituents. The first

constituent is tax policy, which is the particular course of action adopted, and in this case,

the line of action adopted by government in respect of taxation. Taxation, we know is one

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of the major fiscal policy instruments used in regulating the economy, boosting

investments, encouraging savings capacity, regulating inflation and so on. Ariyo and

Raheem (1991) stated that the policy objective of any government tax system is aimed at

achieving the following: to create a fair and equitable society; to create an economic

society free of distortion to investment decisions; to encourage a fair allocation of savings

amongst investment opportunities; to create incentive to hard work or for risk taking in

business; to attract foreign investments or at least avoid capital flight to countries with

lower taxes; to reduce evasion and avoidance and the growth of underground economy

and encourage voluntary compliance and to reduce the complexity of the system both for

the tax administrators and the tax payers. The second constituent is tax laws, which are

the laid statutory acts, that guide the collection and administration of taxes in Nigeria.

These laid statutory acts where identified by Odusola (2006) as the major tax laws in

existence as of September 2003 and their various related amendments. The thirdly

constituent is tax administration in Nigeria, which is the regulatory framework set up to

guide and monitors the collection of taxes. Taxation has been in existence even before the

amalgamation of Nigeria as a political entity in 1914. Direct taxes, which were first

introduced into the northern part of Nigeria, were successfully administered because the

citizens were already used to one form of tax or another before the formalization of direct

taxes.

The effectiveness of the administrative arrangement under the emirate system was the

major factor responsible for successfully administration of tax. With the amalgamation of

the northern and the southern protectorates in 1914, direct taxation was introduced into

the Western territory in 1919, and into the Eastern provinces around 1928. Therefore, the

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enabling laws and regulations were fashioned after those of Britain. As a result, Odusola,

(2006) opined that the Nigerian tax administration faces serious, complex and

multidimensional problems. Similarly, according to Ariyo, (1997), the problems are; the

deficiency in tax administration and collection system, complex legislation and apathy of

the Nigerians caused by the lack of value received in return for their taxation money as

taxes.

However, according to Odusola, some of the major problems are, the politics of revenue

allocation in Nigeria, which does not prioritize tax efforts. Instead, it is anchored on such

factors, as equality of states 40%, population 30%, landmass and terrain 10%, social

development needs 10%, and internal revenue efforts 10%. This approach, discourages a

proactive revenue drive, particularly for internally generated revenue, and makes all

government tiers heavily reliant on unstable oil revenues, which are affected by the

volatility of the international oil markets. Apart from the national Cake Sharing

Syndrome, the instability and volatility of oil revenue created an opportunity for

improved tax efforts within the provisions on taxation ratified in the 1999 Constitution.

Although some states governments such as Lagos, Edo, Delta, River etc, have initiated

measures to enhance their revenue generation base through taxation, the outcome has not

reflected any level of serious effort.

Taxation is one of the sources of revenue to the government, which is used to finance or

run public debts, and for any tax to be legal, it must be a creation of the law as no citizen

would want to pay any imposition which is not backed by law. Therefore, the basic laws

or principles applicable to all forms of tax collection are also applicable to the trading

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income of individuals and companies, on their profits or gains. There is exception

however for agricultural business where there is no time limit for set-off of losses. All

income accruing to a company are taxed on preceding year basis rule and none is taxed

on actual basis except when the commencement or cessation provisions are being

applied. In case of Personal Income (PIT) however, salary, pension, commission, and

allowances are taxed on current year basis while rent, dividend, interest, and business

profits are taxed on preceding year basis.

However, due to high rate of corruption and fiscal indiscipline coupled with low tax base,

the revenue generated from taxation has not always been sufficient for the purposes for

which the revenue is generated. This insufficiency creates the problems of fiscal deficit as

most government often borrow to augment their revenue. When the government acquires

loans and it is not properly managed for the purposes for which the loan is acquired, the

vacuum created my result to macroeconomic instability in the country. Anyanwu,

(1997) opines that the size of public sector fiscal deficit is one of the most reliable

indicators of the overall macroeconomic instability or macroeconomic balance and

growth if not properly managed. He further contended that, high fiscal deficits is an

indication of at least one form of macroeconomic imbalance such as increase foreign

debts, increased inflation rate, shortage of foreign exchange and the crowding out of

public sector.

Researchers have found out that the most important statistics used in measuring the

impact of government fiscal policy in Nigeria is the size of government surplus or deficit.

In fact, Ariyo (1997), recalled that, the magnitude of government surplus or deficit is one

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of the single most important statistics used in measuring the impact of government fiscal

policy on an economy. Based on this fact, it is widely accepted by scholars such as

Okpara (2010), Obi and Nurudeen (2008) as well as Ariyo (1993) that public sector

finances and related policies constitute the central aspect of the management of the

economy. Thus, the quality of this management in no small measure influences overall

macroeconomic performance as well as the distribution of resources between the public

and private sectors.

The budget structure of most developing countries indicates that fiscal deficit is a

recurring feature of public sector financing. This phenomenon is partly influenced by the

desire of these governments to meet up with the ever-increasing demands of their

populace and to accelerate economic growth and development. Ariyo, (1997) buttressed

this fact when he opined that the recurring feature of deficit is a common phenomenon in

developing countries where the populace looks up to the government for the satisfaction

of their needs.

