Taxation and the Challenge of Fiscal Sustainability in a Resource-Rich Developing Country: A Re-evaluation of the Nigerian Perspective

Abstract

Taxation plays a pivotal role in the fiscal management and financing of the public sector by the government. This study is dedicated to a comprehensive exploration of taxation and its implications for fiscal sustainability, particularly in the context of a resource-rich developing nation, with a specific focus on Nigeria. In our investigation, we harnessed the power of the Autoregressive Distributed Lag (ARDL) model alongside other robust econometric tools such as the Augmented Dickey-Fuller unit root test and the ARDL bounds test of cointegration. The empirical findings of this study underscore the substantial influence of taxation on Nigeria’s economic growth over the entire period under consideration. While petroleum profit tax exhibited a dampening effect on economic growth, companies’ income tax and value-added tax contributed positively. Significantly, the impact of value-added tax on overall productivity eclipsed that of companies’ income tax. The recommendations emphasize strengthening tax collection institutions for better compliance. The government should also focus on establishing an efficient tax system that widens the tax base, which can be achieved by formalizing informal businesses. This approach is crucial for increasing tax revenues, enhancing fiscal sustainability, and restructuring Nigeria’s economy.

1. Introduction

1.1 Background to the study

A resource-rich nation like Nigeria has a great deal of potential for sustainable growth and economic transformation. The potential for tax revenue as a key source of financing crucial development initiatives has been reduced by the enormous endowments in natural resources, particularly with regard to oil and gas resources. The Nigerian economy has been exposed to vulnerabilities that pose a serious threat to fiscal sustainability due to the country’s heavy reliance on oil revenues and the high volatility of its price on the global market. These factors, along with supply-side issues caused by domestic unrest, have made the Nigerian economy vulnerable [1].

One of the most reliable methods of funding public spending has been shown to be taxation. However, in resource-rich nations like Nigeria with a horrendously low tax to GDP ratio, a weak institutional framework for tax administration, and a high rate of tax evasion, the government has over the years relied on debt (domestic and external) to finance both capital and recurrent spending, with significant implications for fiscal sustainability and sustainable development financing [2].

Fiscal sustainability refers to the use of fiscal policy tools, such as government spending and taxation, to fund or finance economic activities so that the country’s financial health is such that current government expenditure or liabilities do not exceed the amount the government will need to have in its treasury in the future to achieve the desired economic growth [3]. If it is maintained indefinitely and unchanged, a sustainable fiscal strategy would, over the long term, make the government financially solvent. It refers to the government’s capacity to uphold its current tax, spending, and other policies over the long term without jeopardising the ability to pay off its debts or meet its obligations [3, 4].

Fiscal sustainability has drawn so much attention especially in developing countries, and this huge attention is attributed to the fact that most developing countries mostly experience significant fluctuations in their revenue generation thereby resulting to notable fiscal constraint in their development plans [4]. A commitment to fiscal sustainability increases the confidence level of the private sector (which comprises-firms, markets and individuals) regarding the overall direction of government policy. Tax revenue generation and government expenditure are two yardsticks for measuring fiscal sustainability in Nigeria [5].

The political, economic and social development of any country depends on the amount of revenue generated for the provision of infrastructure in the given country, and a well-structured tax system would boost the generation of income for this purpose. Fiscal sustainability is the ability of a government to maintain public finances at a credible and serviceable position over the long term. Ensuring long-term fiscal sustainability requires that governments engage in continual strategic forecasting of future revenues and liabilities, environmental factors and socio-economic trends in order to adapt financial planning accordingly [6]. High and increasing debt levels are harmful to governments’ fiscal positions and can cause a vicious cycle of growing debt, reducing the potential for economic growth as funds are diverted away from productive investments. A sustainable fiscal policy is a policy that can be pursued however long without any major interventions in tax and spending patterns [4, 7].

The predominance of informal sector activities in Nigeria has significant effects on the complexity and efficacy of the tax administration structure, leading to low tax revenue and weak tax penetration. As a result, the government is more dependent on income from the exploitation of natural resources like oil and gas, which have a propensity for significant volatility in relation to commodity pricing on the global market. In order to finance important development initiatives, the nation therefore turns to borrowing, which carries a significant danger of increasing the debt burden and jeopardising fiscal sustainability. The main objective of this study is to examine Nigeria’s fiscal sustainability with reference to the effects of taxation on economic growth in Nigeria. The majority of earlier studies on the topic used contemporaneous models, which severely restricted the ability to assess the dynamic properties connected to variables of interest. This chapter will bridge this research gap by using an analytical framework known as the autoregressive distributed lag model, which has the built-in ability to incorporate the dynamic characteristics of the variables under consideration. With an emphasis on Nigeria’s tax potentials in connection to fiscal sustainability and financing for sustainable development, this chapter investigates the role of taxes in Nigeria’s financing of sustainable development.

1.2 Issues with Nigerian taxation and fiscal sustainability

Despite its vast potential and endowment of abundant natural and human resources, Nigeria has one of the lowest tax-to-GDP ratios in Africa. Nigeria’s tax-to-GDP ratio dropped by 0.4 percentage points from 6.0% in 2019 to 5.5% in 2020. Comparatively, over the same time period, the average for the 31 African countries dropped by 0.2 percentage points, reaching 16.0% in 2020. The average for the 31 African countries has risen by 1.6 percentage points since 2010, rising from 14.4% in 2010 to 16.0% in 2020. In Nigeria, the tax-to-GDP ratio fell by 1.7 percentage points over that time, from 7.3% to 5.5% [8].

