**1.2. Taxation–theoretical underpinnings**

**1. Introduction**

62 Taxes and Taxation Trends

**1.1. Why taxation?**

flows and export revenues.<sup>3</sup>

volatile.2

1

2

assistance 3

Taxation is an important fiscal policy instrument at the disposal of governments to mobilise

to carry out their traditional functions such as the provision of public goods and services; maintenance of law and order; defence against external aggression; and regulation of trade and business to ensure social and economic maintenance [1]. Effective tax revenue mobilisation reduces an economy's dependence on external flows which have been found to be highly

their development agenda; conditions states to improve their domestic economic policy environment, thus creating a conducive environment for the much-needed foreign direct investments; and strengthens the bonds of accountability between governments and the citizens [2]. The 2008/2009 global financial and economic crisis provided useful lessons for countries on the need to direct more attention to domestic resources mobilisation efforts, including through increasing tax revenues, and shift away from over-dependence on external financial

Although tax structures vary considerably across countries, the primary objective of any tax structure is to attain maximum revenue and economic growth with minimum distortions. Different countries have different philosophies about taxation and different methods of tax collection. In the same manner, countries have different uses for their revenue which affect growth differently [3]. Agell et al. [4] have argued that the different uses of total government expenditure affect growth differently and a similar applies to way tax revenue is raised. Romer [5] emphasises factors such as 'spill-over effect and learning by doing' by which firms' specific decisions to invest in capital and research and development, or investment in human capital, can yield positive external effects that benefit the rest of the economy. Solow [6], was the first to examine how taxation affects growth. He argued that steady state growth is not affected by tax policy; that is, tax policy, regardless of distortion, has no impact on long term economic growth rates, even if it reduces the level of economic output in the long term. On his part [7], argued that the different uses of total government expenditure affect growth differently and a similar argument applies to the way tax revenue is raised. The economic growth of Singapore for instance can be attributed to low rates of corporate and personal income taxes. Relatedly [8], argue that there exists a structural difference in taxation in developing countries and developed countries. For developing countries, they established that roughly two-thirds

Whereas tax revenues are needed for public investments, including in productive and social and other sectors of the economy, taxation can also hamper growth, for instance, when corporate, income and capital gains taxes are so high that they serve as a disincentive for investments and do not attract the necessary skills; slow down growth in labour supply by disposing labour leisure choice in favour of leisure; discourage investments in research and development expendi-

External financial flows include foreign direct investments, portfolio investments, remittances and official development

The Nigerian economy has been negatively impacted by the recent significant fall of oil prices since June 2014 from the

tures; and cause the flow of resources to other sectors that have lower productivity.

peak of \$114 per barrel to below \$30 per barrel in early 2016.

Taxation also allows governments' greater flexibility in designing and controlling

Governments use tax revenue

revenue and promote economic growth and development.1

The differing views of the effects of taxation of growth notwithstanding, important conceptual questions arise however, with respect to the optimal level of taxation for a defined objective function - whether growth or revenue generation; how taxation burden should be allocated among tax payers; the extent of state involvement in taxation; and how tax revenues should be allocated among various public goods and services.

Lindahl [9] attempted to address these questions using a model which allows for determination of the extent of state provision of goods and services and the relative tax shares of two individuals who are free to reveal their preferences for state services against corresponding tax liability. The central thesis of the Lindahl model is the voluntary exchange between the taxes paid by the two individuals and the services rendered by the state. The Lindahl model therefore sought to seek a solution for the following problems: the decision regarding the extent of state activity; allocation of the total expenditure among various goods and services; and allocation of tax burden among tax payers.

From **Figure 1** below, if we assume a linear and homogenous production of goods and services, SS' is the supply curve of the state services while DDa and DDb are demand curves of two individuals - A and B; the vertical summation of which gives the [total] community's demand curve for state services—DDl. When ON is amount of the state services produced, A contributes NE; B contributes NF while NG represents the cost of supply. Since the state is not a profit maker, it increases its supply up to OM, at which level A contributes MJ while B contributes MR which when combined, equals the cost of supply—MP. P is therefore, the point at which equilibrium (SS = DD) is obtained on the basis of voluntary exchange of goods and services.