Attempts have been made to categorise fiscal deficit in various ways. For example, the

usefulness of fiscal deficit as a tool for enhancing accelerated growth and development

has been discussed along positive and negative directions. The work of Thornton (1990)

indicates a net positive effect between fiscal deficit and economic growth and

development. On the other hand, Baily, (1980) and Landau (1983) indicate a net negative

effect. Secondly, the mode of financing a fiscal deficit is another issue. Ariyo, (1997)

identifies the different finance options available to the government as, (i) running down

government accumulated cash balance (ii) net borrowing from the banking system or

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abroad (iii) issuing of new currency (iv) drawing down the countrys foreign assets. In

using any of these options however, the government has to be careful as each has

different impacts on the economy. The sustainability of a fiscal deficit requires that, if

there is no sustainability of the fiscal deficit, then according to Wickens and Uctum

(1990), the country will be permanently insolvent.

Taxation was one of the largest sources of government revenue before the discovering of

petroleum. Nevertheless, the amount of revenue collected from taxation is a function of

the tax system, which on its own is a major determinant of other macroeconomic indexes.

It is on this basis that Hinricks (1986) and Musgrave (1984) observed that economic

development has a very strong impact on a countrys tax system and policies. This is

because, the countrys tax policies vary with stages of development as the criteria by

which a tax structure is judged depends on the relative importance of each of the tax

sources and other sources of revenue generation, which as we know vary from time to

time. In spite of the huge amount of revenue realized from taxation, the government

especially in developing countries still engage in deficit financing. This was the view of

Anyawu, (1997) when he said that despite the fact that the revenue realized are often

above budgetary estimates, extra-budgetary expenditures have been rising so fast,

resulting in ever bigger fiscal deficit. He therefore defines the overall fiscal deficit as

the difference between the sum of both current and capital revenues plus grants and the

sum of current and capital expenditures plus net lending.

A critical review of the deficit financing option even from the lay point of view shows

that there is no identifiable macroeconomic objective given increase revenue from

25

petroleum, rising inflation rate, increasing in national debts, and low industrial capacity,

to justify the deficit financing option of the government. Hence, there is a reason to

believe that fiscal deficit in developing countries and Nigeria in particular, has generated

the problem of non-productivity of the tax system.

The problem of non-sustainability of fiscal deficit has become a recurring feature of

public sector financing all over the world. However, the tendency toward deficit

financing is more pronounced in developing countries where the populace looks to the

government for the satisfaction of most needs. In view of its phenomena growth, it is

now widely accepted that public sector finances and related policies constitute a central

aspect of the management of macroeconomic policies. The quality of this management in

no small measure influences overall macroeconomic performance as well as the

distribution of resources between the public and private sectors.

In other to enhance the quality of tax administration and management, the Federal

Government of Nigeria in 1991 set up a study group on the Review of the Nigerian Tax

System and Administration. This is relevant for the fact that an accurate estimation of the

optimal level of expenditure requires the knowledge of the productivity of the tax system.

This will assist in identifying a sustainable revenue profile for the country and will help

in determining appropriate modifications to the existing tax structure and rates as well as

areas for improving tax administration.

Various scholars have identified three issues that would guide decisions making on the

fiscal deficit profile for an economy. The first issue relates to the usefulness of fiscal

26

deficit as a tool for enhancing accelerated growth and development. This is an issue on

which, there is yet no consensus among economists, given the divergent findings of

reported studies. While some studies like that of Thornton, (1990) indicate a net positive

effect, that of Baily, (1980), Feldstein (1980) and Landau, (1983) suggest a net negative

effect. Ariyo and Raheem, (1991) also reported mixed results on the effect of deficit

financing as reported by some other studies.

The second issue relates to the mode of financing the deficit suggesting that running

down of government accumulated cash balance, net borrowing from the banking system

or from abroad, issuing of new currency as well as drawing down of foreign assets (Ariyo

and Raheem, 1990) are mode of financing fiscal deficit. However, Chibber and

Khalizadeh, (1988), Yellen, (1996) opined that each mode of financing fiscal deficit have

different impact on the economy. Thirdly, and most importantly, Buiter, (1988) as well as

Wickens and Uctum, (1990) reiterated that a fiscal deficit profile must be sustainable,

otherwise, the country will become perpetually insolvent.

The Nigerian tax system prior to the discovering of oil was dominated by revenue from

the traditional sources of revenue, export of primary products. Okpara (2010), opined that

between 1960 and early 1970s, revenue from agricultural products dominated the revenue

structure, while revenue from other sources was considered as residual. However, Ariyo

(1997) posited that, since the discovering of oil, and following the boom resulting from it,

oil revenue dominated the Nigeria revenue structure and thus, there is sharp increase in

the share of federally collected revenue. Since then, oil has accounted for at least over

80% of the federally collected revenue, implying that the traditional tax revenue sources

27

are being neglected and does not assume any strong role in the management of fiscal

policy in the country. The implication was a drastic fall in revenue from these sources

creating varied problems in the country.

The need to address the problems created through the negligence of the traditional

sources of revenue led to different tax policy reforms. These reforms however have

created no much impact on revenue generation in Nigeria since petroleum still dominates

the revenue profile. Therefore, the efficacy of the effect of the tax system reforms in

general seems to be questionable.

