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IMF Selected Issues on Nigeria - Mobilizing Tax Revenues in Nigeria

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Wednesday, March 7, 2018 /06:12PM / IMF 

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Options for Revenue Mobilization in Nigeria
Low non-oil revenue mobilization is affecting the government’s objectives to expand growth-enhancing expenditure priorities, foster higher growth and employment, and comply with its fiscal rule which limits the federal government deficit to no more than 3 percent of GDP. There is significant revenue potential from structural tax measures. A broad-based and comprehensive tax reform program is needed in the short and medium term to address these objectives and generate sustainable revenue growth by broadening the bases of income and consumption taxes, closing loopholes and leakage created by corporate tax holidays and the widespread use of other associated tax expenditures, as well as creating incentives for the sub-national tiers of government to raise their own source revenues.

Current Tax Effort
Relative to peers, Nigeria has one of the lowest revenue-to-GDP ratios. Between 2011 and 2017, a sharp decline in oil revenues led to consolidated government revenues falling from 17.7 percent to 5.1 percent of GDP (Figure 1). During this period, non-oil revenue stayed relatively stable at about 3 and 4 percent of GDP, although with an accelerating decline in 2016–17. In particular, the corporate income tax (CIT) decelerated by 0.1 percent of GDP and value added tax (VAT) by 0.2 percent of GDP relative to 2011. Comparing Nigeria’s tax structure with those of a selected sample of advanced, emerging, and developing economies, none of its domestic tax collection showed a promising performance. Nigeria raised the least revenue of all comparators and at 5.3 percent of GDP in revenue in 2016 was significantly below the sample’s 22 percent of GDP average (Figure 2). In most countries, excises alone raise 3.6 percent of GDP.

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Nigeria has a significantly higher revenue potential
. Recent empirical work shows that internationally, there is a tipping point in the relationship between tax capacity and growth. A minimum tax-to-GDP ratio of 12 ¾ percent is associated with a significant acceleration in the process of growth and development, and likely with changes in social norms of behavior and state capacity (Gaspar at all, 2016). Taxation is not an end in itself, but an instrument for advancing citizens well-being as part of a well-functioning state.2 Tax is a core part of state-building and constitutes a visible sign of the social contract between citizens and the state, enshrining the principle of revenue-for-service. Estimates of tax potential from the literature (Fenochietto 2013, IMF 2017b) suggest that a non-oil tax capacity of 16 to 18 percent would be optimal for a country with Nigeria’s economic structure and per capita income levels. This estimate implies space for additional tax collection of percent of GDP.

The authorities have made a key development objective raising the non-oil revenue to GDP ratio to percent by 2020.
Both the ERGP published in March 2017, which seeks to keep the fiscal deficit within the boundary established by the Fiscal Responsibility Act, and the draft 2018 Budget emphasize this revenue target. Increasing non-oil tax revenue would be realized through a series of tax administration initiatives (improving tax compliance, broadening the tax net, employing appropriate technology) combined with tax policy reforms (strengthening tax legislation, introduction of tax on luxury items, and other indirect taxes to capture a greater share of the informal economy

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This chapter analyzes key features of the Nigerian tax system and administration, and suggests there is significant scope for broad-based and comprehensive policy and administration reforms
. Achieving higher revenue performance depends heavily on building capacity in tax administration to gain control of the tax system, complemented by targeted tax policy reforms being implemented in parallel—as also demonstrated by the experience of countries that implemented successful reforms over the past 15 years (Akitoby et al, 2018). Staff will argue that in the short term, the tax reform should include broader use of revenue-productive excises (such as alcohol, tobacco products, fossil fuels, and mobile phone air use), and placing a moratorium on new business tax holidays; followed by decisive steps to transition toward a broad-base consumption VAT at a higher rate, an all-embracing rationalization of expenditures, and a reform of personal income and property taxation in the medium term.

