CHAPTER ONE

INTRODUCTION

1.1    BACKGROUND OF THE STUDY

Nigeria is governed by a federal system; hence its fiscal operations also adhere to the same principle. This has serious implications on how the tax system is managed in the country. In Nigeria, the government’s fiscal power is based on three – tiered tax structure divided between the federal, state and local governments, each of which has different taxes jurisdiction. As of 2002, all three levels of government share about 40 different taxes and levies.

The Nigeria tax system is lopsided, and dominated by oil revenue. The most veritable tax handles are under the control of the federal government while the lower tiers are responsible for the less buoyant ones – the federal government taxes corporate bodies while state and local government tax individuals. While the federal government on average accounts for 90 per cent of the over all revenue annually, it only accounts for about 70 per cent of total government expenditure. In 1995, the breakdown of total tax and levy collection of the three tiers was 96.4 per cent for the federal government and 0.4 per cent for the local government (Phillips, 1997). A major element contributing to this development was the prolonged military rule that had ignored constitutional provision.

Over the past four decades, the country’s revenue was largely derived from primary products. Between 1960 and the early 19970s, revenue from agricultural products dominated, while revenue from other sources was considered as residual. Since the oil boom of 1973/4 to date, however, oil has dominated Nigeria’s revenue structure and its share in federally collected revenue rose from 26.3 percent in 1970 to 81.8, 72.6 and 76.3 in 1979, 1989 and 1999, respectively. Over the past two decades oil was accounted for at least 70 percent of the revenue, thus indicating that traditional tax revenue, has never assumed strong role in the country’s management of fiscal policy. Instead of transforming or diversifying the existing revenue base, fiscal management has merely transited from one primary product based revenue to another, making the economy susceptible to fluctuation of the international oil market.

The need to address this problem led to several taxes policy reforms. The tax policy reviews of 1991 and 2003, as well as the yearly amendments given in the annual budget, were geared towards addressing this issue. But not much has been achieved. Perhaps to understand the importance of tax policy reforms, one needs to appreciate the urgency for such reforms. Why the need for tax policy reforms in Nigeria? First, there is a compelling need to diversify the revenue portfolio for the country in order to safeguard against the volatility of crude oil prices and to promote fiscal sustainability an economic viability at lower tiers of government. Secondly, Nigeria operates on cash budget system, where as proposals for expenditure are always anchored to revenue projections. This facilitates determining the optimal tax rate for a given level of expenditure. Thus accuracy in revenue projection is vital for devising an appropriate framework for sustainable fiscal management, and this can be realized only if reforms are undertaken on existing tax polices in order to achieve some improvement.