The Impact of Tax Reforms and Economic Growth of ...

The Empirical Economics Letters, 15(5): (May 2016)

ISSN 1681 8997

The Impact of Tax Reforms and Economic Growth of Nigeria Gylych Jelilov*, Samira Abdulrahman and Abdurahman Isik Department of Economics, Nigerian Turkish Nile University Nigeria Abstract: The study examines the impact of tax reforms on the economic growth of Nigeria from 1986 to 2012. Results shows that tax reforms is positively and significantly related to economic growth and that tax reforms indeed causes economic growth. We conclude that favorable tax reforms improves the revenue generating capacity of government to undertake socially desirable activities that translate to economic growth in real output and per capita basis. However, it is recommended that sustainable economic growth can be heightened through taxes in line with macroeconomic objectives, corrupt-free and efficiency in tax policies of the government, alongside, accountability and transparency of government officials. Keywords: Tax Reforms, Economic Growth, Government, Nigeria JEL Classification Number: G 28, G30, H10, H21

1. Introduction In general, tax is a compulsory levy imposed on the citizens (including their property) by the government for the main purpose of providing infrastructures for economic growth and development. The political, economic and social development of any country depends on the amount of revenue that is generated for the provision of infrastructure in that given country. One means of generating the amount of revenue for providing the needed infrastructure is through a well-structured tax system. Tax is a major player in every society of the world. The tax system is an avenue for government to collect additional revenue that is needed in discharging its immediate obligations. A tax system serves as one of the most effective means of mobilizing a nation’s internal resources and it lends itself to creating an environment conducive to the promotion of economic growth (Azuibik, 2009). Taxes constitute important sources of revenue to the federation account jointly shared by the federal, state and local governments (Nzotta, 2007). Similarly, in Nigeria, the government’s fiscal power is divided into three-tiered tax structure between the federal, state and local governments, each of which has different tax jurisdictions. The system is however dominated by oil revenue. Odusola (2006) argues *

Corresponding author. Email: [email protected]


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that over the past 20 years oil revenue has accounted for at least 70% of the revenue, thus indicating that traditional tax revenue has never assumed a strong role in the country’s management of fiscal policy. Instead of transforming the existing revenue base, fiscal management has only transited from one primary product-based revenue to another, making the economy vulnerable to fluctuations in the international market. It is on the account of this lopsided revenue structure that tax experts and scholars stated that the Nigerian tax system needs to be reformed and revamped in order as to achieve long term economic growth and development. 2. Nigeria and its Tax Reform Policies Nigeria’s over dependence on oil revenue has made the federal government to reform the existing tax laws. The objectives of tax reforms in Nigeria are: to bridge the gap between the National and the funding of the needs; to ensure taxation, as a fiscal policy instrument, to achieve improved service delivery to all; to improve on the level oftax derivable from non-oil activities, vis-à-vis revenue from oil activities; efforts at constantly reviewing the tax laws to reduce/manage tax evasion and avoidance; and to improve the tax administration to make it more responsive, reliable, skillful and taxpayer friendly and to achieve other fiscal objectives (Alli, 2009). The Nigerian tax system has experienced series of reforms since 1904 to date. The effects of the various reforms in the country are: introduction of income tax in Nigeria between 1904 and 1926; grant of autonomy to the Nigerian Inland Revenue in 1945; the Raisman Fiscal Commission of 1957; formation of the Inland Revenue Board in 1958; the promulgation of the Petroleum Profit Tax Ordinance No. 15 of 1959; the promulgation of Income Tax Management Act 1961; establishment of the Lagos State Inland Revenue Department; the promulgation of the Companies Income Tax Act (CITA) 1979; establishment of the Federal Board of Inland Revenue under CITA 1979; establishment of the Federal Inland Revenue Service between 1991 and 1992; and tax policy and administration reforms amendment 2001 and 2004. A more recent reform embarked upon by the Nigerian government was instituting the Study Group on the Nigerian Tax System. This group which was launched on the 6th of August, 2002, was in a bid to examine the tax system and make appropriate recommendations towards achieving a better tax policy and overall improvement in the tax administration within the country. This group consists of individuals from business, academia, intellectuals and the government. The result of the reform was the approval of nine (9) new bills on tax reforms by the Federal Executive Council for the consideration of the National Assembly and was subsequently passed as Acts. The Acts, include : Federal Inland Revenue Service Act 2004; Companies Income Tax Act 2004; Petroleum