**Figure 1.** Lindahl model.

Many economists however, tend to favour the Bowen approach [10] since it can be easily adapted to depict what happens when social goods are produced under conditions of increasing costs, as opposed to Lindahl model which assumes linear and homogenous production (**Figure 2**).

in total revenue fell to 61.8% in 1978 while non-oil sector's share rose to 38.2%. More recently, the oil sector share in total revenue has been on an upward trajectory peaking at 88.6% in 2006. As at 2012, oil sector share in total revenue stood at 75.3% while non-oil sector accounted for 24.7% of the total revenue [11]. Overall, tax revenue, as a proportion of GDP, has been on a downward trend in the recent past. From a high of 5.459% in 2009, the tax to GDP ratio stood at 1.557% in 2012 which compares unfavourably with, for instance, the situation in South Africa,

Taxation and Economic Growth in a Resource-Rich Country: The Case of Nigeria

http://dx.doi.org/10.5772/intechopen.74381

65

Despite the many policy, legislative and administrative reforms effected in the recent past,<sup>6</sup> the Nigerian tax system is still riddled with several challenges which limit its optimal performance. These challenges have been highlighted, variously, by [12–17]; and include, but are not limited to the following: non-availability of tax statistics, inability to prioritise tax efforts, poor tax administration, multiplicity of taxes, regulatory challenges, tax evasion, tax avoidance, structural problems in the economy and a thriving underground economy. The role of taxation in promoting economic growth in Nigeria has therefore, not been optimally felt, owing to defective tax policy framework and administrative mechanisms. Tax administration process and the institutions saddled with the responsibility of tax collection often suffer from limitations in skilled manpower and financial resources; and appropriate tools and technology required to meet the ever-increasing challenges and difficulties associated with tax administration. Over the years, Nigeria has relied heavily on crude oil exports as a major source of government revenue, and consequently, neglecting other critical sectors of the economy that would have broadened the country's tax base. However, the high volatility associated with crude oil prices has made it imperative for the country to explore other sources of revenue to help fund public expenditure. In this chapter, we examine the relationship between the availability of higher resource revenue—oil revenue in this case, and lower taxation effort of other (non-oil) revenue categories and the effects of these on growth. Specifically, we seek to examine the role of Petroleum Profit Tax in stimulating economic growth in Nigeria; determine the contribution of Companies' Income Tax to economic growth in Nigeria; ascertain the impact of Customs and Excise Duties on economic growth in Nigeria; determine factors responsible persistent low tax efforts in Nigeria; and recommend plausible policy proposals for enhancing optimal and effective tax administration in Nigeria. Whereas previous studies (See for instance [1, 18, 19]) have aggregated the various components of taxation and analysed their impact on economic growth, we disaggregate the various components of taxation in Nigeria with a view to ascertaining their respective influences on economic growth in Nigeria. We also expand the scope of the study to capture the effects of the most recent reforms and policy instruments relating to taxation in the Nigerian economy such as the Company's Income Tax (Amendment) Act. 2007; the Federal Inland Revenue Services (Establishment) Act, 2007 and the Personal Income Tax (Amendment) Act, 2011. More broadly, we examine taxation as an instrument for stimulating economic growth in Nigeria, by tracing trends and performance of various categories of taxes. We also present a cross-country analysis of tax effort in Nigeria and a select group of African countries.

with a tax to GDP ratio of 26.81 and 25.52%, respectively, in 2009 and 2012.<sup>5</sup>

World Bank data. Available at http://data.worldbank.org/indicator/GC.TAX.TOTL.GD.ZS?locations

These reforms measures include the Value Added Tax (Amendment) Act, 2007, intended to widen the tax base and improve collection while the Company's Income Tax (Amendment) Act. 2007; the Federal Inland Revenue Services (Establishment) Act, 2007 and the Personal Income tax (Amendment) Act, 2011, were all aimed at encouraging tax com-

5

6

pliance and increasing tax yield.