A countrys tax system is a major determinant of other macroeconomic indexes. There is

the fact that, for both developed and developing economies, there exist a relationship

between tax structure and the level of economic growth and development. In fact,

Hinricks, (1992) and Musgrave and Musgrave, (1994), have argued that the level of

economic development has a very strong impact on a countrys tax base, but however, tax

policy objectives vary with the stages of development. For example, during the colonial

era and immediately after the Nigerian political independence in 1960, the sole objective

of taxation was to raise revenue. Later on, emphasis shifted to the infant industries

protection and income redistribution objectives.

In addressing this issue of the relationship between productivity of the tax system and

economic development, Musgrave and Musgrave (1984) divided the periods of economic

development into two, the early period when an economy is relatively underdeveloped

28

and the later period when the economy is developed and that during the early period,

there is limited scope for the use of direct taxes because the majority of the populace

reside in the rural areas and are engaged in subsistence agriculture. Because their

incomes are difficult to estimate, tax assessment at these stages is based on presumptions

and prone to wide margins of error.

In the early period of economic development, government revenue is characterized by the

dominance of agricultural taxation, which serves as a proxy for personal income taxation.

This was not different in Nigeria where the various marketing boards served as effective

mechanisms for administering agricultural taxation. Ariyo (1997) opined that

agricultural taxation substituted for personal income tax given the difficulty in reaching

individual farmers and the inability to measure their tax liability accurately. Furthermore,

Musgrave and Musgrave (1984) opined that the large percentage of self-employment to

total employment makes effective personal income tax unworkable and this was the

situation in Nigeria. This problem thereby necessitates the use of the ability-to-pay

principle, effectively limiting personal income taxation to the wage income of civil

servants and employees of large firms both of which account for an insignificant

proportion of the total working population.

During the early period of economic development, direct taxes in form of Company

Income Taxes (CIT) were looked down upon because there were few home-based

industries and so revenue generation from these sources was insignificant. The same

principle applies to excise tax (an indirect tax) on locally manufactured goods. However,

29

both direct and indirect tax increased in relative importance as economic development

progresses, and due to growth or non-static nature of the bases of these taxes.

At this early stage also, taxes are difficult to collect because of the lack of skills and

facilities for tax administration (Hinricks, 1996). Given this, a complicated tax structure

is not feasible and the amount of revenue from personal income tax will depend on

taxpayers compliance and the efficiency of the tax collector. Although taxation was one

of the major sources of revenue to the government, other important source of government

revenue during the early stages of economic development is the foreign trade sector

because exports and imports are readily identifiable and they pass through few ports.

Massel (1996) opined that revenue from export and custom duties is not stable because of

periodic fluctuations in the prices of primary products and this tends to complicate plan

implementation in many developing countries.

Economic development brings with it an increase in the share of direct taxes in total

revenue. This is consistent with the experience of developed economies in which direct

taxes yield more revenue than indirect taxes. For example, personal income tax becomes

important as the share of employment in the industrial sector increases. In developing

countries like Nigeria however, the dominance of the agricultural sector decreases with

the discovery of oil and sales tax may be broadened because a great deal of output and

income go through the formal market as the economy becomes more monetized.

Musgrave and Musgrave, (1984) noted that at this stage, taxes may be imposed on firms

or individuals, on expenditures or receipts, and on factor inputs or products, among

30

others. He further argued that there would be a tendency to shift from indirect to direct

taxes. His theory relates to a normal development process. This was not however

relevant to Nigeria as he does not consider a situation where the sudden emergence of an

oil boom provides an unanticipated source of huge revenue. Hence, this stereotype may

not be applicable to an oil-based economy like Nigeria. Nevertheless, the theory still

represents a benchmark against which country specific empirical evidence may be

compared.

2.2 Sustainability of the Nigeria Tax System

In this dissertation, I will define the term Sustainable Tax System as means or tax

system that is sufficiently in agreement with or in harmony with the prevailing economic

and political factors in a country to persist without the need for repeated major tax

reforms. Experience suggests that any state that wishes to both grow and to implement

redistributive fiscal policies must first establish an administrable and efficient tax system.

At the same time, however, to make such a system politically sustainable, it must be

considered fair by a majority of the politically relevant population.

One reason why many developing countries like Nigeria do not appear to have either an

efficient or a fair tax system is essentially because of the very limited scope of this

segment of the population, so that the politically relevant domain of the fiscal system is

considerably smaller than the population as a whole. Specifically, researches has

indicated that any instrument that will help in achieving a sustainable tax system should

strike the right balance between the equity and efficiency aspects of taxation in terms of

the equilibrium of political forces.

31

Ariyo (1990) opines that in general however, any country that is absolutely relying on

taxation as their major source of revenue and wishing to attain rapid economic growth

and development must watch the sustainability of their tax system as it were, because it

cannot be induced by better fiscal institutions. On the contrary, a more encompassing and

legitimate state is itself the key ingredient needed for a more balanced and sustainable tax

system. Countries with similar economic characteristics and similar economic situations

can and have sustained very different tax levels and structures, reflecting their different

political situation. However, we must not ignore the phrase currently popular in the

literature of political economics, that when it comes to tax matters in general politics

rule.

2.2.1 Fiscal Deficit in Nigeria

There is no conceptual controversy over the definition of fiscal deficit. From every

ramification, the term is synonymous with budget deficit. Alade (2003) defines fiscal

deficit as the amount by which government spending exceeds government revenue and it

is usually considered expansionary. While the World Bank (1995) refers to fiscal deficit

as the excess of public sectors spending over its revenue. As a result of the fact that

fiscal policies are carried out to manage the entire economy, Anyanwu, (1997) opined

that the most important aspects of fiscal policies are centred on the management of the

public sectors fiscal deficit. This is because, it has been widely recognised that fiscal

deficit is one of the key macroeconomic indicators.