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Profit Tax Act 2004; Personal Income Tax Act 2004; Value Added Tax Act 2004; Education Tax Act 2004; Customs, Excise Tariffs, etc. (Consolidation) Act 2004; National Sugar Development Act 2004; and National Automotive Council Act 2004. To understand the importance of tax policy reforms, one needs to come to terms with the urgency for such reforms. Firstly, there is an urgent need to diversify the revenue portfolio of the country in order to safeguard against the volatility of crude oil prices and to promote fiscal sustainability and economic viability at lower tiers of government. Second, Nigeria operates on a cash budget system, where proposals for expenditure are always channeled towards revenue projections. This enables the ability to determine the optimal tax rate for a given level of expenditure. Therefore, accuracy in revenue projection is of utmost importance for implementing an appropriate framework for sustainable fiscal policy management. This can however be achieved when reforms are undertaken on existing tax policies in order to achieve some improvement. Thirdly, Nigerian tax system is concentrated on petroleum and trade taxes while direct and indirect taxes like the valueadded (VAT) are ignored. This is a structural problem for the country’s tax system. Although direct taxes and VAT possess the ability for expansion, their impact is limited because of the domineering informal sector in the country. Finally, the widening fiscal deficit over the years has threatened macroeconomic stability and prospects for economic growth makes the idea of a tax reform very appealing. Nigeria’s fiscal policy measures have been mainly driven by the need to promote some macroeconomic objectives in promoting rapid growth of the economy, generating employment, maintaining price levels and improving the balance-of payment conditions of the country. Although policy measures change from time to time, the following objectives have however remained somewhat constant. Before mid-1980s, tax policies, for instance, were geared to achieving objectives such as: 1) 2) 3) 4)

Ensuring effective protection for local industries; Promoting greater use of local raw materials; Improving on the value added of locally manufactured and primary products; iv)Promoting greater geographical dispersion of domestic manufacturing activities and; 5) Heightening government revenue. 3. Empirical Studies A lot of empirical studies have been conducted on the effects of taxes on economic growth and development of a nation Among them are the studies of (TOSUN & ABIZADEH, 2005)in their study of economic growth of tax changes in OECD countries from 1980 to


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1999 which revealed that economic growth measured by GDP per capita has a significant effect on the tax mix of GDP per capita. is shown that while the shares of personal and property taxes have responded positively on economic growth, shares of the payroll and goods and services taxes have shown a relative decline. Engen and Skinner (1996) suggests modest effects on the order of 0.2 to 0.3 percentage points’ differences in growth rates in response to a major reform. They stated that such small effects can have a large cumulative impact on living standards of people. Easterly and Rebelo (1993) test the tax rate by their own method of constructing marginal tax rate plus several other methods of defining the marginal tax rate, in tax regressions, in total 13 different measures tax rate are employed. The methodology adopted is to include these measures of the marginal tax rate one at a time within a basic regression equation. The basic equation contained the standard determinants of growth notably initial income, school enrolments, assassination, revolutions and war casualties. Estimation of this equation without the inclusion of rates generated the result with an R of 0.29. They concluded that “the evidence that tax rates matter for economic growth is disturbingly fragile”. Arnold (2011) find that short term recovery requires increase in demand while long run growth requires increase in supply. As short term concessions can be hard to reverse, this implies that policies to alleviate this crisis could compromise long run growth. Widmalm (2001) studied the effect of the tax structure on growth using cross-section data on 3 OECD countries from 1965-1990.However the use of only three OECD countries limits the viability of this study, as more OECD countries could be used for a more efficient result. The methodology follows that of Levine and Renelt (1992), but used four basic variables (initial income, investment to GDP ratio, population growth, and average tax rate). The share of different tax instruments in revenue is considered first (corporate income tax, personal income tax, property tax, taxes on goods and services, and taxes on wages). The proportion of tax revenue from taxing personal income has a negative and robust correlation with growth. There is also some evidence that progressivity affects growth. This hypothesis is addressed in (Lee and Gordon, 2005) by conducting a tax regression using the top corporate marginal tax rate and top personal marginal tax rate to capture the effect of taxation. They justify this choice by an appeal to entrepreneurial activity being the driver of growth, and the top marginal rate being the one that is likely to be applicable to successful entrepreneurs, they concluded that it is corporate taxes that are most damaging for growth since they reduce entrepreneurial activities and lessen the incentive


