Jide Akintunde, Managing Editor/CEO, Financial Nigeria International Limited

Follow Jide Akintunde

View Profile

Subjects of Interest

  • Financial Market
  • Fiscal Policy

Nigeria’s low tax-to-GDP ratio is not a problem 09 May 2023

Nigeria has one of the world’s lowest tax-to-GDP ratios. In 2020, the proportion of the country’s tax revenue relative to the value of aggregate economic output was 5.5 percent. This is much lower compared to an average of 16.0 percent for some 31 African countries, according to data by OECD. The world’s average was 13.5 percent, while the average for Heavily Indebted Poor Countries (HIPC) was 11.4 percent, as per World Bank data.

A cursory glance at these figures would suggest that Nigeria is not collecting enough tax revenues to meet its developmental needs. But this framing of the country’s development challenge is spurious. Indeed, the idea of taxation as a catalyst for development is not very much supported by empirical evidence. Innovation has continued to play a much more transformational role, creating opportunities for the extraction of taxes from its productive value. Efficiency in the collection of corporate and personal income taxes, value-added tax (VAT), wealth tax, etc., and the judicious use of the revenues, further fuel innovation and public investment in physical and social infrastructures for achieving development.

The late professor emeritus of business economics, Richard M. Bird, posited that the notion of development taxation for developing countries has evolved three models since mid-last century. From what he called a comprehensive progressive personal income tax, to a broad-based VAT and much lower rates for personal and corporate income taxes, the new thinking on development taxation favours a home-grown, ‘custom build’ tax system. However, international institutions like the IMF have continued to insist on advising generic tax policy for developing countries.

Last November, IMF advised the Nigerian federal government to increase the VAT rate by 100 percent, from the current 7.5 percent to 15 percent. This proposal is not only locally insensitive, but it is also impractical at two levels. First, it discountenances a cornerstone principle of taxation: ability to pay. Over 40 percent of Nigerians are currently living in extreme poverty. Should the tax rate be increased while simultaneously implementing IMF’s corresponding advice on removal of petrol subsidy, tens of millions of other Nigerians living just above the poverty line would fall under it. And second, a higher VAT rate would dent effective demand and consequently corporate income, jobs, and investments.

But for the avoidance of doubt, tax-to-GDP ratio below global average is not a barrier to achieving development. The average ratio for the Arab World, the region that has some of the fastest-developing economies of the world, was 5.4 percent in 2020. Many of the countries in the region are oil-rich economies, like Nigeria. UAE’s tax-to-GDP ratio was 0.7 percent. Besides, China’s rate was 8.1 percent. The U.S. ratio was also below the world’s average, at 9.9 percent, after rising from 7.9 percent in 2009. With low-income countries having an average tax-to-GDP ratio (11.4 percent) above middle-income countries (10.7 percent) and upper middle-income countries (10.6 percent), the development taxation landscape is confused.

Ideally, countries should be in charge of their tax policy. While this does not preclude tax cooperation among trading blocs, those outside the club should not have to be appendages of tax policies that did not factor their peculiar economic realities and interests when they were being formulated. Local realities should inform tax policy. Therefore, developing countries, including Nigeria, need to jettison tax policy imposition. Even if such a policy is good on paper, an efficient tax administration would be required to deliver the good. This is because tax policy alone cannot deliver the desired good outcomes. But efficiency in tax administration has been a major challenge in Nigeria and many developing countries.

After the government raised the VAT rate by 50 percent in 2020, conventional thinking on Nigeria’s tax policy has focused on “expanding the tax net”. This view deserves sympathy, given the acute fiscal challenges the country is facing, whereby up to 90 percent of actual government revenue is absorbed by debt service cost. But informal sector operators that may be targeted in expanding the tax net, especially micro and small businesses, are very weak. Poor tax administration, including corruption in the system, may have also masked the extent of taxes being paid by these operators, especially in the transportation and trade sectors.

There are a few options for Nigeria in improving publicly-financed development commitments. First, such commitments by the federal government should be drastically scaled back. Thankfully, President Muhammadu Buhari recently signed into law bills that moved investments in power and rail transportation from the Exclusive List to Concurrent List. State governments can now make investments in these areas that were previously the exclusive preserve of the federal government.

Second, both the federal and state governments should seek to crowd in private sector investments in power, rail, and other economic infrastructures. They can do this through public-private partnerships and by creating an enabling environment for private investors to independently invest.

Third, although it is late in the day, Nigeria has to start making its hydrocarbon resources count more for development. The oil-rich Gulf States that embraced this idea decades ago, have amassed massive savings in sovereign wealth funds. The return on investment on such assets by the UAE, which can fund Nigeria’s federal budget in multiple folds, reduces the need to burden the people with excessive taxation. On a broader note, this calls for better management of the country’s natural resources to generate wealth and savings.

Finally, policy attention should shift to making Nigeria’s tax system more efficient. This entails both tax policy and tax administration reforms.