Anyanwu (1997) identifies three different instruments (gauges) with which we can assess

the fiscal deficit profile of a country. The first is, determined by the type of deficit to be

32

measured within the public sector coverage. According to him, the standard measure of

the fiscal deficit is the convectional deficit, which measures the difference between total

government outlays and receipts, excluding changes in debts, which could be measured in

cash or actual basis. As a result, if it is measured on pure cash basis, the convectional

deficit is the same as the Public Sector Net Borrowing Requirement (PSBR). Therefore,

the PSBR is a consolidated public sector deficit, which represents the total excess of

expenditure over revenue at all government levels. The second instrument, which

depends on the coverage or size of the public sector and its composition, recognises that

government transactions relevant for measuring the impact of the fiscal deficit are

sometimes carried out by non-government agencies.

In fact, Anyanwu further affirms that the general government deficit must in many cases

be expanded to encompass the operations of the non-financial public enterprise, which of

cause regenerate non-financial public sector deficit. The third gauge is that which is

relevant to the time horizon. This method of assessing fiscal deficit came into light due to

the failure of the convectional annual fiscal deficit assessment to put into consideration

the effects of changes in prices and valuation. Therefore, that to accurately assess the

sustainability of government fiscal deficit, it requires the replacement of the annual

deficit with a measure of changes in government net worth over the years.

In Anyanwu (1997), the extent to which any given public sector fiscal deficit can be

reconciled with broader macroeconomic goals also depends largely on the way it is being

financed. Thus, the success and failure of public sector fiscal deficit management

depends on how it is being paid for or financed. Iyoha (2004) opined that on account of

33

the structural and systematic problems in the Less Developed Countries (LDCs), budget

deficit invariably appears in the normal course of governance. He therefore, identifies

three sources of financing a public sector deficit as, deficit financing (borrowing from

central Bank), domestic borrowing (from non-bank public) and external borrowing i.e,

borrowing from other countries or international organisations such as International

Monetary Fund (IMF), Paris Club, World Bank etc.

Each of these approaches of financing public sector fiscal deficit has its advantages and

disadvantages depending on whether the money borrowed is being used to finance the

purchase of consumption goods for the economy or it is used to finance white elephant

projects, which is always the case with most Less Developed Countries (LDCs). In an

economy like that of Nigeria, which is prone to high rate of corruption, spending

government revenue on elephant projects is a common phenomenon. Hence, Gordon,

(2006) stated that fiscal deficit causes foreign borrowing in a small open economy; but it

causes both foreign borrowing and crowding out of the economy in a large open

economy.

2.2.2 Monetary Impacts of Fiscal Deficit

Alade, (2003) and Fjeldstad,(2003) pointed out that the impact of fiscal policy on

aggregate demand can also be estimated by looking at the fiscal deficit or surplus and

examining its impact on the liquidity of the economy. According to them, if an economy

is in a recession and operating at less than full capacity, higher government spending may

assist in increasing real output and promoting additional employment. He therefore

opines that monetary effects of government fiscal deficit are complex and show the inter-

34

relationship between fiscal and monetary policy. He identified two broad monetary

impact of fiscal deficit on the economy. Firstly, money supply will tend to rise,

influencing private sector wealth and asset portfolio decisions with respect to financial

and real assets. Interest rate will be affected and so will governments deficit financing

arrangement. Thus, financial crowding out may arise if governments demand for credit

reduces the availability of finance to the private sector. Secondly, as a result of the rise in

money supply arising from a fiscal deficit, the reserve base of the financial institutions

will tend to increase and this will affect their ability to create credit. In addition, if

accretion to financial institutions reserves is not curbed by monetary policy the supply of

credit may grow and contributes to further increase in monetary aggregate.

2.3 Nigerian Fiscal Federalism (Assignment of Tax Powers)

According to Ariyo (1997) fiscal federalism refers to the existence in a country of more

than one level of government, each with different taxing powers and responsibilities for

certain categories of expenditure. Nigeria is a good example of a country operating a

federal system of government through three tiers of government: the federal, the state and

the local. The present state of Nigerias fiscal federalism has evolved over time, starting

with the Phillipson Commission of 1946. As Ekpo and Ndebbio (1992) noted, this

evolution has been influenced by economic, political, social and cultural considerations.

The present arrangement has also undergone several revisions since the initial report of

the Phillipson Commission of 1946. Since then, there have been eight Commissions each

revising the reports of their respective predecessors. One of the most recent revision

exercise was undertaken by The National Revenue Mobilization, Allocation and Fiscal

Commission in 1988.

35

One major characteristic of federalism is the constitutional separation of powers among

the various levels of government. Drawing upon the reports of the various commissions

and revisions to previous constitutions, Section 4 (second schedule) of the 1989

Constitution of the Federal Republic of Nigeria (FGN, 1989b), reviewed in 1999,

specified three categories of legislative functions. The first is the exclusive legislative list

on which only the federal government can act. The second is the concurrent legislative

list on which both the federal and the state governments can act, and the third comprise

residual functions consisting of any matter not included in the above first two lists.