**Figure 2.** The Bowen model.

The model assumes the existence of one social good and two tax-payers - A and B whose demand curves are represented, respectively, by a and b; with a + b being the total demand. The supply curve 'a + b' implies that the social goods are produced under conditions of increasing cost. But economic theory posits that the cost of producing social goods is the value of private goods foregone; that is 'a + b' is also the demand curve of private goods. The intersection of the cost and demand curves at B therefore, gives a determination of how a given national income should, according to tax-payers' desire, be shared between social and private goods - OE social goods and EX private goods. At the same time, it is possible to determine the tax shares of A and B, which are represented, respectively, by GCEO and FDEO out of the total tax requirement represented by area ABEO.

#### **1.3. What ails the Nigerian tax system?**

Irrespective of how a country chooses to share the tax burden among tax payers or allocates tax revenues among various goods and services, the tax revenue to gross domestic product (GDP) ratio is generally accepted as a crude measure of the tax effort of a given country and can be used as a basis for cross country comparisons. Compared to similar economies in Africa, Nigeria has a very low tax revenue to GDP ratio, with the bulk of government revenue being derived from oil and gas sector.4 Between 1981 and 2015, revenues from the oil and gas sector accounted, on average, for 75% of total government revenues, with the non-oil sector, of which taxation is part, contributing, on average, the remainder 25%, albeit with wide annual fluctuations [11]. Nigeria discovered oil in 1956 at Oloibiri in the Niger Delta after half a century of oil exploration, but commercial exploitation only started in 1968. By 1972, the oil sector share in total revenue was 54.4% against 45.6% share from non-oil sector. But by 1974 oil share of total revenue had increased to 82.1% with only 17.9% revenue accruing non-oil sector. Following the glut in the world oil prices in the later part of the 1970s however, the oil share

<sup>4</sup> The Central Bank of Nigeria decomposes Government revenue into oil revenue and non-oil revenue. Tax revenue, as well as petroleum profit tax, falls under non-oil revenue

in total revenue fell to 61.8% in 1978 while non-oil sector's share rose to 38.2%. More recently, the oil sector share in total revenue has been on an upward trajectory peaking at 88.6% in 2006. As at 2012, oil sector share in total revenue stood at 75.3% while non-oil sector accounted for 24.7% of the total revenue [11]. Overall, tax revenue, as a proportion of GDP, has been on a downward trend in the recent past. From a high of 5.459% in 2009, the tax to GDP ratio stood at 1.557% in 2012 which compares unfavourably with, for instance, the situation in South Africa, with a tax to GDP ratio of 26.81 and 25.52%, respectively, in 2009 and 2012.<sup>5</sup>

Many economists however, tend to favour the Bowen approach [10] since it can be easily adapted to depict what happens when social goods are produced under conditions of increasing costs, as opposed to Lindahl model which assumes linear and homogenous production (**Figure 2**).

The model assumes the existence of one social good and two tax-payers - A and B whose demand curves are represented, respectively, by a and b; with a + b being the total demand. The supply curve 'a + b' implies that the social goods are produced under conditions of increasing cost. But economic theory posits that the cost of producing social goods is the value of private goods foregone; that is 'a + b' is also the demand curve of private goods. The intersection of the cost and demand curves at B therefore, gives a determination of how a given national income should, according to tax-payers' desire, be shared between social and private goods - OE social goods and EX private goods. At the same time, it is possible to determine the tax shares of A and B, which are represented, respectively, by GCEO and FDEO out of the