Nigeria has low tax revenue to GDP ratio when compared to other African countries of a similar size, with the majority of government income coming from the oil and gas industries [9]. Despite the fact that tax systems differ greatly between nations, according to them, the main goal of any tax system is to maximise revenue and economic growth while minimising distortions. In recent years, the public debt service burden has grown while the economy of Nigeria has continued to generate below-average tax receipts. The sustainability of state finances is seriously threatened by the costs associated with dealing with the present economic downturn and the demand to increase spending on SDG-related initiatives. Taxation and the financing of fiscal deficits through taxes are two of the most sustainable approaches to guarantee appropriate debt levels and fiscal sustainability [2]. The relationship between taxation and fiscal sustainability in Nigeria must therefore be examined, with an emphasis on how it might affect the achievement of sustainable development goals (SDGs).

Fiscal discipline must be strengthened in the process of managing public finances and the accompanying institutional processes in order to increase transparency in the administration of financial resources and ensure the correction of the public deficit and debt. Nigeria’s capacity to achieve the SDGs will be greatly influenced by the sustainability of the public finances, the efficiency of fiscal control, and a solid institutional framework that enables decision-makers to desist from irresponsible fiscal behaviour. As a result, the focus of fiscal responsibility is on the laws, rules, and practises that have an impact on how fiscal policy is created, approved, implemented, and monitored. In order to achieve this, it defines three crucial concepts that have a broad impact: numerical fiscal laws, independent fiscal institutions, and medium-term budgetary frameworks [10].

One of the most important factors in attaining fiscal sustainability in Nigeria is taxation, yet there are too many loopholes in the Nigerian tax code, making it impossible for it to be fair and successful in accomplishing its sustainability goal. In order to achieve the necessary economic growth while taking into account the taxation challenges the nation faces, this research focuses on the impact that tax income and government spending have had on establishing a financially sustainable Nigerian economy over the period of 2001–2020. But the objective is to make it apparent how important it is for tax revenues to rise and for government spending to rise as well, while making sure that the money raised from both sources is used in the right ways to achieve the required economic growth.

Nigeria’s low tax to GDP ratio has been attributed to a number of factors, including but not limited to inadequate tax revenues (an inefficient tax system that is concealed by enduring institutional problems) and tax administration corruption, which encouraged a generalised persistent weakness in tax collection. One aspect of Nigeria’s fiscal weakness is the abundance of natural resources, which makes tax collections in resource-rich countries seem unimportant. Other aspects include tax avoidance and evasion, inadequate tax authority assessment, a lack of trust between taxpayers and the government, a small tax base, a sizable informal sector, lenient penalties for tax defaulters, and a lack of trust between taxpayers and the government.

According to [10], Nigeria would exceed the 3% ceiling imposed by the Fiscal Responsibility Act with a fiscal deficit in 2022 of $6.39 trillion, or 3.46% of GDP. But it’s important to keep in mind that, given that the budget deficit has climbed from 953.6 billion in 2015 to 3.61 trillion in 2022, a rise in the deficit would surely result in a rise in future debt servicing. Future financial costs could rise as a result, resulting in even greater deficits.

To close the fiscal gap in 2022, the Federal Government of Nigeria (FGN) anticipates borrowing 2.57 trillion dollars from domestic and foreign sources, 1.16 trillion dollars through multilateral and bilateral loan drawdowns, and 90.7 billion dollars from privatisation earnings. When revenue projections are uncertain or outside funding is insufficient, the FGN may also utilise the CBN’s Ways and Means facility (WMF). Government debt as a proportion of GDP is forecast to increase from 35.7% in 2021 to 36.7% in 2022 as a result of the increased borrowing. This will dramatically raise the nation’s debt load and put its ability to service debt in jeopardy [11].

1.3 Taxation, theoretical underpinnings

1.3.1 Benefit principle

In the philosophy of taxation from public finances, there is a notion known as the benefit principle. The benefit approach was initially devised by two Swedish economists, Erik Lindahl (1891–1960) and Johan Gustaf Knut Wicksell (1851–1926), to evaluate the effectiveness of taxation and fiscal policy [12]. Taxes for public goods are based on the principal’s political willingness to pay for the advantages obtained. According to this principle, the state should tax people in proportion to the benefit that has been given to them. A person should contribute to the government more the more benefits they receive from governmental actions. As a result, the benefit-received principle of taxation says that individuals and organisations should pay taxes in a way that is similar to how they would pay for other products and services. The road tax is a good illustration. Therefore, people who gain from using the roads for transportation pay the tax for their upkeep and development. The Benefit Principle of Taxation has three basic explanations or applications: 1. It acknowledges that taxes are levied with the intention of financing government services by requiring taxpayers to pay a share of the benefits from government spending. 2. According to the benefit principle, taxes are thought to have a comparable purpose to pricing in private transactions. Since resources would be allocated through the public sector, this might result in a solution that is economically efficient. 3. It quantifies the benefits that people obtain from specific special taxes, such as the tax on gasoline and the tax on improvements, among others [12, 13].

1.3.2 The theory of optimal taxation

According to the widely accepted theory of optimum taxation put forth by Frank P. Ramsey in 1927, a tax system should be chosen to maximise a social welfare function within a set of limitations [14]. The social planner is often portrayed in the literature on optimal taxation as a utilitarian, meaning that the social welfare function is based on the personal utility of each member of the society. Numerous models that concentrate on different facets of the tax system are included in the field of optimal tax theory. Three characteristics unite these many models. First, each model outlines the government’s revenue requirements as well as a list of practical levies, like commodities taxes. Lump-sum taxes, which would not produce any economic distortion, are often excluded from the models. Second, each model describes how people and businesses react to taxation. In other words, people have preferences for certain types of goods and activities, businesses use certain production technologies, and people and businesses engage under certain market structures (often perfect competition). Third, the government has an impartial role in assessing various tax structures. In the most basic models, the government seeks to maximise revenue generation while minimising the excess burden brought on by the tax system [14].

