What is fiscal policy? ‘The Meaning of Fiscal Policy ‘The term fiscal policy has conventionally been associated with the use of taxation and public expenditure to influence the level of economic activities. Fiscal policy involves the use of government spending, taxation and borrowing to influence the pattern of economic activities and also the level and growth of aggregate demand, output and employment. Fiscal policy is concerned with deliberate actions which the Government of a country take in the area of spending money and/or levying taxes with the objective of influencing macro-economic variables, such as the level of national income or output, the employment level, aggregate demand level, the general level of prices etc. in a desired direction. The implementation of fiscal policy is essentially routed through government's budget. The budget is, therefore, more than a plan for administering the government sector. It (budget) both reflects and shapes a country’s economic life and is used as a tool of managing a nation’s economy. Fiscal policy can be used for allocation, stabilisation of economic activities and income distribution. Fiscal system of an economy may be eitherscentralised or sdecentralised, depending on whether the political structure is federalist or unitary. Nigeria is a federation so that its fiscal system is decentralised, and there exists a division of fiscal powers and responsibilities among the federal, state, and local governments. In a unitary government such as Britain, fiscal powers are concentrated with the central government. Table | presents the allocation of responsibilities in Nigeria between the federal, states and the local governments. Table 1; Allocation of responsibilities by government in Nigeria (1989) SX | Responsibie | Expenditare Category Lever or Government Federal Only | Defense Foreign Affairs International Trade (Export Mi Currency. Banking, Borrowin control Use of Water resources, Shipping Federal Trunk Roads Elections Aviation, Railways Postal Services Police and other Security Services Regulation of labour Inter-State Commerce Telecommunications Customs. Immigration, Mines and Minerals ering) / and Exchange itizenship and naturalisation rights, Social Security. Insurance National Stans ‘System Minimum education guidelines Business Re |(Shared) Culture, Antiquities, Archives, Manuments Stamp Duties, Statistics Commerce, Industry Government Electricity (Generation, Transmission, Distribution) Research Surveys % | State Only “Residual powers (Any subject not assigned to Federal or Local government levels by the constitution 4 | Local Economic Planning and Development Health Services Tand Use, Control and Regulation of Advertisements, Pets, Small Businesses Markets, Public Conveniences, Social Welfare, Sewage and Refuse Births, Deaths, Marriages Primary, Adult and Vocational Education Development of Agriculture and Natural Resources Source: 1989 Constitution of the Federal Republic of NigeriaTable 2: Nigeria’s major taxes, jurisdiction and right to revenue ‘S/N | Type of Tax Jurisdiction Right to Revenue Taw ‘Administration | Federal Account And Collection 1 | Import Duties Federal Federal Federation Account 2 | Excise Duties Federal Federal Federation Account 3 | Export Duties (no longer | Federal Federal Federation Account imposed) 4 | Mining Rents and Royalties | Federal Federal Federation Account 5 | Petroleum Profit Tax Federal Federal Federation Account 6 | Company Income Tax Federal Federal Federation Account 7 | Capital Gains Tax Federal Federal/State | States 8 Personal Income Tax Federal States States 9 | Personal Income Tax: Armed | Federal Federal Federal forces, Extermal Affairs officers, ‘Non-Residents, Residents of the FCT, and Nigerian Police force 10 | Licenses Fees on TV and | Federal Local Local Wireless Radios 11 | Value-added Tax (VAT) Federal Federal/States_| All Governments 12. | Capital Transfer Tax (CTT) —_| Federal States States 13. | Sales Tax Federal States States 14 | Pools Betting and other | States States States Betting Taxes 15 Motor Vehicle and Drivers | States States States Licenses 16 Entertainment Tax States States. States 17 | Land Registration and Survey | States States States Fees 18 | Property Taxes and Rating States Local Local 19 | Market and Trading License | States Local Local and Fees Source: Anyanwu et al (1997)Objectives of the Nigerian Fiscal Policies The objectives of fiscal policy at a particula achieved at another time period. The Nigeria’s fiscal (Generation of significant government revenues; wi a particular time period may differ from objectives to be policy objectives include the following: Diversification of revenue sources away from crude oil-based revenues; Reduction of the tax burden on individual and corporate bodies; Maintenance of economic equilibrium through reduction in inflationary pressures, acceleration of economic growth, reduction in unemployment rate, and reduction in balance of payments deficits; Effective protection of domestic industries; Promotion of self-reliant development process; Progressive reduction and elimination of government budget deficits; ies by social services and public enterprises; (0) Integration of the informal sector into the country’s economic mainstream; («Improving efficiency in government fiscal operations and promoting transparency and accountability in the management