Irrespective of how a country chooses to share the tax burden among tax payers or allocates tax revenues among various goods and services, the tax revenue to gross domestic product (GDP) ratio is generally accepted as a crude measure of the tax effort of a given country and can be used as a basis for cross country comparisons. Compared to similar economies in Africa, Nigeria has a very low tax revenue to GDP ratio, with the bulk of government revenue

sector accounted, on average, for 75% of total government revenues, with the non-oil sector, of which taxation is part, contributing, on average, the remainder 25%, albeit with wide annual fluctuations [11]. Nigeria discovered oil in 1956 at Oloibiri in the Niger Delta after half a century of oil exploration, but commercial exploitation only started in 1968. By 1972, the oil sector share in total revenue was 54.4% against 45.6% share from non-oil sector. But by 1974 oil share of total revenue had increased to 82.1% with only 17.9% revenue accruing non-oil sector. Following the glut in the world oil prices in the later part of the 1970s however, the oil share

The Central Bank of Nigeria decomposes Government revenue into oil revenue and non-oil revenue. Tax revenue, as

Between 1981 and 2015, revenues from the oil and gas

total tax requirement represented by area ABEO.

**1.3. What ails the Nigerian tax system?**

**Figure 2.** The Bowen model.

64 Taxes and Taxation Trends

being derived from oil and gas sector.4

well as petroleum profit tax, falls under non-oil revenue

4

Despite the many policy, legislative and administrative reforms effected in the recent past,<sup>6</sup> the Nigerian tax system is still riddled with several challenges which limit its optimal performance. These challenges have been highlighted, variously, by [12–17]; and include, but are not limited to the following: non-availability of tax statistics, inability to prioritise tax efforts, poor tax administration, multiplicity of taxes, regulatory challenges, tax evasion, tax avoidance, structural problems in the economy and a thriving underground economy. The role of taxation in promoting economic growth in Nigeria has therefore, not been optimally felt, owing to defective tax policy framework and administrative mechanisms. Tax administration process and the institutions saddled with the responsibility of tax collection often suffer from limitations in skilled manpower and financial resources; and appropriate tools and technology required to meet the ever-increasing challenges and difficulties associated with tax administration. Over the years, Nigeria has relied heavily on crude oil exports as a major source of government revenue, and consequently, neglecting other critical sectors of the economy that would have broadened the country's tax base. However, the high volatility associated with crude oil prices has made it imperative for the country to explore other sources of revenue to help fund public expenditure.

In this chapter, we examine the relationship between the availability of higher resource revenue—oil revenue in this case, and lower taxation effort of other (non-oil) revenue categories and the effects of these on growth. Specifically, we seek to examine the role of Petroleum Profit Tax in stimulating economic growth in Nigeria; determine the contribution of Companies' Income Tax to economic growth in Nigeria; ascertain the impact of Customs and Excise Duties on economic growth in Nigeria; determine factors responsible persistent low tax efforts in Nigeria; and recommend plausible policy proposals for enhancing optimal and effective tax administration in Nigeria. Whereas previous studies (See for instance [1, 18, 19]) have aggregated the various components of taxation and analysed their impact on economic growth, we disaggregate the various components of taxation in Nigeria with a view to ascertaining their respective influences on economic growth in Nigeria. We also expand the scope of the study to capture the effects of the most recent reforms and policy instruments relating to taxation in the Nigerian economy such as the Company's Income Tax (Amendment) Act. 2007; the Federal Inland Revenue Services (Establishment) Act, 2007 and the Personal Income Tax (Amendment) Act, 2011. More broadly, we examine taxation as an instrument for stimulating economic growth in Nigeria, by tracing trends and performance of various categories of taxes. We also present a cross-country analysis of tax effort in Nigeria and a select group of African countries.

<sup>5</sup> World Bank data. Available at http://data.worldbank.org/indicator/GC.TAX.TOTL.GD.ZS?locations

<sup>6</sup> These reforms measures include the Value Added Tax (Amendment) Act, 2007, intended to widen the tax base and improve collection while the Company's Income Tax (Amendment) Act. 2007; the Federal Inland Revenue Services (Establishment) Act, 2007 and the Personal Income tax (Amendment) Act, 2011, were all aimed at encouraging tax compliance and increasing tax yield.