1.3.3 Domar’s approach to fiscal sustainability

The first economist to address fiscal sustainability in the context of an expanding economy was Domar (1944). Domar’s stability condition is the name given to Domar’s notion of fiscal sustainability. He referred to a stabilising debt-to-GDP ratio or deficit-to-GDP ratio when defining fiscal sustainability. According to Domar’s condition, for fiscal policy to be sustainable, national output growth (n) must outpace the cost of governmental borrowing (r), or the growth rate of public debt if no new borrowing is made. However, any deficit might result in a fiscal policy that is inherently unsustainable if borrowing costs are higher than growth rates in the nation’s GDP. Domar’s method is unusual in that it makes it easier to determine the necessary primary surplus (PS) or deficit to maintain the debt-to-national production ratio at a specific level, given a growth-interest rate difference. This method assumes that r and n’s behaviour is exogenously determined and unrelated to the management of fiscal policy [15].

1.3.4 Solvency approach

The inter-temporal budget constraint (IBC) of the government serves as the foundation for the solvency method. The present-value budget constraint approach is another name for this. This method holds that a fiscal policy is sustainable if the government can pay off all outstanding debt by producing PSs from future budgetary results. Technically speaking, fiscal sustainability calls for the stock of public debt to be at least equal to the discounted value of predicted future primary budgetary surpluses in a dynamically efficient economy [16]. According to [17], a government is considered to be solvent if its assets are greater than its liabilities. Solvency is guaranteed as long as net worth is positive.

1.3.5 Ricardian equivalence approach

In the 19th century, David Ricardo created this hypothesis. They view taxes and public debt as two methods of funding governmental expenses [17]. While the deficit or the national debt are taxes on future generations, current taxes are a burden on the current generation. Deficit or debt are therefore implicit taxes, and the replacement of taxes by public debt is nothing more than a change in the schedule of taxes. Public debt is the deferral of taxes, which will result in larger tax burdens in the future. Thus, taxes and debt have an impact on both the wellbeing of the present and future generations. The generational welfare neutrality of these two fiscal devices is the fundamental component of Ricardian equivalence. Fiscal policy is unsustainable from a generational welfare perspective if taxes and debt financing have unequal or non-neutral effects on present and future generations. As a result, the generational accounting technique and the Ricardian equivalency approach to budgetary sustainability can both be understood in roughly the same ways. The RET is predicated on certain assumptions. The two main assumptions are (a) fully foresighted and charitable economic agents, and (b) an ideal capital market, in which lending and borrowing rates are the same for diverse agents like the public and private sectors. Taxes are not distorted, and both the market interest rate and each agent’s personal subjective discount rate between present and future spending decisions are identical. The Ricardian approach states that fiscal policy is sustainable if the method used to finance government spending has no negative effects on generational welfare neutrality.

2. Review of the Nigerian tax system

2.1 The Nigerian national tax policy

A revised National Tax Policy (NTP) was approved by the Federal Executive Council on February 1, 2017. The central objective of the tax policy is to establish fundamental rules that will direct the Nigerian tax system’s orderly growth in the direction of achieving its overall goals. In this regard, the Policy emphasises the Fundamental Objectives found in Chapter 2 of the Federal Republic of Nigeria’s 1999 Constitution and reaffirms the necessity of administrative and tax policies that foster economic development [7]. The Policy outlines important policy concepts to address the issues the Nigerian tax system is facing. It outlines the rights and obligations of key stakeholders and acknowledges the contributions they played in the creation of an efficient tax system. The Policy also emphasises the importance of good Tax Administration in the goal of a fair and equitable tax system [18].

The National Tax Policy (NTP) affirms the necessity of tax legislation and administrative procedures for promoting economic development in Nigeria and outlines essential principles to direct the tax system’s orderly development. The Nigerian Tax Plan (NTP) is a plan that establishes broad guidelines for taxation and related issues in Nigeria. It provides a set of guidelines, norms, and operating principles that would regulate taxes in Nigeria and that all participants in the tax system can accredit. It is a clear statement of the principles guiding tax administration and revenue collection [19].

In an effort to ingrain a solid and effective tax system in Nigeria, the National Tax Policy (NTP) was initially released in 2012. Four years later, among other developments, the rapidly shifting business environment and the continued low tax to Gross Domestic Product (GDP) ratio required new approaches to continue achieving government goals of fostering an enabling environment, streamlining the tax code, and ensuring ease of compliance. One of the most important aspects of the NTP is its progressive transition to indirect taxation, purposeful efforts to improve the ease of paying taxes ranks, expansion of the tax base, and use of technology, intelligence, and inter-agency cooperation. The Federal Ministry of Finance has established an office of tax simplification and a committee to implement tax policy. The federal and state legislatures have also established taxation committees. Special tax courts have also been established.