of public finances; (xi) Fighting low productivity in agriculture and low capacity utilisation in manufacturing industry; (xi) Reduction of internal and external debt burdens; (sii) Correction of the distorted patterns of domestic consumption and production; (xiv) Minimisation of wealth, income and consumption inequalities (xv) Achievement of balance-of-payments equilibrium and exchange rate stability. (xvi) Full employment and Exchange rate stability. (vii) Influence the rate of growth of the economy; (viii) Raise the level of national income, output and employment; (xix) Protect local industries from ‘unfair’ competition from abroad Fiscal Policy Measures in Nigeria The major fiscal policy instruments in Nigeria have been changes in tax rates and government expenditures. Major sources of tax revenues for governments have been listed as personal income; company income; petroleum profits; capital gains; import duties; export duties; excise duties; mining rents; royalties; and, NNPC earnings. These taxes are imposed not only to generate government revenue but also to provide incentives and/or disincentives to certain specific socio-economic activities. Tariff rates are also imposed not only to regulate the external of the economy but also to encourage domestic production and protect domestic dustry. Government expenditures, both recurrent and capital, constitute an instrument for resource allocation while generating employment opportunities and influencing the general price level, as well as determining the extent of fiscal deficits and surpluses. Instruments of Fiscal Policy The two key instruments of fiscal policy are: (i) Government Expenditures and (i) Taxation. Government Expenditures During the course ofa year, the Government of any country undertakes expenditures of various kinds. Such expenditures have impact on the level of economic activities. Typically, Government expenditures may be undertaken for the following purposes. : (a) To build roads and bridges (©) To provide housing for the people(b) To promote agriculture and allied activities (@ To improve educational facilities (©) To protect the citizens against aggression - ( To maintain law and order (g) To create jobs indifferent sectors of the economy (h) To service a nation’s debt Fiscal Policy through Variations in Government Expenditure and the Achievement of Desired Economic Goals To see how fiscal policy works, consider a business cycle. A business cycle refers to cyclical movement in the level of economic fortunes of a country, As shown below, the cycle tends to repeat itself overtime. A boom period refers to the highest prosperity level. It describes a situation where output level is high, employment, national income, and all macro-economic variables are at desirably high levels. While a boom period is generally desired, sometimes, an undesirable by-product of this situation is a high level of inflation. A recessionary phase of the business cycle refers to a downturn in the economy. It is characterized by falling levels of aggregate demand, output, income and employment. A depression phase is when things are completely down and there is widespread unemployment and general misery. A recovery phase refers to a situation when an economy is picking up again. Aggregate demand for goods and services may be rising gently to be followed by rising levels of income, output and employment. As the trend continues, this may lead to another boom as shown in figure 1. Figure I: A Business Cyclei it i hich is the effect of changes in Government expenditures, consider an economy whi its spending. This is a fiscal measure. The increased government spending from say, Gl to G2 (G2 higher than G1), will raise the level of aggregate demand (see figure 2). demand (she ig 7) from ; ¢ serge Demand, price. ae) Tncame/Outpu/Employnaent Figure II: Effect of Increase in Public Expenditure on the Economy AD1 (C+14Gi) to ADs (C+14G,). The increased level of aggregate demand will raise national income (through the multiplier effects) and, therefore, output and employment, many times more than the increased Government spending that sets the scenario off. In fact, the level ta Which national income will rise, will depend on the marginal propensity to consume: If the ‘marginal propensity to consume is say */s then, the marginal propensity to save will be (1- 4/ (1, The multiplier coefficient will then be'S the reciprocal of the marginal propensity to sexe: Consequently, if the inital government spending were increased by say, N20 million, then the inereased level of income that would result, would be N20 millien x 5 ‘NO million. By the time income is increased by N100 million, output level in the economy would have increased and so would the employment level through the multiplier effecce Thus, the 6turn, will eventually lead to a reduction in prices. But again, an undesirable effect of a reduction in Government spending, may be a reduction in national income, output level and-, consequently, employment level. Because’ of this undesirable effect, Governments are very cautious about deflationary policies which affect the level of employment. Taxation as an Instrument of Fiscal Policy A tax is a form of levy imposed by the state on people, corporate bodies or goods. There are two forms of taxes: These are: (@) Direct taxes and (b) Indirect taxes Direct taxes are levied on