BAYERO UNIVERSITY, KANO

BAYERO BUSINESS SCHOOL

15th October, 2015

COURSE: BUS 8237 — Public Finance

CLASS: Masters in Business Administration (MBA) Full-Time (Special I)
SESSION/SEMESTER: 2014/2015 Session — Second Semester
LECTURER: Kabir Tahir Hamid, PhD., M.Sc., MBA, B.Sc., FCIFC, FIDRP
CONSULTATION: Saturdays, 2-4pm
OFFICE: A8, Department of Accounting, Aminu Alhassan Dantata School of Business, New Campus,
Bayero University, Kano

A. COURSE DESCRIPTION
This course is designed to introduce students to the basic aspects of public finance, government
revenue and expenditure, fiscal policy, government activities and economic development, tax
system and Value Added Tax, monetary policy, the Federation Account and monitoring strategies
for government allocation and expenditures.

B. COURSE OBJECTIVES
On completion of this course, it is expected that the students will be able to understand:
(i) the basic aspects of public finance;
(ii) the sources of government revenue and expenditure and issues related to them;
(iii) expenditure and revenue framework of public sector;
(iv) policy issues surrounding public finance;
(v) fiscal and monetary policies;
(vi) government activities and economic development;
(vii)tax system and Value Added Tax;
(viii) the Federation Account; and
(ix) monitoring strategies for government allocation and expenditures in Nigeria.

C. COURSE CONTENTS
1. Introduction to Public Finance
1.1 Meaning of Public Finance
1.2 Nature and Scope of Public Finance
1.3 Functions of Public Finance
1.4 The Role of Taxation in Public Finance
2. Government Revenue
2.1 Introduction
2.2 Meaning of Revenue
2.3 Sources and Classification of Government Revenue
2.4 Taxation as a Source of Government Revenue
2.5 Diversification of Nigeria‘s Sources of Revenue
3. Public Expenditure
3.1 Meaning of Public Expenditure
3.2 Theory of Public Expenditure
3.3 Classification of Public Expenditure
3.4 Models of a State

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3.5 Determinants of Public Expenditure
3.6 Reasons for Increase in Public Expenditure
3.7 Purposes/Functions of Public Expenditure
3.8 Guiding Principles/Standards of Public Expenditure
3.9 Public Expenditure Management and Control
3.10 Financing Public Expenditure
4. Fiscal Policy
4.1 Meaning of Fiscal Policy
4.2 Objectives of Fiscal policy
4.3 Fiscal Policy Measures in Nigeria
4.4 Instruments of Fiscal Policy
4.5 Taxation as an Instrument of Fiscal Policy
4.6 Automatic Stabilizers
4.7 Progressive Income Tax
4.8 Transfer Payments
4.9 Advantages of Automatic Stabilizers
4.10 The Use of Taxation as an Instrument of Fiscal Policy in Nigeria
5. Government Activities and Economic Development
5.1 The Concept of Economic Development
5.2 Relationship between Government Activities and Economic Development
5.3 Relationship between Public Expenditure and Real GDP
6. Tax System and Value Added Tax
6.1 Nigerian Tax System and VAT
6.2 Challenges Facing the Nigerian Tax System
6.3 Challenges Militating Against VAT in Nigeria
6.4 Addressing the challenges
7. Monetary Policy
7.1 Objectives of Monetary Policy
7.2 Stance of Monetary Policy
7.3 Instruments of Monetary Policy in Nigeria
8. The Federation Account
8.1 Revenue Allocation in Nigeria
8.2 Causes of Revenue Allocation Problems in Nigeria
8.3 Nigeria‘s Experience in Revenue Allocation
8.4 The Principles of Revenue Allocation
8.5 Structure of Revenue Allocation from the Federation Account
8.6 Revenue Sharing in Nigeria
9. Monitoring Government Allocation and Expenditure
9.1 The Executive Control
9.2 The Legislative Control
9.3 Ministry of Finance Control
9.4 The Treasury Control
9.5 Control by Warrants
9.6 Departmental Control Over Budgeted Expenditure
9.7 Control by the Auditor General

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D. RECOMMENDED TEXT BOOKS
(i) Public Finance in Theory and Practice by Musgrave, R.A & Musgrave, P.B.
(ii) Principles of Public Sector Accounting and Finance by Jimoh, B.
(iii) Public Sector Accounting and Finance by Adams, R.A.
(iv) Public Sector Accounting and Finance for Decision-Making by Banmeke, S.A.
(v) Public Sector Accounting and Finance by ICAN
(vi) Public Sector Accounting by Daniel, G.I.
(vii)Theory and Practice of Public Sector Accounting and Finance by Tiku, G.J.D.
(viii) Introduction to Public Finance (NOUN) by Anthony I. Ehiagwina
(ix) Introduction to Public Sector Accounting and Finance ICAN Pack
(x) Monetary Economics, 2nd Edition by Jagdish Handa
(xi) Public Financial Management (NOUN) by Mr. E. U. Abianga
(xii) Monetary Economics: Theory, Policy and Institutions by Anyanwu, J. C.
(xiii) Economic Development in Nigeria (NOUN) by Onyemaechi J. Onwe