2.2 Fiscal sustainability commission

In a bid to foster fiscal discipline and ensure fiscal sustainability in, the Nigerian Fiscal Responsibility Commission was created by the Fiscal Sustainability Act of 2007 [9]. The commission’s statutory responsibilities include the following: to monitor and enforce the fiscal responsibility act’s provisions and, in doing so, to advance the economic goals outlined in Section 16 of the Constitution; and to disseminate standard practises, including international good practise, that will lead to greater efficiency in the allocation and management of public expenditures, revenue collection, debt control, and transparency in fiscal matters [9]. In order to encourage efficient tax revenue collection and foster fiscal sustainability in Nigeria, the Fiscal Sustainability Act has established a number of institutional instruments, such as:

2.2.1 Medium term expenditure framework

In accordance with the Fiscal Sustainability Act’s requirements, the Medium-Term Expenditure Framework (MTEF) must include a Macro-Economic Framework that outlines the macroeconomic projections for the next three fiscal years, the underlying assumptions used to make those projections, as well as an assessment and analysis of the macroeconomic projections for the previous three fiscal years. A Fiscal Strategy Paper (FSP) outlining the Federal Government’s medium-term financial goals, taxation, recurrent (non-debt) expenditure, debt expenditure, capital expenditure, borrowings and other liabilities, lending and investment, as well as the Federal Government’s strategic economic, social, and developmental priorities for the next three fiscal years is also anticipated to be included in the MTEF [20].

The MTEF is also anticipated to include an expenditure and revenue framework that details estimates of total revenues for the Federation for each fiscal year based on the predetermined commodity, projections of tax revenues and reference prices, as well as projections of total expenditures and total tax expenditures for the Federation over the course of the next three fiscal years. According to the Fiscal Responsibility Act, the Minister must submit the Medium-Term Expenditure Framework to the Federal Executive Council for review and approval by the end of the second quarter of each fiscal year. The Federal Executive Council’s approved Medium-Term Expenditure Framework will go into effect once a resolution of each house of the National Assembly has been approved. The National Assembly-approved Medium-Term Expenditure Framework will be published in the Gazette [21].

A MTEF may be amended at the president’s request. However, any modification to the MTEF shall only be made to remedy obvious errors and significant, in the President’s opinion, changes to the fiscal indicators. The MTEF must also serve as the foundation for the estimates of revenue and spending that must be created and presented to the National Assembly, as well as for the sectoral and compositional distribution of the estimates of expenditure, according to the Fiscal Sustainability Act [22].

3. Methodological approach

3.1 Review of the literature

Numerous studies have been conducted on the connection between taxation and economic expansion. Some of these studies contend that tax policies significantly and favourably affect the pace of output growth, whilst others have found an adverse relationship between the two variables. Using an overlapping generation’s model with exogenous growth settings, [23] examined expenditure- and tax-based consolidations under the rule of reductions in debt-to-GDP ratios to the target level and the consequences of these consolidations on fiscal sustainability and welfare. According to the study, tax-based consolidation must proceed more quickly than expenditure-based consolidation in order to guarantee budgetary sustainability. In terms of welfare, governments may choose several types of consolidation depending on the quantity of outstanding debts in relation to capital, the efficiency of the economy, the levels of taxation, and the degree to which people benefit from public goods and services. More importantly, it might also depend on whether governments prioritise social welfare or equity in the allocation of welfare among generations. In contrast, fiscal consolidation cannot last much longer than 30 years from the perspectives of both social welfare and equitable distribution of welfare across generations.

Anthony [24] used a multivariate framework to study the 1970–2019 fiscal policies and public debt sustainability in Nigeria. To ascertain the long-term relationship between the variables, the autoregressive distributed lag (ARDL) bounds test is used. The findings of the ARDL test show that the variables employed in this study have a long-term association. In particular, the outcome demonstrates that budget deficit affects public debt positively and significantly over the short and long terms, but interest rates, real gross domestic product, and inflation rate were statistically insignificant across all time periods and had no effect on public debt. In order to ensure that allocative efficiency is attained in the budgeting system, it was advised that the budgeting process in Nigeria at the federal and state levels be reviewed.

In Cosimo [25] the fiscal sustainability of the six Gulf Cooperation Council (GCC) nations was examined from 1990 to 2017. Mixed results are obtained from panel unit root tests when government revenues, expenses, the main balance, and debt are subject to cross-sectional dependence. However, cointegration tests show that there is a long-term relationship between government revenues and expenditures, although the relationship between the primary deficit of the government and debt remains debatable. Saudi Arabia is at risk and must keep its debt under control, according to panel assessments of the cointegrating relationship. However, Bahrain and Qatar appear to be up against the most difficult obstacles. The findings of causality tests indicate that the GCC governments make decisions about their revenues and expenditures at the same time, supporting the theory of fiscal synchronisation. According to the study, the GCC region should take into account three general factors. First, countries will also need to raise their non-oil tax collection in order to address budgetary crisis. Second, it’s likely that governments will have to scale back as future economic pressures might be lessened with more non-oil tax revenue. Third, nations ought to reconsider their approach to saving.

Using annual data on public revenues and expenditures, all expressed as a ratio of GDP, [25, 26] evaluated the sustainability of fiscal policy in Nigeria from 1961 to 2016. The study uses the cointegration approach of ARDL bounds testing to identify an equilibrium relationship between the variables. A data analysis approach called Autoregressive Distributed Lag (ARDL) is also used to assess how well the Nigerian government complies with the budget restriction equation. The findings indicate that there is no equilibrium between public revenue and expenditure, which excludes sustainability in Nigeria’s public finances. Therefore, it is sensible for the government to increase the revenue base, lower tax rates, and exercise fiscal restraint in order to prevent spending money ineffectively.

