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AN EMPIRICAL ASSESSMENT OF THE IMPACT OF CORPORATE TAX ON PRIVATE SECTOR INVESTMENT (1970-2008)
1.1 Background of Study
The effect of fiscal policy instruments on growth and development with taxation playing a central role is perhaps the oldest, most studied, and most controversial topic in economics. The effect of corporate taxes on private sector investment is one of the central questions in both public finance and development. This is premised on economists concern as regards how changes in tax policy and feedback behavior affect economic activity. As a result, a pool of divergent theories, opinions and empirical studies on taxation, constitute a significant portion of economic literature.
The need for government in the affairs of man is the basis for taxation. Tax simply is a demand made by the government of a country for a compulsory payment of money by the citizens of the country. It is an instrument used to withdraw resources from the populace. Taxes are known to play various roles ranging from revenue generation which finances public expenditures to trade/individual protection, consumption management, behavior modification and income redistribution.
Private sector investment on the other hand has to do with spending on goods that is undertaken by companies and organizations that are not owned or controlled by the government (Encarta World English Dictionary). It is the process of investing in a product that is not traded publicly. It includes all profit and non-profit enterprises/activities not initiated by the government. Private sector investment also includes buying goods directly from the source and keeping them until they are sold for profit. Investments in healthcare, schools, research organizations, medical care units and other community projects which do not involve profit but for improving the standard of living of a certain region, qualifies for private investment. It is one of the major components of Gross Domestic Topic.
Adebayo (2008) notes that many governments have find it more convenient to generate income from tax than other sources. The relative importance of tax has sometimes pushed some government into overstressing its role, to the point where its use becomes counter-productive. A more general philosophy is that a tax regime should not discourage the creation of wealth but should act as a precursor for investment and economic growth. Economic theory suggests that replacing taxes that tend to have high rates and narrow bases with a tax that has a broad base and a low rate would reduce the economic dislocation caused by the tax system and make the entire tax structure simpler, more neutral and more productive (PAI 2007, see Aleksandra and Akisz, 2008).
Adebayo (2005) asserts that tax accounts for a considerable portion of revenue for public spending at all levels of government in Nigeria. At the Federal Government level especially, between the period of 1994 and 2003, Adebayo (2005) observes that it was never lower than 34.3% of the federally collected revenue recording as high as 86.0% in 2002. This alone Adebayo (2005) maintains is a good indicator of the prominence of tax in funding government programmes in Nigeria. This position is further strengthened when it is realized that federal government independent revenue as a percentage of total tax revenue was very low.
It is worthwhile to say at this juncture, that, from the days of the early economists down to the present day economists, the role taxation plays as one of the major fiscal policy instruments, in economic growth and development cannot be overemphasized. It’s role (in the case of boosting investments, regulating the economy, encouraging savings capacity, checking/regulating inflation etc), has always been a topic of intense debate. This is why an empirical Appraisal of the impact of Tax variables on private sector investment in relation to Nigeria’s economic growth is being reviewed and researched on, in this work.
1.2 Statement of Problem
Tax revenue depends solely on the level of output in an economy. The level of economic activity including private investment determines the tax base for income and payroll taxes, as well as, the level of private spending. These in turn determine the tax base for expenditure/consumption taxes, such as Value Added Tax, Sales Tax and Import duties. In recognition of this fact, Nigerian economy has witnessed a range of policy changes in tax administration. Following inconsistencies and apparent confusion in the operation of various tax systems in the then Northern, Western and Eastern regions of the country, Raisman Fiscal Commission of 1958 then recommended that there be a uniform basic principle for taxing incomes throughout the country. It is this recommendation that was embodied in the Nigeria Constitution Order in Council 1960, which resulted eventually in the enactment of the Income Tax Management Act 1961 (ITMA, 1961). ITMA 1961 was the precursor to Companies Income Tax Acts 1961, 1979 and 1990 as well as the Personal Income Tax Act 1993 as amended. It is important to note that there had been amendments to the various tax laws to reflect the intention of the government. Adebayo (2005) states that federal government expenditures are functionally classified into recurrent and capital expenditures. The latter is of greater interest as it touches the nerve-centre of welfare enhancement. The percentage of expenditure on social and community services, to the total capital expenditure, has been too low. The highest figure of 23% was in 2003. It is not unlikely that the actual figure will eventually be low. The highest actual figure is 12.2% of the total capital expenditure. This figure itself may amount to nothing especially if high inflation rate of the period is considered (Adebayo 2005). Aluko (2006) perhaps in agreement states that Nigeria tax laws needs to be restructured to conform with the present day realities; noting that tax collection in Nigeria has been mainly from organized private sector while the self-employed pay lesser tax.