Ariyo (1997) further reiterated that In Nigeria, two major factors influence the

assignment of tax powers or jurisdiction among the three tiers of government. These are

administrative efficiency and fiscal independence. The efficiency criterion requires that a

tax be assigned to the level of government that is most capable of administering it as

efficiently as possible. Fiscal independence on the other hand requires that each level of

government should, as far as possible, be able to raise adequate funds from the revenue

sources assigned in order to meet its needs and responsibilities. Very often the efficiency

criterion tends to conflict with the principle of fiscal independence. The former entails a

great deal of centralization or concentration of tax powers at the higher level of

government, due to the limited administrative capacity of lower levels of government.

Conversely, the latter requires the devolution of more tax powers to the lower levels of

government to match the functions constitutionally assigned to them. In the Nigerian

context, the scale has always been tilted in favour of the efficiency criterion.

36

The Phillipson Fiscal Commission of 1946, set very stringent conditions for declaring

any revenue source as regional. It required revenue or taxes to be easily assessable by

local authority for easy assessment and collection, to be regionally identifiable, and in

general to have no implication for national policy. Given such conditions, very few

revenue heads (taxes) could be considered as regional and assignable to either the state or

the local government levels. There is also a distinction between the ability to legislate on

a particular tax and the ability to collect a particular tax. The two powers can reside with

the same level of government or be separated.

Available evidence from the current jurisdictional arrangement summarized in Table 4.9

suggests that both types exist in Nigeria. Researches by Ariyo (1997) shows that all the

major sources of revenue are left solely to the federal government in legislation and

administration (See Fig 4.9). These are import duties, excise duties, export duties, mining

rents and royalties, petroleum profit tax, and company income tax. This may be

attributable to the bias for the efficiency criterion noted earlier. The principal tax with

shared jurisdiction is the personal income tax on which the Federal Government Nigeria

(FGN) legislates. In terms of its administration, the FGN collects the personal income tax

of armed forces personnel and the judiciary. Olopoenia, R.A. (1991 recalled that, each

state government administers and collects personal income tax from other categories of

residents in its territory. Capital gains tax is also under shared jurisdiction in which the

FGN legislates while state governments collect the tax. Given the bias for the efficiency

criterion, the state and local governments have jurisdiction over minor, low-yielding

revenue sources. For example, state governments have jurisdiction over football pools

and other betting taxes, motor vehicle and drivers license fees, personal income tax

37

(excluding the judiciary and the military), and sales tax. Local governments administer

entertainment tax, radio and TV licensing, motor part fees and the potentially buoyant

property tax.

2.3.1 Revenue Profile of the Federal Government of Nigeria

Public revenue has been defined to mean cash flow from all available sources of income

to the government of a country in a given period of time, usually a fiscal year. Public

revenue is also used to refer to all funds required by the government or public authority

for the execution of its functions. Public revenue has been defined as the mobilization of

funds from available sources of finance the government, the collection, proper handling

and recording of the receipts by delegated agents of public authorities for the purpose of

discharging the national functions and responsibilities. In general, government sources of

revenue varied from country to country depending on the political and economic system

of that country.

The pre-independent and the period before 1970 were characterized by the dominance of

agricultural taxation (non-oil revenue source) which serves as a proxy for personal

income tax. There was the problem of collecting personal income tax in this period due to

the difficulty in reaching individual farmers and their inability to measure tax liability

accurately, yet non-oil revenue was the largest source of government revenue. In other to

enhance this, the government adopted the use of the various marketing boards as effective

mechanism for the administration of agricultural tax. During this period also, a large

percentage of the people were self-employed and so the effectiveness of personal income

tax was not workable. This was the same view by Musgrave and Musgrave, (1984) and

38

Hinricks, (1986) both of whom agreed that taxes are difficult to collect because of lack of

skills and facilities for tax administration. It was therefore not out of place when the

government shift base to the oil revenue sources and thus the revenue from the non-oil

sector gradually gave way.

The dominance of non-oil revenue gradually gave way to oil and gas revenue sales of

crude oil, introduction of petroleum profit tax (PPT), royalties, as there was increase in

oil export. However, the major fiscal policy instruments in Nigeria have been categorized

in four major headings namely:

(a) Non-Oil Revenue

- Company income tax (CIT)

- Import and export duties

- Education levy

- Personal income tax (PIT)

- Capital gain tax

- Value added tax

- Mineral rent and leases

- Fines, fees, licenses

- Stamp duties

- Investment and interest income

- Property rent/leases

- Withholding taxes

(b) Oil and Gas Revenue - Crude oil sales

39

- Sales proceeds of liquified natural gas

- Oil exploration license

- Oil mining lease

- Royalties

- Rents

- Petroleum profit tax

(c) Capital Receipts

- Government borrowing

- Grants and international aids

- Sales of government investments

- Sales of government properties

- Donations

- Issuance of bonds and other securities

(d) New Sources of Public Revenue

- Premium from sales of foreign exchange

- GSM operating licenses

- Internally generated revenue from virtually all government agencies

- Saving from debt cancellation

- Recovery of looted public funds from some corrupt government officials.

The examination of the revenue profile above, showed that Nigeria has passed through

structural changes over time. Egwakhide, (1988) opined that some structural changes

emerged in the revenue profile in the early 1970s whereby indirect taxes gave way to

direct taxes with the emergence of the oil boom. Thus, there was a fall in revenue from

40

the non-oil sector; especially as agricultural was being neglected in favour of white-collar

jobs. This was however complemented with increase in excise duties except in 1975 and

1976 (see table below). This appreciable increase in revenue from excise duties was due

to enhance performance of the industrial sector in that period.