Using state-level data for India from 1980 to 1981 to 2017–2018, [27] analysed budgetary sustainability. The findings, which were obtained using cointegration and dynamic ordinary least squares techniques, indicate that the majority of states have excellent budgetary sustainability. States in the north, west, and south are more financially stable than states in the east. Financial sustainability was also discovered by the investigation for both the income and capital accounts. In terms of policy, state governments should review their spending habits to cut down on non-developmental spending, especially in those states with weak sustainability.

A research on Japan’s fiscal sustainability was done in 2020 by [28] they claim that Japan has the highest debt to GDP ratio among advanced countries and is at the forefront of the demographic ageing process in terms of both speed and magnitude. Furthermore, it is predicted that public pension, healthcare, and long-term care (LTC) costs will rise at a much faster rate than revenues, further straining the economy. In order to control the earnings and labour supply profiles of heterogeneous agents and their cohort shares, the study developed an accounting model that is populated with overlapping generations of people and incorporates social insurance programmes in detail. It also uses the most recent estimates of Japanese microdata and government demographic projections. According to the findings, if existing policies are not changed, Japan will continue to experience significant deficits in the areas of public health, pensions, and necessities, and its debt to GDP ratio will soar to previously unheard-of heights with rising interest costs.

Fiscal sustainability in the Caribbean was studied by [29]. They said that for small economies with high debt and increased vulnerability to climate change, fiscal sustainability continues to be a major concern. They used the model-based fiscal sustainability test in 16 Caribbean nations between 1980 and 2018 to fulfil the study’s goals. The findings suggest that fiscal policy in the Caribbean adopts corrective measures to counterbalance a growth in the debt-to-GDP ratio since the coefficient on lagged government debt is positive and statistically significant. However, nonlinear estimations reveal that the quadratic debt parameter is negative, indicating that the fiscal policy response is insufficient to ensure sustainability at greater levels of debt. The empirical findings show that conservative fiscal policies must be maintained, and growth-promoting structural reforms must be put in place in order to create fiscal buffers and guarantee debt sustainability with a high likelihood even in the event of long-term negative shocks.

The sustainability of Sri Lanka’s fiscal imbalance and state debt was examined by [30]. The study uses a symmetric ARDL (autoregressive distributive lag) technique to estimate a government’s intertemporal budget constraint in order to determine if the fiscal imbalance is sustainable. Additionally, it uses an asymmetric ARDL technique to estimate a fiscal reaction function to assess the sustainability of public debt. This technique allows for differing primary budget balance responses depending on whether regressor shocks are positive or negative. The estimations are based on annual data from 1961 to 2018. The findings show that Sri Lanka’s fiscal management is incompatible with strong form sustainability, which calls for making sure that spending does not increase faster than income. However, estimate of the fiscal reaction function uncovers solid proof of the inequalities in fiscal policy. There is growing evidence that Sri Lanka’s fiscal policy is pro-cyclical, with strong stabilisation tendencies during economic booms but weak stabilisation tendencies during recessions. Authorities are observed to undertake fiscal consolidation in response to increases in the debt-to-GDP ratio, which suggests a weak form of sustainability.

Olufemi [31] conducted research on Nigeria’s budgetary sustainability in relation to the nation’s economic performance. A fiscal sustainability equation is created and the conditions for creating sustainability are determined using the framework of an intertemporal budget constraint for the government. The empirical methodology uses the dynamic OLS (DOLS) regression method, the unit root test, and the cointegration test to examine the viability of the fiscal position from 1961 to 2016. The DOLS regression result in particular supports the empirical evidence of weak sustainability. Similar to this, the results regarding the relationship between budgetary sustainability and economic performance show a weak reaction from the latter. The evidence from this study generally did not significantly differ from earlier investigations in this body of literature. This study’s key policy recommendation is that Nigeria’s government make sure there is a stronger, systemic connection between tax and spending policies and the development of the public debt.

3.2 Model specification and estimation technique

We used a Autoregressive Distributed Lag (ARDL) model to capture the relationship between taxation and economic growth in Nigeria for the period 2001–2020. Included in the model are; gross domestic product as the dependent variable; and companies income tax (CIT) revenue, petroleum profit tax (PPT) revenue, value added tax (VAT) revenue as the explanatory variables.

3.2.1 Petroleum profit tax (PPT)

Companies involved in the production and transportation of petroleum products are subject to the petroleum profit tax (PPT). It relates to parts of oil mining, prospecting, and exploration leases that are related to rents, royalties, margins, and profit-sharing arrangements. PPT serves as a tool through which the government restricts the number of players in the petroleum business and takes ownership of public assets in addition to generating cash for the government. The PPT is, in a sense, a tool for wealth redistribution between the wealthy and industrialised economies who control the knowledge, expertise, and technical know-how, as well as the capital required to develop the oil and gas sector in Nigeria and other developing countries.

3.2.2 Companies income tax (CIT)

The profit or gain of any company that is incurred in, derived from, imported into, earned in, or received in Nigeria is subject to companies income tax (CIT). The tax rate, which was previously 30% and applied to the company’s gross or chargeable profits, was lowered to 20% under the new (2010) tax law. It should be noted that oil marketing and oil service businesses are subject to education tax at a rate of 2% on the assessable profit.

3.2.3 The value added tax (VAT)

The Value Added Tax Act Cap V1, LFN 2004 governs value added tax (VAT) in Nigeria (as amended). It is a consumption tax that is paid when products are bought and services are provided. The final consumer is responsible for a multi-stage tax. Except for those expressly exempted by the VAT Act, all products and services, whether domestically produced or imported, are subject to taxation. 7.5% is the VAT rate.