Tax Administration Reforms

The very low tax collection rates in Nigeria are a direct reflection of weaknesses in revenue administration systems and a high level of systemic noncompliance.
Despite successful initiatives to bring in a significant number of new corporate and self-employed individuals (over 530,000 new corporate registrations were made during the first quarter of 2016—a 67 percent increase), these efforts have not delivered expected revenue. Of 1.5 million registered corporations, only 522,000 could be matched (as of May 2016) to any type of data available within the Federal Inland Revenue Service (FIRS), and only 77,000 filed VAT returns in 2016—suggesting an active taxpayers’ population of only 5 percent. For CIT, the active taxpayers were 5.6 percent of the registered taxpayers, while for personal income tax (PIT) they were less than 2 percent (Table 1). Data on payment compliance is incomplete, but it is generally believed to vary between 15 and 40 percent for VAT. 

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Recent reform measures have sought to strengthen revenue collection at the federal level through information technology improvements and by expanding the number of registered taxpayers
. FIRS has implemented technology initiatives such as online portals for assessment and payment of stamp duties (e-stamp) which has dramatically reduced the time to register a company, the processing of tax clearance certificates (e-TCC), and the automation of withholding tax remittances by MDAs. The Integrated Tax Administration System (ITAS) project had also been completed following its deployment in a majority of tax offices, although a major test for success remains that it also be actively used for compliance management FIRS has also continued to expand the taxpayer register, and has taken steps to create a specialized collection enforcement function and improve the integrity of the audit process. It also continued to improve staff capacity and infrastructure. Importantly, these measures are strengthening the foundation of tax administration, yet compliance levels across all levels of tax payments remain low. The strategy of relying on strengthened collection efforts and one-off initiatives (such as the Nigerian Voluntary Asset and Income Declaration Scheme, VAIDS4) as a first level intervention may not be that effective in delivering higher revenues sustainably.

Additional revenue could be raised in the short term with tax and customs administration measures
, including by:

Strengthening the Large Taxpayers Offices (LTOs)
Organizationally, it will be important to protect the investments Nigeria has made in implementing taxpayer segmentation principles and allow the LTOs to focus exclusively on the administration of large tax payers.5 Other measures include:

(1) cleansing of taxpayer data in the LTO; (2) updating taxpayer ledgers in ITAS and deactivating dormant taxpayers; (3) strengthening audit and enforcement capacity by recruiting additional staff into the LTOs supported by a well-established mentoring program (thus relying less on external auditors doing audit work); and (4) by making full use of the recently—deployed ITAS to support the collection and audit functions. A comprehensive independent review of the ITAS system will be necessary to assure completeness of deployment, and identify major strengths and areas in need of improvement, including strategies for transitioning fully to the automated system.

Initiating large scale data analysis and cross matching using the Taxpayer Identification Number (TIN) and the Unified Taxpayer Identification Number (UTIN) as part of a broader compliance management framework.

Data analysis and cross matching offers real potential for enhancing
revenue, reducing both administrative and compliance costs, and strengthening the working relationship between the FIRS and the Nigerian Customs Service (NCS). Developing a repeatable data matching methodology for deployment, initially for a small group of data sets, will be needed. This should be supported by legislative, policy and procedural changes to support long term data acquisition and management. This would also require further capacity development, better coordination, and progressively increasing data capture and analysis, was well as integrating the results into information systems and operational process, in particular risk assessment.

Recovering tax arrears (such as, unremitted withholding of PAYE)
The stock of arrears has grown significantly and as of mid-2017, it stood at N 1.4 trillion—N1.2 trillion of which were attributable to large taxpayers. Early wins could thus be made by targeting large and medium taxpayers for migration into ITAS, fully utilizing the debt management module, and implementing a well-resourced collection and enforcement compliance improvement plan to validate arrears, institute collection measures, and enforce difficult debt, including debt owed by public agencies. Staff estimates that additional minimum revenue yields of N150 billion could be generated in 2018 only from these measures.

Improving filing and payment compliance
In the short term, the focus would need to be on outreach initiatives for dormant registered taxpayers to motivate them to start filing and paying taxes and actively sending bulk reminders to taxpayers shortly before the filing dates. Data analysis and cross-matching can help identify taxpayers with active economic activities.

