Only war-torn Somalia and Yemen’s governments are expected to earn less money relative to their economic size than Nigeria in 2022, according to the International Monetary Fund’s (IMF) estimate.
Nigeria is in bad company here with Somalia and war-torn Yemen, the only countries where the government collects less than 7 percent of Gross Domestic Product (GDP) in revenue. On average, revenue to GDP ratio in frontier markets is slightly more than double of that while in South Africa, it’s nearly 30 percent.
“This looks like almost no one pays tax in Nigeria,” said Charles Robertson, the chief economist at Renaissance Capital. “But I’ve been told in Lagos by business people that the tax burden is far higher than these numbers suggest.”
A low revenue to GDP is an indicator that a government is not collecting its fair share of taxes from economic activity.
The Nigerian government has intensified efforts to boost its tax income since the drastic slump in oil revenues, which had sustained the economy for many years, in 2016.
Little progress has been made six years later. Policies like the one-off Voluntary Asset and Income Declaration Scheme (VAIDS), which was supposed to add $1 billion to the federal purse, fell flat on its face. Zainab Ahmed, the finance minister, said last year that the scheme raked in N70 billion ($167.8 million), 16 percent of the target.
The government also raised the Value Added Tax (VAT) rate by 50 percent to 7.5 percent. The money from that has not, however, been able to make much of a difference, subdued by weak consumer purchasing power and an economy fresh off a COVID-induced recession.
The irony here, however, is that while the official numbers suggest the government collects less than half in taxes as a percentage of GDP compared to 2011 (when it was 17.7 percent), Nigerians are paying more taxes. Only that it is informal and to non-state actors.
“Nigerians pay a lot of taxes but the government collects so little because Nigerians not only pay formal taxes, but also pay informal taxes and implicit taxes,” said Taiwo Oyedele, a partner and head of tax and regulatory services at consulting firm PwC Nigeria.
According to him, the formal taxes are the ones that result in a 6 percent tax-to-GDP ratio that is well known, and that itself is low because there’s a lot of inefficiency in the design of the tax system.
“We duplicate collecting agencies, use consultants with very unreasonable commissions and we have multiple taxes that are all over the place creating apathy,” Oyedele said.
He said in its attempt to improve its tax income, the government had been more focused on increasing the formal tax base rather than finding a way to tax the informal economy and curbing the revenue lost to non-state actors collecting taxes.
Nigeria’s tax-to-GDP ratio sits at 6.3 percent, which is lower than the average of 30 African countries as surveyed by the Organization for Economic Cooperation and Development (OECD) in 2018 by 10.2 percentage points (16.5 percent) and also lower than the Latin America and the Caribbean (23.1 percent).
What this implies is that Nigeria’s tax base has been on a steady decline due to growing unemployment rates. The highest tax-to-GDP ratio in Nigeria was 9.6 percent in 2011, with the lowest being 5.3 percent in 2016.
A major reason for the low tax-to-GDP ratio in Nigeria is the large size of its informal economy, estimated by the International Monetary Fund to be around 65 percent of the GDP, which is higher than the sub-Saharan average of 34 percent.
By comparison, the informal economy in Europe is 23 percent of its GDP, and 17 percent of the GDP in OECD countries.
Despite repeated attempts by tax authorities to tax the informal sector, there has not been much success due to challenges including the lack of information on businesses in the sector, lack of documentation and proper regulation.
The strengths and weaknesses of businesses in the informal sector make it difficult for them to be taxed: the ease of starting micro, small and medium enterprises (MSMEs) in the informal sector means that the businesses might not be legally registered, making it hard to assess for tax purposes.
Additionally, a prevalence of informal funding rather than structured loans for these businesses to start or expand further reduces the obligation for business registration and information available to the tax authorities or regulators. Then, poor bookkeeping practices by MSMEs, even legally registered ones, complicates the process of assessing them for tax purposes.
As a result, tax authorities end up using bank account transactions and receipts to assess the businesses for tax purposes, exposing them to punitive tax assessments, liabilities and audits. Physical MSMEs are at greater risk of multiple taxation and levies by agencies at all levels of governments. Local governments, for example, are notorious for using force through task forces and touts to compel such businesses to pay their taxes.
This method of tax collection worsens tax compliance by creating distrust between the MSMEs and the government, and leading the MSMEs to view the approach of government as a lack of support for MSMEs rather than as a drive for improved tax compliance.
The increasing adoption of social media for commerce and remote working will further complicate the ability of tax authorities to assess MSMEs for the purposes of tax compliance, even when some of the businesses exceed the N25 million threshold, beyond which businesses have to pay taxes.
However, although tax authorities struggle with tax compliance with the informal sector, a 2021 report by Lagos-based consulting firm, SBM Intel, found that businesses in the informal sector pay taxes, often to one agency on a more frequent basis and with the taxes forming a larger proportion of their incomes in the same time period compared to taxes on the formal sector.
The report stated that 98 percent of businesses in the informal sector actually pay taxes.
With oil income dwindling and Nigeria unable to benefit from higher oil prices, the urgency to improve tax income by incorporating the informal sector should take a new dimension, according to Muda Yusuf, CEO of the Centre for the Promotion of Private Enterprise.
“The government must, however, convince the people that it can utilise tax revenues efficiently and not burn it on subsidies for instance,” he said.
Tax experts surveyed by BusinessDay say that the government must also tackle multiple taxation to successfully incorporate the informal sector into the tax base of the country.
The report by SBM Intelligence noted that the informal sector could be incorporated into the formal net if the process of administering Tax Identification Numbers were and tax administration simplified.