people or corporate bodies and the burden of such a tax cannot be shifted to anyone else (However, some tax experts have argued in recent times that virtually all taxes can be shifted). Indirect taxes are levied on goods and services. The whole or part of the burden of an indirect tax may be shifted by producers to consumers. Automatic Stabilizers Taxes and transfer payments which change with income are referred to as automatic stabilizers. They are regarded as automatic stabilizers because they reduce fluctuations in income, output and employment without deliberate action on the part of policy makers. Thus, automatic stabilizers are built into the economy. The two automatic stabilizers are progressive income tax and transfer payments. To see how these automatic stabilizers work, let us consider the two cases separately. Progressive Income Tax In virtually all economies, some taxes are progressive. This means they change at a higher rate with changes in the level of income. Thus, if income changes, taxes, if progressive, change more than the proportion by which income has changed and thereby dampen Consumption. If, therefore, income is rising as a result of the operation of the multiplier process, the extent of the fluctuation is checked to some extent by the higher progressive taxes. Thus, the progressive nature of taxes tends to have a stabilizing effect on income by reducing consumption expenditure, thereby making the multiplier smaller. The reverse is also true. A fall in income will lead to a less than proportionate fall in the amount of taxes collected. This will lead to a higher consumption relative to the amount of income. Transfer Payments Another set of automatic stabilizers are transfer payments, As already mentioned earlier, transfer payments are expenditures such as unemployment benefits, pensions, ete which arc Paid to beneficiaries by the government or the private sector even though the people involved may not have contributed to the present national income. Transfer payments are stabilizing because when economic activity is at a low level and national income is declining, unemployment benefits and pensions tend to rise because more People qualify for these payments. The resulting spending from the transfer payments made to these people may generate the multiplier process leading to rising income te compensate automatically forthe initial decline in income, Conversely, as economic fortunes improve for a country the level of national income starts rising and the number of people who were PEN ee, tnemployed reduces. Also, some of those who probably retived eetlter may now this time around. The reduction inopposite direction to the initial rise in income, as a result of the earlier improved economic conditions. This Situation stabilizes the economy and serves to moderate fluctuations. Advantages of Automatic Stabilizers : Automatic stabilizers have many advantages. In the first place, as already implied above, they serve to moderate fluctuations in economic activity. As the level of economic activity declines for example, output and employment eventually would fall. This, in turn, would result in an automatic fall in taxes while government transfer payments would increase. These changes prevent disposable income, and, consequently consumption, from decreasing by as much as they would in the absence of the automatic stabilizers. This makes the decline in economic activity not to be as severe as it otherwise would be. The second advantage of automatic stabilizers is that since taxes and transfer payments change automatically when income changes, the resulting change occur rapidly. Thus, if workers lose their jobs, taxes are no longer paid. Some of them may become eligible for unemployment benefits immediately. This is unlike discretionary fiscal policy (see below) which may require legislation and therefore takes time to become effective. Despite these advantages, automatic stabilizers have one major disadvantage, Automatic stabilizers retard a nation’s recovery from recession. As income and employment increase, taxes will increase automatically and transfer payments will fall. These changes, in turn, lead to a fall in the rate of increase in disposable income and consumption which eventually leads toa fall in income, ‘The Use of Taxation as an Instrument of Fiscal Policy in Nigeria Fiscal policy is part of government policy concerning taxation and other revenues, public spending, and government borrowing (the public sector borrowing requirement). Governments have to decide how much to spend, how resources should be shared between different spending programmes, how much to raise in taxes and in borrowing, as well as what taxes to levy, thereby directing the economy. For example, value-added tax (VAT) and excise duty on tobacco discourages cigarette smoking; mortgage tax relief encourages people to buy their own home. At macroeconomic level, more public spending and less taxation will stimulate total spending in the economy, leading probably to a fall in unemployment but a rise in inflation. In Nigeria, the Fiscal Policy Department, of the Federal Ministry of Finance, formulate and implement the fiscal policies of the Federal Republic of Nigeria. Formulation of Government’ fiscal policy is made on the basis of the required adjustments and changes, to be made in taxation, revenue and expenditure for purposes of economic growth, stabilisation and equity. 