Improving integrity and putting in place appropriate management controls in customs.
Stakeholders
report widespread “irregular practices and payments” that have a negative impact on revenue flows and investor confidence. Implementation of a comprehensive integrity strategy that is anchored in a strategic plan would help improve ease of doing business and improve revenue. At a minimum, these measures could yield N15 billion in additional revenue in 2018.

Reforming the VAT System
The VAT in Nigeria raises 0.9 percent of GDP in revenue, which is notably smaller than the 3.8 percent of GDP collected by ECOWAS peers. The VAT yield has stagnated at this level for more than a decade. By comparison, for the same period the average revenue collection was3.6 percent of GDP for the group of emerging and developing economies, 4.4 percent of GDP for the group of lower-middle income countries, and 4 percent of GDP for the member states of the Southern Africa Development Community (SADC). The VAT rate of 5 percent is also very low compared to a regional average of 16.8 percent.

The Nigerian VAT does not have the features of a modern consumption tax
. The current system disallows credit on capital goods and services, making it a gross product VAT (and de facto, a turnover tax) which penalizes investment and makes Nigerian manufacturing and related sectors uncompetitive relative to foreign suppliers of goods and services. The lack of a VAT registration threshold, coupled with a large informal sector, implies that the number of potential VAT taxpayers is very large—making it difficult for the tax authorities to monitor and control effectively. While hard data is not available, it has been suggested that filing compliance levels are between 15 to 40 percent. Importantly, the lack of a registration threshold in combination with limited input tax credits encourages taxpayers to continuously lobby for VAT exemptions.

Over time, extensive exemptions have substantially narrowed the VAT base. Exemptions now include commercial vehicles, all farming inputs including capital equipment, all medical and pharmaceutical products, some services, educational material, and basic food items. The many exemptions and the very low compliance rate have contributed to a low VAT revenue productivity7 of 0.16 percent in Nigeria compared to averages of 0.4 percent in relevant comparators.

A reform of the VAT in Nigeria would primarily aim to transform it into a system that generates revenue predictably and efficiently, and grows as its base (consumption expenditures) expands with economic development.8 A modern VAT would embed features such as:

Allowing input tax credits for intermediary inputs and capital expenditures. A proper VAT with a functioning input tax credit could neutralize business’ motivation to lobby for direct and indirect tax preferences, portrayed as compensatory measures for the inability to offset input tax credits against output tax.

Introducing an annual turnover threshold (for example, of US$40,000) for VAT registration so that only larger companies and persons that make supplies of goods and services are subject to VAT, and thus small and micro businesses are excluded.

Having a comprehensive base that includes in principle all goods and services, using only a few and well-targeted exemptions.

The VAT is an ineffective mechanism for addressing concern about vertical equity (Cnossen 1982). Exemptions should only be provided for the public provision of non-commercial goods and services; and for technical reasons, when certain supplies are difficult to tax under a credit-invoice VAT and when the compliance and administrative burden associated with taxing small businesses does not justify the revenue raised. The experience of other countries has showed that streamlining exemptions could immediately and lastingly increase revenue—as for example in Uganda, where revenues went up by 1 percent of GDP after streamlining exemptions during 2013–14, or in Rwanda, whose tax-to-GDP ratio increased by 2.9 percent between 2010–14, in part due to revisions of the investment code in 2012 to reduce exemptions (IMF 2017).

Introducing a single positive rate consistent with revenue targets, with a zero rate on all exports.

Depending on the revenue target, Nigeria could choose a single rate in the range of 10–15 percent—which would still be below ECOWAS average of 16.8 percent. Based on worldwide experience, a one percentage point increase in the VAT rate could raise on average 0.4 percent of GDP in VAT revenue. Depending on the final design of the system, a 5 (10) percent VAT rate could collect 2 (4) percent of GDP only if the compliance rate (currently at 25 percent) is significantly improved (Table 2).

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