Different researches conducted have shown that the revenue profile of Nigeria indicates

that import and excise duties constitute the bulk of the government revenue since

independence. Hence, Ariyo (1997) observed that import and excise duties accounted for

41.9% and 21.9% respectively while Petroleum Profit Tax (PPT) and Company Income

Tax (CIT) stood at 19% and 8.9% respectively. He further opines that this trend starts

declining with respect to import and excise duties while PPT was increasing

progressively. The reason for this increase in revenue form PPT was due to the

negligence of agriculture as petroleum export replaces the traditional agricultural export.

And as at 1979, revenue from PPT rose to 74.9% while import duties and excise duties

fall to 12.8% and 3.7% respectively.

The 1979 constitution, section 149 (S.1) establishes the Federation account into which all

the revenue collected by the federal government shall be paid into except PIT. The

federal government has exclusive right to collect and remit into the federation account

revenue from crude oil and gas, oil lease rent, oil mining license, PPT, non-oil revenue

such as CIT, import and export duties, excise duties, mineral mining rents etc. Thus,

Ariyo (1997) puts it that before the advent of the oil on 1971, revenue from the

traditional sources such as tax on export products like cocoa, groundnut and palm kernel

provided adequate revenue for the needs of the public sector. Following the oil boom,

41

however, little attention was paid on non-oil revenue sources. Consequently, there arose

an over dependence on oil revenue as the anchor for public expenditure. Hence, given the

fragile nature of the oil market, the countrys revenue profile has been subjected to wide

fluctuations over the years.

2.3.2 Structure of Tax-Based Revenue in Nigeria

A brief review of the Nigerias tax-based revenue profile since 1960 shows a progressive

decline in income from the traditional sources of revenue. The revelation throw light on

the shifts in the relative importance of each revenue source over time and the extent to

which the Nigerian tax-revenue profile conforms with Musgraves theory. In the 1960s,

emphasis was on accelerated economic growth and development, and the main goal of

tax policy was maximum revenue generation to finance public sector programmes.

Similarly, policy makers emphasized import substitution to underlie the industrial

development strategy (Ekuarhare, 1980). Attention was directed toward increasing the

existing tax rates (especially import duties) in the form of high protective tariffs, and as a

consequence import duties provided the bulk of federal government revenue in the early

1960s (Phillips, 1991).

Another major macroeconomic objective underlying the increase in tariffs was the desire

to discourage imports and thereby curtail consumer demand. Excise duties were also

introduced on several goods to broaden the revenue base. Given the low industrial base,

the contribution of the latter was insignificant. Therefore, in overall, revenue from these

sources accounted for about 73% of total revenue. This makes the foreign trade sector the

major source of revenue in the 1960s. Some structural changes emerged in the revenue

42

profile in the early 1970s whereby indirect taxes gave way to direct taxes with the

emergence of the oil boom (Egwakhide, 1988). The fall in non-oil tax revenue due to the

neglect of the traditional (agricultural) sources was matched by an increase in import

duties until 1973. Further, there was an appreciable increase in revenue from excise

duties in the 1970s due to the enhanced performance of the industrial sector. This overall

picture has been sustained up till now given the dominant role of the oil sector as major

source of government revenue.

This scenario appears to conform with Musgraves theory to the effect that as an

economy develops, more reliance may be placed on direct tax revenue. However some

caution is advisable in confirming the relevance of Musgraves theory to the Nigerian

environment. We should note that the mere classification of petroleum profits tax and

royalties as direct taxes immediately distorts an objective assessment of the relative

importance of indirect taxes over time. In fact, a focus on non-oil revenue sources shows

that the indirect tax still dominates the old and traditional revenue sources.

In effect, Ariyo, and Raheem (1991) concluded that in reality Musgraves theory is not

applicable to the Nigerian environment for several reasons. For example, the behavioural

explanation in the context of Dutch disease noted earlier might have accounted for low

efforts on direct non-oil taxes. Similarly, the proceeds of the oil boom were spent largely

on massive importation of consumer goods, thus enhancing the income from import

duties, a policy which would have hindered rather than enhanced the pace and level of

industrial development in the economy. Nevertheless, documentation of objective

evidence relating to this issue awaits in-depth research.

43

2.4 Current Legal Framework

The Nigerian Tax System has undergone significant changes in recent times. The Tax

Laws are being reviewed with the aim of repelling obsolete provisions and simplifying

the main ones. Under current Nigerian law, taxation is enforced by the three tiers of

Governments, i.e. Federal, State, and Local Government with each having its sphere

clearly spelt out in the Taxes and Levies (approved list for Collection) Decree, 1998. Of

importance at this juncture however are tax regulations pertaining to investors both

foreign and local. The importance of tax regulations cannot be overemphasized, as most

transactions with any Ministry, department, or government agency cannot be concluded

without evidence of tax clearance, i.e. a Tax Clearance Certificate certifying that all taxes

due for the three immediately preceding years of assessment have been settled in full.

2.4.1 Tax Reforms in Nigeria

As a means of meeting their expenditure requirements, many developing countries

undertook tax reforms in the 1980s. Osoro (1991) however pointed out that most of these

reforms focused on tax structure rather than on tax administration geared towards

generating more revenue from existing tax sources. The situation was even of a wider

dimension in Nigeria. Osoro (1993) further opines that tax reform which is a change in

the status quo has been one of the major preoccupations of most developing countries in

the 1980s. He confirms that over 100 attempts at tax reforms in developing countries

have been recorded since 1945. In fact, Gills, (1989) reechoed that tax reform has turned

from a desired or preferred task to being a necessary one.