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 Run In Nigeria, the government's fiscal power is based on a three-tiered tax structure divided between the federal, state and local governments, each of which has different me jurisdictions. As of 2002, about 40 different taxes and levies are shared by all three levels of government, The Nigerian tax system is lopsided, and domin: handles are under the contro! of the federal for the less buoyant ones—ihe federal gover ated by oil revenue. The most veritable tax government while the lower tiers are responsible Thment taxes corporate bodies while the states and 8glocal governments tax individuals. While the federal government on average accounts for 90 per cent of the overall 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, 3.2 per cent for the state and 0.4 per cent for the local government. 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 revenues were largely derived from primary products, Between 1960 and the early 1 970s, 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 from 26.3 per cent in 1970 to 81.8, 72.6 and Nigeria’s fiscal policy measures have been largely driven by the need to promote such macroeconomic objectives as 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 frequently, these objectives have remained relatively constant. Until the mid 1980s, tax policies, for instance, were geared to achieving such specific objectives as: (i) ensuring effective protection for local industries; (i) encouraging greater use of local raw materials; (iii) enhancing the value added of locally manufactured and primary products; (iv) promoting greater geographical dispersion of domestic manufacturing activities; (v) generating increased government revenue. Since the implementation of the structural adjustment programme (SAP), however, taxes have been used-to enhance the productivity and competitiveness of business enterprises. Consequently, attention has been focused on promoting exports of manufactures and reducing the tax burden of individuals and companies. In line with this change in policy focus, many measures were undertaken. These involved, among others, reviewing custom and excise duties, continuing with the reduction of company income taxes, expanding the range of tax exemptions and rebates, introducing capital allowance, expanding the duty drawback scheme and manufacturing-in-bond scheme, abolishing excise duty, implementing VAT, monetizing fringe benefits and increasing tax relief to low-income earners. In line with its federal structure, Nigeria operates a three-tier government, with certain fiscal responsibilities and powers delineated to each level. To avoid conflict among the three levels, the 1999 Constitution classified governmental responsibilities and powers into exclusive, concurrent and residual categories or lists. The National Assembly is empowered to issue legislation on the taxation of incomes, profits and capital gains. It is also authorized to legislate on matters classified in the concurrent list, particularly those related to the ‘division of public revenue’ tax collection. The State Houses of Assembly, on the other hand, may prescribe the collection of any tax, fee or rate, or the administration of a law to provide for such collection by a local government council. This constitutional provision enables the state government to impose, collect and spend any tax, fee or rate which is not expressly stipulated as being within the authority of the federal government. Consequently, the state government is empowered to Impose tax on all items in the concurrent list as well as residual matters.Effects of Fiscal Measures : | ‘Although fiscal measures are aimed at promoting rapid economic growth, they also generate some unintended effects, making taxation a double-edged sword. Apart from encouraging (or discouraging) activities that are socially or environmentally friendly (unfriendly), fiscal policy is also used as a tool to provide direct assistance to society or individuals. As an fconomie development tool, taxation provides the financial base for providing and maintaining, among others, infrastructure such as roads, electricity, telecommunications, and water that have direct impact on living conditions. The need to bring social succor to the people recognizes the potential offered by personal taxation for improving exemption ‘benefits such as individual allowance, tuition for children, insurance premiums and allowance for dependent family members, all of which are factors that affect the social structure of the whole country. Part of the adverse impact of taxation is the possible migration of people and businesses. Taxation can become a ‘push’ or ‘pull’ factor for migration because businesses relocate to areas with smaller taxes. In fact, taxation in ‘ecent times is one of the instruments for promoting foreign investments in developing countries. ‘The foregoing has a significant practical impact for Nigeria. For instance, an increase in import duties in the country would cause an intensification of smuggling and underutilization of some productive capacities. The approved budget for the year 2000 highlights the seriousness of this problem: Imports destined for Nigeria are still diverted to ports of neighbouring countries. This is due to relatively high port