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for innovation cutting corporate tax by 10 percent points and can increase annual growth rate by 1.1 percentage point. 4. Data and Estimation Procedure The source of data for this research work is purely a secondary source. For the purpose of this research work time series variables obtained from Federal Inland Revenue Services, Central Bank of Nigeria publications, Office of the accountant general of the Federation and the publications of Federal office of statistics, text books, published and unpublished thesis. The Scope of the work will be from 1986-2012. The choice of 1986 is because the researcher wants to study taxation from the period of post-structural adjustment in Nigeria. Hence, our total sample is 26. Our study employs the use the analytical tools of analysis which consists of the use of ordinary least square (OLS) Regression Technique. The ordinary least square method of multiple regression analysis is adopted to determine the effect of tax reform on economic growth of Nigeria. 4.1. Specification of the Model This involves the expression of the theoretical relationship in mathematical form with which the economic phenomenon will be explored empirically as: GDP= f (PPT, CIT, VAT) GDP= β0 +β1PPT +β2CIT+β3VAT+µ Where GDP = Gross domestic product as a proxy for economic growth; PPT=Petroleum Profit Tax; CIT=Companies Income Tax; VAT=Value Added Tax; β0, β1, β2 and β3 are the parameters to be estimated; and µ= Stochastic term or error term. This model undergoes three major evaluation criteria. 4.2. Economic A priori Criteria The parameter β0 is expected to be positive (+) which means that even if when fdi, exchange rate and exports are zero, gross domestic product (GDP) will assume a positive value. 4.3. Statistical Criteria The statistical criteria (first order test) aimed at the evaluation of statistical reliability of the estimates in the parameter of the model. They are as follows: The Standard Error of the Estimates: If the standard error (β1) β1, we conclude that β1 is statistically insignificant.


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The Student T-Test: This will be used in testing the statistical significance of each regression coefficient at a given level of significance with N-K degree of freedom and in this case, we will use 5% level of significance and it is given as;±tα/2(N-K) where; If tc±tα/2 (N- K) we accept HO and reject H1,and take a decision based on the findings. 4.4. Economic Criteria The economic criteria (second order tests) are used to test the presence of autocorrelation between independent variable and error term. The test compares the empirical (d*) value calculated from the regression residuals with the upper (du) and lower (dL) limits for the significance levels of d in the DW tables and with their transforms (4-du) and (4-dL). The comparison using Dl and du investigates the possibility of positive auto correlation. While the comparison with (4-Dl) and (4 –du) investigates the possibility of negative autocorrelation. If d* (4-du) we reject HO and conclude that there is autocorrelation. But if du bi/2, that is, 0.00016 > –0.00059/2, we conclude that the coefficient Value Added Tax is statistically insignificant; also since S.E (b2) < b2/2, i.e., 0.01916. >0.00335/2, we conclude that the coefficient estimate of Petroleum Profit Tax is statistically insignificant, and for b 3, 0.1887 < 1.15931/2, we conclude that the coefficient estimate of Company Income Tax is statistically significant. Table 1: Estimated Results of the Model Variables (Constant) VAT PPT CIT

Coefficients 284517.3 -0.00059 0.03335 1.15931

Standard Error 17664.17 0.000163 0.01916 0.1887

T-Statistic 16.10703 -3.592531 1.740190 6.141745

T- Test: This hypothesis IS tested at 5% level of significance with N –K degree of freedom which means 95% level of confidence. Therefore, the critical value of t is; ±tα/2 (n – k) = ±t 0.05/2 (22 – 4) = ±t 0.025 (18) = tt = ±2.074. Since tc (βi) < ± tt i.e. – 3.392531 < ±2.074. It is concluded that the coefficient estimate of Value Added Tax is statistically significant at 5% level. Since 1.74091 < 2.074 it is concluded that the coefficient of


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Petroleum Profit Tax is statistically significant, and given ±t t< tc(β3) i.e. ±2.074 < 6.141745 then the coefficient of Company Income Tax is statistically insignificant at 5% level of significant which means 95% level of confidence we can attribute the effect of the explanatory variables on the dependent variable in our model. Table 2: Model Summary Model

1

R-Square Adjusted R-Square

0.960

0.950

Std.Error Durbin of Esti mate Watson

45176.25

1.237444

F Statistics Prob. FStatistics

118.0579

0.000000

Note: Predictors: Constant, PPT, CIT, and VAT; and Dependent Variable: GDP

F – Test: At α = 5%, with K – 1 (v1) and N – K (v2), i.e. (V1 = 3) and (V2 = 22) degree freedom. From the F – distribution table we have F – critical, F0.05 v1, v2= 3.05 and F – calculated, F Stat =118.06.Since F stat > F0.05 v1, v2, i.e. 118.06> 3.10 at 5% level of significance, we reject H0 and conclude that the variables in the model are statistically and jointly significant. Test For Autocorrelation: Autocorrelation of the estimated model with α = 5%: From the Durbin – Watson table when N = 26 and K = 3, then dL = 1.14 while du = 1.65..However, the computed Durbin – Watson result presented in the table is 1.24 i.e. since d*