Fiscal Revenue Dilemma - FDC

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Friday, May 1, 2015 8:56 AM/FDC

A top priority of the new federal government administration will be how to cover the huge fiscal gap created by the plunge in oil revenues and massive election spending in the 2015 general elec-tions. This must be addressed in order to finance development programs and facilitate the day-to-day running of government and economic activities. To shore up government revenues, op-tions available to the government include: raising the tax rate, blocking existing leakages and borrowing. While many have agreed that there is need for borrowing, there are differing views when it comes to blocking leakages and increasing taxes. With an estimated population of 170 million and GDP of $568.5 billion, Ni-geria’s tax to GDP ratio was 5.23% in 2014 (See Table 1).



This is quite low compared to tax-to-GDP ratio of over 20% in most countries (See Table 2). In fact, the tax revenues collected in Nigeria in 2014 was lower than in 2013 despite an 11.3% in-crease in
GDP (See Table 1).

A high level of tax leakage, the difference between tax potential and tax collection2, accentuated by the non-transparency of the current tax structure, has often been cited as one of the reasons for low tax revenues in Nigeria. The Minister of Finance noted that blocking leakages is expected to add several millions to Nigeria’s revenues3 while the new federal administration expects over N1 trillion to be recovered. Evidence from other countries also shows the negative effects of fiscal leakages. A study of fiscal leakages in Kerala, India found that almost 35% of the total tax potential of general sales tax was not tapped in the state4. Furthermore, the study shows that the amount of tax leakage was enough to elimi-nate the primary account surplus from the economy and could affect fiscal sustainability.

In addition to leakages, Nigeria also has one of the lowest VAT rates (5%) in the world. The IMF recently advised, in its Article IV report, that there is an urgent need for Nigeria to increase its VAT5. It is believed that increasing the VAT rate will boost reve-nues, which will help to create the fiscal space necessary to imple-ment developmental projects in spite of declining oil revenues.

While increasing tax rates will go a long way in boosting govern-ment revenues, we believe it should be done with caution to pre-vent a backfire6,7. Higher taxes have often been found to encour-age tax avoidance and evasion. This is all the more likely in an environment where a lack of transparency with the tax structure discourages people to trust the taxation system or voluntary com-ply with payment.



Hence, it seems more reasonable that the government block leak-ages as an immediate step to recovering revenues rather than increasing the existing tax rate. In the medium to long term, we believe as the government undertakes more developmental pro-jects and put a better tax structure in place that encourages transparency, it can convince the people to accept a higher tax rate.

How are Tax Leakages Encouraged?
The overarching belief is that leakages are the major reason for low tax revenues in Nigeria. The Federal Inland Revenue Service (FIRS) has improved a lot since 2004 by investing in staff train-ing, re-organizing some of its operations and automating part of its processes8. However, these have been inadequate to block leakages. The presence of tax leakages are seen to be a reflection of a culture of corruption and the inefficient tax administration. Several factors have facilitated leakages including9:


        Weak legal sanctions for defaulters: Government does not follow through with punishment for tax defaulters, thereby encouraging involuntary compliance
        Narrow tax base: The informal sector is not properly captured. Petroleum tax revenue collection remains higher than non-oil tax revenues (See table1).
        Double taxation: Lack of collaboration between all tiers of government often lead to duplication of taxes, which is a disincentive for investment
        Illicit financial outflows: Funds illegally earned are transferred to other countries
        Use of political influence: Potential tax revenues have been lost to unnecessary waivers and exemptions


Strengthening the Nigerian Tax System
A good tax system should have at least five basic qualities: fair-ness, adequacy, simplicity, transparency, and administrative ease10. To boost tax revenues in Nigeria, there is need for a re-view of the existing tax structure to imbibe these basic qualities, especially transparency. This will encourage voluntary compliance since people will know what tax funds are used for. Other meas-ures that may be taken to strengthen the tax structure include:


        Improve quality of tax information system to determine the accurate number of eligible tax payers
        Enforce penalties for tax evasion and strengthen tax au-dits
        Greater collaboration between the tiers of government to harmonize taxes
        Encourage international collaboration to combat illicit out-flow of funds from the country

The incoming federal government administration led by General Buhari will likely follow through on its promise to block tax leak-ages based on its anti-corruption stance. This is a step in the right direction but will not come easy since some of the problems are deep-rooted and may require some time to overhaul.

In sum, Nigeria’s dependence on oil revenues has exposed the country to oil price shocks. The country’s already weak fiscal buff-ers coupled with huge election spending has created a fiscal gap that must be bridged to enable the new government administra-tion to perform its duties effectively. Whilst borrowing has been embraced as a necessary option to facilitate government spend-ing, there is no consensus on how tax revenues should be in-creased. In the short term, we believe that blocking leakages is a more viable option to boost tax revenues, rather than raising the tax rates. This is because increasing the tax rates immediately may provoke further ways of avoiding tax. In the medium-to-long term, we advise that government work towards improving trans-parency in the tax system as a way of building trust. Then, it might become more feasible to raise the tax rate.

Below links discusses some of these issues from different perspectives.

1. General Buhari 2.0-  A new dawn or a pipe dream??

2.Budget 2015 passed with No Subsidy Allocation

3.Global Perspective - the President-elect faces enormous tasks, starting with halting corruption

4.March Macro-Economic Indicators - FDC

5.March Stock Market Round up

6.Corporate Focus: Flour Mills - FDC

7.Corporate Focus: Julius Berger - FDC


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