Future of Nigerian Fiscal Policy: Taxes

The Covid-19 pandemic has forced governments to spend more than anticipated in their budgets. In the process of bailing out dying airlines, subsidizing wages to sustain employment, or granting businesses tax breaks, authorities have surpassed their projected expenses for the year. Of course, developed economies were better equipped to move ahead without external help, but developing economies struggled a lot more.

Due to a larger informal sector, smaller scope for fiscal and monetary policy, and a weaker health care system, developing economies had to seek other measures to finance their fiscal deficits. Given the sharp decline in oil prices, it’s no surprise that Africa’s oil-producing giant, Nigeria, was also among countries seeking international help. This article is not so much about the implication of the borrowed funds on the economy, but about the future of fiscal policy in Nigeria.

Before the Pandemic:

With Nigeria just recovering from the 2016 recession, the central bank and the federal government pursued mainly expansionary policies to stimulate economic growth. The central bank decreased interest rates and required banks to increase their loan book by lending more to small and medium enterprises. At the same time, the government introduced lower tax rates for these businesses, thereby encouraging growth in the real sector.

A critical factor in ensuring that these expansionary policies were sustainable was the prospects of increased oil revenue for 2020. The boost in revenue was expected to support the central bank in managing the currency through increased foreign reserves, while the federal government was to enjoy more money to finance its budget.

Unfortunately, oil prices declined, coronavirus struck, and a heightened government deficit became increasingly unavoidable.

Spend that money!

In order to limit the effects of the coronavirus, the Nigerian governments took decisive actions to support households and businesses.

On the monetary front, amongst other measures, the CBN introduced a N50 billion Targeted Credit Facility (TCF) as a stimulus package to support households and Micro, Small and Medium Enterprises (MSMEs) affected by the COVID-19 pandemic.

On the fiscal front, the National Assembly introduced an “Emergency Economic Stimulus Bill 2020” to provide for tax relief, suspension of import duty on selected medical goods and deferral of residential mortgage obligations.

At first glance, one would think that there’d be no problem as the government had already estimated a hefty revenue from oil in 2020. However, the oil market did a quick 360 as price per barrel declined from its target $57 to under $20 in April 2020.

With a decline in revenue and the obvious need to up its weak health care system, Nigeria had to look to international authorities for assistance.

The help from outside

In the 2008 financial crisis, Nigeria was able to narrowly avoid a painful decline in growth as the price of oil briefly rose to about $100. Although the unfortunate circumstances of a riot in the Port Harcourt area contributed to this increase, it supported the boost in foreign reserves and government revenue. In September 2008, Nigeria recorded an all-time high foreign reserve of $62 billion, giving not only the government revenue but also, the central bank had more wiggle room with managing the currency.

Unfortunately, this pandemic did not come with a silver lining for the oil-producing nation's bank account. Along with fallen demand for oil, increased oil supply further pushed oil prices down to under $20 in April 2020. As the government relies heavily on oil for about 85% of its revenue, it no longer had enough funds to finance the budget. Although the nation was able to get US$3.4 billion in emergency financial assistance from the IMF, it makes one wonder about how sustainable Nigeria's current budget structure is.

Nigeria recorded a debt service to revenue ratio of about 99% in the first quarter of 2020.

If anything has been obvious this year, it is that the reliance on minerals for revenue is unsustainable.

Less than 15% of Nigeria’s GDP in 2019 was from tax revenue.

Source: Nigerian Budget Office/AfriKnowledgeBank

In the revised 2020-2022 fiscal framework released by the Ministry of Finance, we can see the switch in the federal government's preference from seeking revenue from gross minerals to other forms such as corporate tax revenue. In 2020, authorities expected a higher revenue from gross minerals. However, due to unexpected circumstances, the revised proposal accounts that revenue from other sources (excluding gross minerals) will be higher this year, with the relationship expected to persist even till 2022.

The future of fiscal policy in Nigeria

Efforts to restore public finances early through increased tax revenues will harm growth. Even after the pandemic, there will still be a need (in the short term) for loose fiscal and monetary policy to stimulate broader household consumption and business investments. However, Nigeria's current tax base is narrow, and there is room to generate more revenue.

Many in the underground economy and the informal sector go through their activities without paying taxes. Expanding the tax base through the digitalization of the tax administration, property tax, carbon tax, and VAT are ways we expect Nigeria to increase revenue.

In conclusion

The brief crash in oil price has been a wake-up call for Nigeria to revisit its tax system. While the tightening will not happen immediately as the economy recovers, the longer-term impact is immense. It remains necessary for the Nigerian government to seek out more effective tax collection procedures and see them to completion. This is invariably one of the significant building blocks the economy needs, especially after the hard-hitting effects of Covid-19.

More importantly, the question is whether Nigeria will take this step in the right direction or settle for a below-par tax base, as it has in the past years.

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