44

One of the victims of numerous economic crises that have plagued developing countries

like Nigeria since the first oil shock in 1973 has been the tax system. Consequently, tax

collections have been hit hard resulting in large fiscal deficits. Unfortunately, in the

1980s external finances with which to finance fiscal deficits were not forthcoming.

Developing countries were left with no option but to print more money to finance

deficits, with consequent double-digit inflation.

Most developing countries therefore suffer from over-dependence on a small number of

sources of tax revenue, which are vulnerable to external events, which remains a crucial

problem in their tax system. These sources include import and export taxes on mineral

products, the prices of which are determined on world markets, and tend to be volatile.

These taxes constitute a major source of revenue in many developing countries.

It was based on the above problems that led many developing countries to undertake tax

reforms during the 1980s. However, most of these reforms, however, have been on tax

structure, with the general objectives of revenue adequacy, economic efficiency, equity

and fairness, and simplicity. It is therefore pertinent to point out the fact that even if the

reform is compatible with the macroeconomic objectives of the government, there is little

chance of success because it either cannot be administered, or administrative reforms

cannot be undertaken. Many tax reforms carried out in developing countries have been on

tax structure rather than on tax administration.

In Nigeria, Odusola (2003) discussed the review of the existing tax policies and reforms

and opined that Nigerias fiscal policy measures have been largely driven by the need to

45

promote such macroeconomic objectives as promoting rapid growth of the economy,

generating employment, maintaining price levels and improving the balance-of-payment

conditions of the country. Although policy measures change frequently, these objectives

have remained relatively constant. Until the mid 1980s, tax policies, for instance, were

geared to achieving such specific objectives as:

(i) Ensuring effective protection for local industries;

(ii) Encouraging greater use of local raw materials;

(iii) Enhancing the value added of locally manufactured and primary products;

(iv) Promoting greater geographical dispersion of domestic manufacturing

activities;

(v) Generating increased government revenue

In accordance with Odusola (2003), the recent developments in the Nigerian tax system

and components of the countrys tax system, especially those included in the exclusive

and concurrent legislative lists, are briefly examined below:

(a) Personal Income Tax (PIT):- It was the oldest tax in the country and was first

introduced as a community tax in northern Nigeria in 1904. It was introduced the

western and eastern regions in 1917 and 1928, respectively and latter amendments

in the 1930s, and incorporated into Direct Taxation Ordinance No. 4 of 1940. The

need to tax personal incomes throughout the country prompted the Income Tax

Management Act (ITMA) of 1961. In Nigeria, personal income tax for salaried

employment is based on a pay as you earn (PAYE) system, and several

amendments have been made to the 1961 ITMA Act. In 1990, further amendments

were made to PIT.

46

(b) Company Income Tax (CIT):- Company income tax (CIT) was introduced in

1961. The original law (Company Income Tax) has been amended many times

and is currently codified as the Company Income Tax Act 1990 (CITA). The

Federal Board of Inland Revenue, whose operational arm is the Federal Inland

Revenue Services (FIRS), is empowered to administer the tax. The Company

income tax Act (CITA) policy regimes can be divided into two phases, namely, pre-

1992 and post-1992. The CIT policies in the pre-1992 era were narrowly based and

characterized with increasing tax rates and overburdening of the taxpayers, which

induced negative effects on savings and investment. Since 1992, however, measures

have been taken to address these structural problems.

(c) Education Tax:- This was introduced in 1993 under the Education Tax Act No.

7. The essence of this tax is to prevent the educational system from total collapse

due to the financial crisis that had affected the sector for years. Thus, an education

tax of 2% of assessable profits is imposed on all companies incorporated in

Nigeria. This tax is viewed as a social obligation placed on all companies in

ensuring that they contribute their own quota in developing educational

facilities in the country. The tax is applied to company net profits, and is deducted

from net profits before tax, thus it is not subject to company income tax. Odusola

(2006) argued that the introduction of this tax has added to the list of multiple taxes

that eats away the profit margins of companies. It is therefore a double tax on

company profits, and is argued to be a major disincentive to foreign investment in

Nigeria.

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(d) Capital Gains Tax:- This accrues on an actual year basis and it pertains to all gains

accruing to a taxpayer from the sale or lease or other transfer of proprietary rights in

a chargeable interest which are subject to a capital gains tax of 10%, such

chargeable assets may be corporeal or incorporeal and it does not matter that such

asset is not situated in Nigeria. Where however the taxpayer is a non-resident

company or individual the tax will only be levied on the amount received or brought

into Nigeria. Computation of capital gains tax is done by deducting from the sum

received or receivable from the cost of acquisition to the person realizing the

chargeable gain plus expenditure incurred on the improvement or expenses

incidental to the realization of the asset.

(e) Value Added Tax (VAT):- This was introduced by the VAT Act No. 102 of 1993

to replace the old sales tax but its implementation actually began in January 1994.