The challenge taxation faces in a complex economy like that of Nigeria will remain daunting for a while. Whereas the government sees taxation as a way of improving prosperity, the citizens see it as a means of impoverishing them the more. For instance, Ajakaiye (2000) opines that government may be happy about the high and growing VAT revenues in Nigeria, but there are increasing complaints from the organized private sector about the effects of the VAT on their operating costs and the prices of their products. The complaints about the adverse effects of Nigeria’s VAT suggest that there is a problem with the way taxable organizations are treating their liabilities, especially the VAT they pay on their inputs. Moreover, there may be a problem with the way government is managing the expenditure of the tax revenues in the economy. It is the official view that tax should have no cascading or cumulative effect whatever. Another noticeable feature of the trend is the imposition of tax on petroleum products. The figures for this were made distinct particularly between 1999 and 2004. It is observed that the total collected tax revenue from this source, increased from N14, 376.2million in 1999 to N25, 467.2million in 2000 and N30, 240.3million in 2001. Since petroleum products are price inelastic, an increase of this nature is indicative of a heavier financial burden on the poor (Adebayo, 2005).
Bearing the above in mind, one would wonder why empirical works that explain the impact of taxation on Nigeria’s economic growth have been found lacking. It is even more worrisome to note that no feasibility study was done on the impact of the corporate tax burden on private investment before taxation was introduced, neither have impact assessments been done since to ensure the sustainability of the tax and its beneficial effects in Nigeria (see Ajakaiye 2000). “Unfortunately, this information, going by available empirical literature is close to nil. Many have carried out qualitative investigation on the impact of growth related issue, but that of taxation is as good as not being available”. Few of the studies in existing literature were done in foreign economies mostly on developed economies (see Aleksandra and Akisz (2008), Maradon (1983) in Ferretti (2006). Only two studies (Ademola (1997), and Nnadi and Akpomi (2008)) carry studies that relate taxation to Nigeria’s economic environment. Even at this, Nnadi and Akpomi (2008) restrict their study to the banking subsector while that of Ademola (1997) uses a limited set of data whose validity may not conform to the current realities in Nigeria’s tax system. This indeed confirms that there is an information gap on empirical studies that explain the economic implications of taxation in Nigeria. It is of more concern that this gap continues to exist at a time when government emphasizes higher tax revenue in order to close the loophole persistent falls in oil prices created on Nigeria’s government finances. These observations pose unhealthy implications for policy makers, public and private investors and the tax payers themselves. It also denies government relevant information needed to have a better understanding of how taxation affects Nigeria’s macroeconomic environment especially as it concerns private sector investment (which is a major component of GDP) and total output growth. It is not just enough to generate tax revenue, there is also the need to know what role or how each of the tax variables affects private investment and economic growth at large; a situation that should be subjected to empirical examination. It is against this backdrop that we have been motivated to carry out this research in which we seek to answer the following questions:
- Does corporate tax affect private sector investment?
- Does corporate tax affect economic growth vis-à-vis credit to private sector?
- Is there a long run relationship between private sector investment and corporate tax?
1.3 Objectives of The Study
This work in specific terms, has the following as its objectives
- To investigate the impacts of key tax variables on private sector investment.
- To estimate the impact of corporate tax on economic growth vis-a-vis credit to private sector.
- To investigate whether there is a long run relationship between corporate tax and private sector investment.
- Statement of Hypothesis
For the purpose of this work, these hypotheses are drawn for investigation.
- II Tax variables do not significantly affect private sector investment.
- III Financial deepening does not significantly affect private sector investment…
- IIII There is no sustainable long run relationship between corporate tax and private sector investment.
- Significance Of The Study
The findings of this work will go a long way in helping policy makers to make appropriate and more effective decisions. It would also help the tax- paying public, private and public investors, manufacturers, firms, individuals and other stakeholders to understand the essence of monetary deductions from their income/profit. It would also help the government and the international community to come to terms or better understand the implications of certain tax policies on a developing country like Nigeria, especially, in a regime of global call for the abolition of cross-border taxes/duties.
It still brings evaluative and empirical information on the impact of tax variables on private investment. It stands to explain how contributory tax variables are in tax revenue generation. It shall serve as a reference point to tax practitioners, tax administrators and other stakeholders. Lastly, it would serve also as a reference material for further studies.
- Scope of The Study
In this work, we set to study the effect of tax variables on private investment. It covers a period of 38 years (1970 to 2008) with secondary data source from Federal Inland Revenue Service (Circulars, Journals and Magazines/Bulletins) and CBN bulletin (2007 and 2008 editions). The impact of tax variables such as Corporate Income Tax and Petroleum Profit Tax, on economic growth shall be evaluated.
- Limitation of The Study
The period of this study (1970-2008) was chosen because available data from 2009 to 2011 were not available at the time of this work. Sourcing secondary data from Federal Inland Revenue Service and CBN offices were not easy, aside data/materials from the internet.
- Organization of The Study
The work was divided into 5 chapters with chapter 1 containing introduction and background of the study which explain the relative importance of taxation as well as, the relationship between taxation and private sector investment on one hand and economic growth at large. Chapter 2 has literature review, while chapters 3 and 4 contain the methodology and data analysis/presentations. Chapter 5 closes the work with the summary/findings, conclusion and the policy recommendations. The references and the relevant appendices are found after chapter 5.