The functional specification of the model used for the purpose of this study is stated as:

$$\mathrm{GDP}=\mathrm{f}\left(\mathrm{CIT},\mathrm{PPT},\mathrm{VAT}\right)$$E1

The Autoregressive Distributed Lag Model of the functional specification in Eq. (1) is written as:

$${\mathit{GDP}}_t={\alpha }_0+\sum _{i=1}^p{\lambda }_i{\mathit{GDP}}_{t-i}+\sum _{i=0}^{q_1}{\beta }_{1i}{\mathit{CIT}}_{t-i}+\sum _{i=0}^{q_2}{\beta }_{2i}{\mathit{PPT}}_{t-i}+\sum _{i=0}^{q_3}{\beta }_{3i}{\mathit{VAT}}_{t-i}+{\mu }_t.$$E2

Where:

GDP = Gross Domestic Product.

CIT = Companies Income Tax.

PPT = Petroleum Profit Tax.

VAT = Value Added Tax.

${\alpha }_0$ to $\beta$₃ = the parameters to be estimated.

${\mu }_t$ = Stochastic error term.

p and q are optimal lag order, where.

p = lag length of the dependent variable.

$q_1$ = lag length of CIT.

$q_2$ = lag length of PPT.

$q_3$ = lag length of VAT.

${\beta }_{1-3}$ = parameters of the independent variables.

$\gamma$_i = parameters of the lagged values of the dependent variable included as independent variables.

∑ = summation sign.

A-priori expectation

By theoretical expectation, the coefficients of CIT, PPT and VAT are all expected to be positive.

$${\mathrm{\alpha }}_0>0;\gamma >0;{\beta }_1>0;{\beta }_2>0;{\beta }_3>0;$$

An Autoregressive Distributed Lag (ARDL) model was specified as part of the quantitative analytical technique used to analyse the data collected for the aim of this study. The data were subjected to diagnostic studies to ascertain their stationarity status as well as the trend trajectory of the data in an effort to prevent the occurrence of spurious regression. Unit root tests, bounds tests for cointegration, and trend analysis are some of the investigations that were conducted. The Breusch-Pagan-Godfrey test for heteroscedasticity, the Cumulative Sum Test (CUSUM) for model stability, and the Breusch-Godfrey LM Test for Serial Correlation are all used as post estimation diagnostic tests.

The model’s and the estimating technique’s justification depends on how well they measure the dynamic aspects of taxation and economic growth in Nigeria throughout the time period under consideration. In order to accomplish the study’s stated aims, it is believed that the model is appropriate. The ARDL model permits the integration of both the current and lagged values of the variables taken into consideration for this study when analysing the effects of one variable on another. A second argument in favour of the model is that it is straightforward to use.

3.3 Nature and sources of data

The nature of data for this research is secondary data obtained from the National Bureau of Statistics (NBS) and Federal Inland Revenue Service (FIRS) covering the fiscal period 2000–2020. The quarterly time series data regarding gross domestic product (GDP) was obtained from the NBS while the quarterly time series data regarding CIT, PPT and VAT were obtained from the FIRS.

4. Regression results and analysis of taxation trends

4.1 Analysis of tax trends in Nigeria

This section shows the trend of selected tax variables in Nigeria considered for analysis from 2001 to 2020. From Figure 1, companies’ income tax (CIT) shows a fairly stable movement pattern from the first quarter of 2001 to second quarter of 2008. However, an upward but wave-like oscillatory pattern can be observed in the trend from 2009 to 2020. This trend pattern shows a relatively unstable contributions of companies income tax revenue during recessions and economic downturns. This is attributable to the fact that companies’ profits are also affected by macroeconomic shocks and unfavourable government policies. It is therefore important to maintain a conducive and business friendly environment for companies to thrive, while ensuring effectiveness of the companies income tax administration framework.

Figure 1.

Trend of companies’ income tax measured in billions of Naira (2001–2020). Source: Authors’ computation based on data from Federal Inland Revenue Service (FIRS).

From Figure 2, the trend of petroleum profit tax shows a highly unstable trajectory throughout the entire period under consideration. This movement pattern can be attributed to the high volatility associated with commodity prices in the international market. Petroleum profit tax revenue increases when crude oil price rises in the international market, and falls sharply with falling crude oil prices. This is an indication that reliance on such tax revenue to finance critical development projects necessary for economic transformation, may not be sustainable. It is therefore imperative to focus more on the non-oil tax revenue in order to engender fiscal sustainability.

Figure 2.

Trend of petroleum profit tax measured in billions on Naira (2001–2020). Source: Authors’ computation based on data from Federal Inland Revenue Service (FIRS).

The trend trajectory of value added tax is depicted in Figure 3. The trend pattern shows a relatively stable and upward trajectory throughout the entire period of study. The trend pattern is an indication that non-oil tax revenue such has VAT are imbued with the potential for sustainable financing of government expenditure without compromising fiscal sustainability. The consistency in the trend trajectory of VAT is a testament to the enormous revenue potentials of a broadened tax base and the efficacy of collection systems.

Figure 3.

Trend of value added tax measured in billions of naira (2001–2020). Source: Authors’ computation based on data from Federal Inland Revenue Service (FIRS).

4.2 Regression results and discussions

The Augment Dickey Fuller (ADF) unit root test was used to evaluate the time series properties of the data used for the regression analysis in an effort to prevent the phenomenon of spurious regression, which is frequently linked with non-stationary time series data. The unit root test has a decision rule that states that we reject the unit root null hypothesis when the absolute value Augmented Dickey-Fuller (ADF) t-statistics is greater than the critical value at 5% level of significance and the probability value (p-value) corresponding to the test statistic is less than 0.05, indicating that the time series data under consideration is stationary. However, if the p-value is higher than 0.05, the unit root hypothesis is not rejected and it can be concluded that the time series data is not stationary at 0.05 level of significance.