charges and levies. The result is a loss of revenue in terms of import duties going to neighbouring countries. In addition to the loss of revenue, port facilities are seriously under-utilized since importers now ship goods through neighbouring ports. The prohibitive taxes imposed by the government also cause, in some cases, excess capacity in domestic manufacturing plants. Since the adoption of SAP in 1986, government has used taxation as a tool to fight poverty, with the emphasis on increasing disposable income as well as shifting the focus from income to consumption. Prior to 1986, tax measures were concentrated on income when PIT was increased from N 600 or 10 per cent to N 1,200 or 12.5 per cent for income exceeding N 6,000. The 1990s witnessed a different story, when minimum individual tax was reduced in 1990 from 1 to 0.5 per cent. In anticipation of the 1994 introduction of VAT, the PIT ‘marginal tax rate was reduced from 45 to 30 per cent in 1993, and again in 1995 and 1966 to 30 and 25 per cent, respectively. The PIT rate was also made progressive. The need to enhance disposable income has been the primary objective since 1995, poverty alleviation allowances, for instance, standards. In 1996, the 1,500 per child up to a dependant relative allo be farther increased to mind, the government is paying attention to tax relieves and in order to enhance workers” disposable income for better living government also increased children allowances from N 1,000 to N maximum of four children, This was increased to N 2,500 in 1998. A wance of N 1,000 (up to two dependants) was introduced in 1997, to N 2,000 in 1998. During the same year, the personal allowance of N 3.000 plus 15 per cent of earned income was raised to N’5,000 plus 20 per cent of eared income, Other relevant tax relieves include life insurance scheme which offers an exemption on paid premiums up to 10 per cent of the insured capital as well as certain disability allowances. To advance this initiative, the minimum ta i i a ix-free income was raised from N 7,500 in 1995/6 to N 10,000 and to N 30,000 over the n ‘ , , 1ext two years. geared towards increasing the dispos i a aggregate demand, 10Tax relieves have significantly reduced the tax liability of the people, particularly among low-income groups. During 1995-98, the relative reduction in tax liability ranged between 48.4 and 87.5 per cent for low-income groups while it was between 25.4-45.0 per cent for high-income earners. This is clear evidence of a tax liability reduction among the poor. Relief measures have been aimed at helping workers adjust to the impact of inflation and the rising cost of living. The multiplier effect of this serves as a means of reviving the economy. With added purchasing power, aggregate demand grows and according to the accelerator principle, capacity utilization, output. This has been a recurrent event in Nigeria, as has frequently been expressed in the government’s annual budget statements. Special prominence was given to this fact in the Approved Budget for the 2001 Fiscal Year, and employment ‘opportunities increase. However, the welfare effect of the tax relieves may not be significant because the majority of the population lives in rural areas and the ratio of formal sector workers is relatively small compared to their informal counterparts. ‘The fiscal policies have imposed hardships on consumers and producers in the form of high prices and increased production costs. Experience shows that producers in Nigeria treat VAT input as a cost. To this end the price effect has become non-neutral, i.e, exceeding the 5 per cent rate. Some empirical studies have drawn attention to the cascading impact of VAT. Using a general equilibrium analysis, these authors conclude that if input VAT is treated as a cost under mark-up pricing regimes, its price effect is distortionary regardless of whether or not the mark-up rates are rigid or flexible downwards, The distortionary impact is severely felt in sectors such as housing, livestock, vehicle assembly, mining, drugs and chemicals, and iron and steel, Price implications of the cascading effects range between 8.7-17.5 per cent across the 29 economic sectors of Nigeria. The effect of this on the purchasing power of the domestic currency and the welfare of the citizens cannot be underestimated. The generous tax reliefs have been considered as counter-productive to the revenue generating efforts of the states. The states of Lagos, Delta and Oyo which generated Substantial part of their internal revenue from PIT are unhappy with this development. Despite efforts to diversifSr the tax structure, not much has been achieved. The introduction Of the structural adjustment programmes in 1986 did not help matters. Due to an inflexible tax structure, oil and gas receipts still constitute about 75 per cent of total revenue. And in the absence of policy, Nigeria's fiscal operations are largely influenced by oil-driven volatility, which impacts on both revenue and expenditure, For instance, revenue and expenditure have increased Sharply during periods of high oil prices as in 1979-82, 1991-92 and 2000-2002, ut as prices decline, scaling back of expenditure is the order of. implications of Se ae etn the order of the day. The implications of tor employees, particularly at the implementation of development it also influences the ing infrastructure. i