Ajakaiye and Odusola (1996) opined that VAT is a consumption tax levied at each

stage of the consumption chain, and is borne by the final consumer. It requires a

taxable person upon registering with the Federal Board of Inland Revenue (FBIR) to

charge and collect VAT at a flat rate of 5% of all invoiced amounts of taxable goods

and services. VAT paid by a business on purchases is known as input tax, which is

recovered from VAT charged on companys sales, known as output tax. If output

exceeds input in any particular month the excess is remitted to the Federal Board of

Inland Revenue (FBIR) but where input exceeds output the taxpayer is entitled to

a refund of the excess from FBIR though in practice this is not always possible. A

Taxpayer however has the option of recovering excess input from excess output

of a subsequent period. It should be stated at this point that recoverable input is

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limited to VAT on goods imported directly for resale and goods that form the

stock-in-trade used for the direct production of any new product on which the

output VAT is charged.

(f) Petroleum Profits Tax (PPT):- Nigerian law by virtue of the Petroleum Profits

Tax Act requires all companies engaged in the extraction and transportation of

petroleum to pay tax. The taxable income of a petroleum company comprises

proceeds from the sale of oil and related substances used by the company in its own

refineries plus any other income of the company incidental to and arising from its

petroleum operations. The taxable income of a petroleum company is subject to tax

at 85%, but this percentage is lowered to 65.75% during the first 5 years of

operation. Where oil companies operate under production sharing contracts they will

be liable to tax at a rate of 50%. There are however some concessions granted

petroleum companies known as, Capital Allowance and Petroleum Investment

Allowance; the former is deducted in arriving at the taxable income and entails

expenditure on equipment, pipelines, and storage facilities, buildings and drilling

costs, these are referred to as qualifying assets.

The applicable rate of Capital Allowance for any year is of 20% of the cost of the

qualifying assets applied on a straight-line basis for the first 4 years and 19% for the

5th year. Anyanwu (197) opines that the latter is regarded as an addition to capital

allowance and covers allowance in respect of new investments in assets for

petroleum exploration; it is available in the accounting period in which the assets are

first used. It must be stated that the deduction of Capital Allowance is restricted, so

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that for any accounting period, the tax on the company should not be less than 15%

of the tax which would have been assessable had no capital allowances been granted

the company. Currently, the legal provisions of the various types of taxes have been

codified, although they have been subjected to several revisions. Interested readers

are referred to Federal Government of Nigeria (1989a) and Federal Inland Revenue

Service (1990) for the latest set of amendments to the tax sources covered in this

study.

Adesola (1995) further recalled that the frequency of amendments to the various

acts or decrees makes it very difficult to keep track of the various legislative

reforms. The worrisome frequency led interested observers to advise the FGN to

ensure the stability of each tax regulation for at least five years. This is meant to

encourage purposeful planning and investment decisions especially by corporate

agencies and foreign investors. For the purpose of this study, however, we are

interested in the net effect of the legion of reforms on tax yield. All efforts to secure

similar information on customs and excise duties proved abortive. The quality of

information currently available on tax reforms is constrained in at least two respects.

Firstly, it is not possible to assess objectively the net effect of tax burden over time.

We do note, however, government has stated intention to move towards a lower tax

regime especially on company income tax. Nevertheless, an objective determination

of the net effect of these tax-rule changes and reforms still awaits in-depth research.

Second, it is not possible to separate discretionary from non-discretionary tax

changes. The information shown in Table 6 merely covers some specific periods

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without any information about the underlying reasons for the changes. Also, the

observed stability in tax rates is more apparent than real given the frequent changes

experienced in practice.

2.4.2 Approved Taxes and Levies for the Three Tiers of Government

In recent time, a list of taxes and levies for collection by the three tiers of government has

been approved by government and published by the Joint Tax Board (J.T.B.). These were

identified by Adesola (1995), Adekanola (1997), and Abiola (2002) as follows:

2.4.3 Taxes Collectible by the Federal Government

(1) Companies income tax

(2) Withholding tax on companies

(3) Petroleum Profit Tax

(4) Value-added tax (VAT)

(5) Education tax

(6) Capital gains tax - Abuja residents and corporate bodies

(7) Stamp duties involving a corporate entity

(8) Personal income tax in respect of:

- Armed forces personnel

- Police personnel

- Residents of Abuja FCT

- External Affairs officers; and

- Non-residents.

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2.4.4 Taxes/Levies Collectible by State Governments

(1) Personal income tax:

- Pay-As-You-Earn (PAYE);

- Direct (self and government) assessment;

- Withholding tax (individuals only);

(2) Capital gains tax;

(3) Stamp duties (instruments executed by individuals);

(4) Pools betting, lotteries, gaming and casino taxes;

(5) Road taxes;

(6) Business premises registration and renewal levy;

- Urban areas (as defined by each state): Maximum of N 10,000 for registration

and N5,000 for the renewal per annum

- Rural areas: Registration N2,000 per annum

- Renewal N 1,000 per annum

(7) Development levy (individuals only) not more than N100 per annum on all taxable

individuals;

(8) Naming of street registration fee in state capitals

(9) Right of occupancy fees in state capitals;

(10) Rates in markets where state finances are involved.

2.4.5 Taxes/Levies Collectible by Local Governments

(1) Shops and kiosks rates;

(2) Tenement rates

(3) On and off liquor licence;

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(4) Slaughter slab fees;

(5) Marriage, birth and death registration fees

(6) Naming of street registration fee (excluding state capitals)

(7) Right of occupancy fees (excluding state capitals)

(8) Market/motor park fees (excluding market where state finance are involved)

(9)