The summary of ADF unit root tests shown in Table 1 demonstrates that CIT, PPT, VAT, and GDP are all stationary at first difference. The p-values for all of the ADF-statistics were less than 0.05, and their absolute values were all higher than the absolute 5% critical values. This suggests that all variables are integrated to order one I(1). In other words, while the time series data with respect to the time series data under examination are not stationary at level, they are all stationary at the first difference. It is crucial to look at the variables for cointegration Source: Author’s computation because they are not stationary at level.

Variable	ADF-statistics	5% critical value	P-value	Order of integration
GDP	−3.593576	−2.900670	0.0081	1(1)
CIT	−26.08183	−2.900137	0.0001	1(1)
PPT	−7.957927	−2.899115	0.0000	1(1)
VAT	−9.848912	−2.899115	0.0031	1(1)

Table 1.

ADF unit root test results.

Source: Author’s computation.

The F-statistics is 7.344302, which is higher than the upper critical bound value of 3.67 at 5% level of significance according to the findings of the ARDL Bounds test of cointegration shown in Table 2. Because of this, we accept the alternative hypothesis that there is Cointegration at 5% level of significance and reject the null hypothesis that there is no Cointegration at this level of significance. This suggests that the factors being thought about have a long-term link. Since cointegration has been established, we can now estimate the model’s long-run form and the error correction model, which gauges how quickly equilibrium shifts between the short-run and long-run.

Statistics	Values	Significance levels	1(0); Lower critical bound value	1(1); Upper critical bound value
F-Statistics	7.344302	10%	2.37	3.20
		5%	2.79	3.67
		2.5%	3.15	4.08
		1%	3.65	4.66

Table 2.

Auto-regressive distributed lag bounds test of cointegration.

Source: Author’s Computation.

Based on the results of the long run model presented in Table 3, the estimated coefficient of petroleum profit tax (PPT) is negative and statistically insignificant at 5% level of significance. The P-value corresponding to the t-statistic is 0.0082 which is less than 0.05, implying a rejection of the null hypothesis that the coefficient of PPT is not statistically significant. A unit increase in petroleum profit tax will result in a decrease in economic growth on the average by 8.571372 units, holding companies income tax and value added tax constant. This outcome indicates that petroleum profit tax has a negative and significant impact on economic growth in the in the long run. This results shows that petroleum profit tax has a negative influence on the long run growth path of the economy.

Variable	Coefficient	Standard error	T-statistics	P-values
PPT	−8.571372	3.131866	−2.736825	0.0082
CIT	26.18403	16.87352	1.551783	0.1262
VAT	120.7390	27.09763	4.455705	0.0000
C	−981.9481	1017.499	−0.965061	0.3385

Table 3.

ARDL Long Run Form regression results.

Source: Author’s Computation based on output from E-VIEWS10 software.

Companies’ income tax (CIT) shows a positive but statistically insignificant relationship with economic growth. The P-value corresponding to the t-statistic is 0.1262, which is greater than 0.05, implying a no rejection of the null hypothesis that the coefficient of CIT is not statistically significant at 5% significance level. A unit increase in companies income tax will result in an increase in economic growth by 26.18403 units, holding petroleum profit tax and value added tax constant. Hence, companies income tax has a positive but insignificant impact on economic growth in the long run.

Value added tax (VAT) shows a positive and statistically significant relationship with economic growth. The P-value corresponding to the t-statistic is 0.0000, which is lower than 0.05, implying a rejection of the null hypothesis that the coefficient of value added tax is not statistically significant and the acceptance of the alternative hypothesis that the coefficient of value added tax is statistically significant at 0.05 significance level. A unit increase in value added tax will result in an average increase in economic growth by 120.7390 units, holding petroleum profit tax and companies income tax constant. This implies that value added tax has a significant positive impact on economic growth in the long run.

The error correction model is examined to evaluate the short run dynamics between the dependent and independent variables and its speed of adjustment to equilibrium. Its results are presented in Table 4. The short-run form is represented as the first differenced variables. From the results of estimated Error Correction Model presented Table 4, the estimated coefficients of petroleum profit tax (PPT) shows that the current value has a negative and insignificant impact on economic growth, while the lagged coefficients have positive impact on economic growth. Only the second and third lagged coefficients are statistically significant, indicating the presence of delays in the transmission of the effects of petroleum profit tax to economic growth in Nigeria. Hence, petroleum profit tax has a positive and significant effect on economic growth in nigeria in the short run with some time lags required for the impact to fully take effect.

Variable	Coefficient	Std. error	t-statistics	P-values
D(GDP(−1))	0.048913	0.102040	0.479351	0.6335
D(GDP(−2))	−0.372648	0.095016	−3.921972	0.0002
D(GDP(−3))	−0.213931	0.103797	−2.061062	0.0438
D(PPT)	−0.991867	1.205642	−0.822688	0.4141
D(PPT(−1))	3.090010	1.250695	2.470634	0.0164
D(PPT(−2))	1.600954	1.279585	1.251151	0.2159
D(PPT(−3))	4.136915	1.240565	3.334703	0.0015
D(CIT)	3.148992	2.378288	1.324058	0.1907
D(CIT(−1))	−4.398355	3.133672	−1.403579	0.1658
D(CIT(−2))	−0.302398	2.798384	−0.108062	0.9143
D(CIT(−3))	−6.337973	2.581409	−2.455237	0.0171
D(VAT)	9.939373	7.757969	1.281182	0.2052
D(VAT(−1))	−26.98527	10.10646	−2.670100	0.0098
CointEq(−1)*	−0.268736	0.042893	−6.265304	0.0000
R-squared	0.751638	Mean dependent var		4781.114
Adjusted R-squared	0.699562	S.D. dependent var		9803.505
S.E. of regression	946.2699	Akaike info criterion		20.20353
Sum squared resid	55,516,463	Schwarz criterion		20.75862
Log likelihood	−620.8947	Hannan-Quinn criter.		20.38447
Durbin-Watson stat	1.958871

Table 4.

Error correction model regression results.

Source: Author’s Computation.

The current value of companies income tax is positive but not statistically significant while the third lag coefficient is negative and statistically significant at 5% significance level. This implies that the impact of companies income tax on economic growth in Nigeria is associated with some delays in the short run. Also, the current value of value added tax (VAT) is positive but not statistically significant in the short run while the second and third lag coefficients are negative and statistically significant at 5% significance level. This implies that the impact of value added tax on economic growth in Nigeria is also associated with some delays in the short run.

Also, the results of the Error Correction Model presented in Table 4 indicates that the error correction term is negative and statistically significant at the 5% level of significance. The estimated ECM coefficient (−0.268736) measures the speed of adjustment towards an equilibrium relationship. It indicates that about 27% of the disequilibrium is adjusted each quarter. This also implies a long run causal relationship. The adjusted R² shows that about 70% of the total variations in economic growth in Nigeria is explained by all the explanatory variables explicitly captured in the regression model. This implies that the regression model has a good fit.

The CUSUM test is used to determine the appropriateness and stability of the estimated model. It is used to test whether the model is stable and appropriate for any long run decisions. The basis of the test is that if the plot of the CUSUM test stays within the 5% critical bounds, the null hypothesis that all the parameters are stable cannot be rejected. If either of the parallel lines are crossed or the cumulative sum goes outside the boundaries of the two critical lines, then the null hypothesis of parameter stability is rejected at the 5% significance level.

From Figure 4, the plots are confined within the 5% critical bounds which prove that the residual variance is stable. Thus, the null hypothesis that all parameters are stable cannot be rejected at 5% level of significance, implying that the model is stable.

Figure 4.

Cumulative sum test for model stability.

The economic implication of the long run result is that both companies income tax and value added tax have a long run positive impact on economic growth while petroleum profit tax has a negative impact on economic growth. Hence, measures targeted at enhancing the efficacy of non-oil related taxed have tremendous potential to boost growth of the economy in the long run. With reference to the petroleum profit tax, the estimated coefficient is negative and statistically significant at 5% level of significance. This is an indication that overreliance on oil revenue has a negative long run impact on economic growth in Nigeria.

The results of the estimated Error Correction Model, which measures the dynamics of change from short run to the long run, shows that there are delays associated with the transmission of taxation to economic growth in the short run. Also, the Error Correction Term (ECT) shows that the speed of adjustment from short run to long run equilibrium is −0.268736. This is an indication that the model converges towards equilibrium in the long run and about 27% of the disparity between short run and long run equilibrium is adjusted each period.

5. Conclusions and policy recommendations

In this chapter, we looked at taxes and the issue of fiscal sustainability in a resource-rich developing nation, paying specific attention to how taxes affected Nigeria’s economic growth from the first quarter of 2001 to the fourth quarter of 2020. Value added tax (VAT), petroleum profit tax (PPT), and companies income tax (CIT) received particular attention (VAT). According to the study’s empirical results, taxes have a big impact on Nigeria’s economic growth over the long and short terms. However, certain tax provisions are more successful than others at promoting growth. The results of the autoregressive distributed lag model demonstrate that while oil-related tax components, such as the petroleum profit tax, had significantly negative long-term effects on Nigeria’s economic growth, non-oil tax components, such as companies’ income tax and value added tax, had long-run positive effects on the country’s economy. Additionally, compared to corporate income tax, value added tax had a substantially higher impact on overall productivity in the Nigerian economy among the non-oil tax components. Therefore, it should be highlighted that this result is illuminating for both policy and planning in terms of improving Nigeria’s taxes systems. Therefore, policy actions aimed at increasing tax revenues and taxation capacity can aid in raising the country’s productivity, which will then favourably impact economic growth. Based on the findings from the empirical investigations in this study, the following policy recommendations are designed:

In order to improve the performance of corporate income tax as it relates to its contribution to economic growth in Nigeria, the government should ensure the establishment of an efficient tax system with a focus on widening the tax net. The Nigerian government should ensure the formalisation of enterprises operating in the informal sector in order to increase tax revenues from the Companies Income Tax, according to the study’s conclusions. This can be done by encouraging business registration with the use of specific grants and government benefits.

Incentives should be offered as well to encourage tax payer compliance. Concessionary tax rates for individuals and corporate organisations that were able to file their tax returns within the required timeframe can be used to include these incentives into the administrative tax systems. Government should also implement specific socio-welfare measures to encourage Nigerians, including individuals and businesses, to voluntarily comply with their tax duties. Because of this, fiscal deficits will be lower and more sustainable.

Government officials should be held accountable and transparent for managing the funds obtained from the various forms of taxation. This is done to ensure that citizens, who should be able to benefit from paying taxes, receive the maximum benefits of taxation. Further strengthening of the regulatory agencies in charge of tax collection is necessary in order to ensure taxpayer compliance. Above all, tax income should be fairly allocated to enable economic progress, particularly in Nigeria’s need for basic infrastructure and social amenities.