E. COURSE REQUIREMENTS
Every student is required to attend the class regularly and participate actively in group discussions
and study group activities. Attendance at lecture is compulsory and at least 75% attendance record
is mandatory for a student to qualify to sit for the end of semester examination.

F. COURSE DELIVERY STRATEGIES/METHODOLOGY

Face to face lectures, multi-media presentation class discussion, group work. The course outline
along with the complete lecture notes would be made available to the class and would be posted
onto the internet. Students are expected to photocopy (and or download) and read the notes before
each lecture for better understanding and effective participation during class discussion.

G. BREAK-DOWN OF GRADING
S/No. Type
Scores (%)
1 Assignments 20
2 Continuous Assessment 20
(Tests)
3 Final Examination 60
Total Score 100

The continuous assessment marks are to be absorbed through snap test (s) to be given without
notice, scheduled test (s) and/or paper presentation.

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1.0 Introduction to Public Finance

1.1 Meaning of Public Finance

Finance is a discipline concerned with the acquisition and disbursement of funds in an optimum way for
efficient operations and attainment of desired objectives of an organization. Finance is a function in
business (private/public) that acquires funds for the organisation and manages those funds within the
organisation. These activities include preparing of budgets; doing cash flow analysis; and planning for the
expenditure of funds assets.

Public finance is the field of economics that deals with budgeting the revenues and expenditures of the
public, taxes, public debt and public financial administration. Public Finance, therefore, deals with
methods used to finance government expenditure, the characters of such expenditures and the keeping of
adequate record for money raised and spent. Essentially, Public Finance deals with acquiring, spending
and accounting for revenue and other receipts of the government with a view to ensuring efficiency of the
state and the general well-being of the people. It is the study of the role of the government in the economy.

In recent years, Public Finance has tended to shift from the traditional taxation and expenditure approach to
that of stabilisation and general application of macro-economic models. Some Economists such as
Musgrave and Prese focused on resource allocation, income distribution and stabilisation aspects. In
respect of resource allocation, Government plays a paramount role in the economy because of market
failure. The stabilization aspect of Public Finance is concerned with achieving macro-economic objectives
such as:
(a) Economic growth and development.
(b) Price stability.
(c) Balance of payment equilibrium
(d) Equitable distribution of income.
(e) Full employment.

The principles of public finance were developed as far back as the period of the classical economists. Most
of the early writers on the subject focused on different areas. Adam Smith focused on taxation. David
Richard and J. S. Mill laid emphasis on revenue, expenditure and public debt. A.C. Pigou in his own
contribution dealt with taxation principles which are based on the theory of 'economic welfare'. He stated
that taxes are levied in such a way that the overall marginal sacrifice of taxation is equal to the overall
marginal benefit of public expenditure.

Public finance encompasses both positive and normative analysis. Positive analysis deals with issues of
cause and effect, for example, ―If the government cuts the tax rate on gasoline, what will be the effect on
gasoline consumption?‖ Normative analysis deals with ethical issues, for example, ―Is it fairer to tax
income or consumption?‖ Modern public finance focuses on the microeconomic functions of government,
how the government does and should affect the allocation of resources and the distribution of income.
Public financial management is defined by the Chartered Institute of Public Finance and Accountancy
(CIPFA) as ―the system by which financial management resources are planned, directed and controlled to
enable and influence the efficient and effective delivery of public service goals.‖

1.2 Nature and Scope of Public Finance

The scope of public finance is cover four basic issues, namely (i) government expenditure, (ii) government
revenue, (iii) public debt, and (iv) financial management.

(i) Public Revenues: Every government has to make a number of expenditures, both recurrent and
capital. For this purpose it has to raise revenues with a view to finance the expenditures and the
major share of public revenues is obtained through taxes. Again, government also raises revenue

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 through non-tax sources like fees and penalties. Thus in the science of public finance, different
types of taxes are studied, as well as, the principles of taxation, the burden of taxes, and the system
of taxes.

(ii) Public Expenditures: The revenues which a government raises have to be spent on different items.
Thus in public finance, the principles of making government expenditures are studied, and the
major items of government expenditures. Again, whether the expenditures are diverted to
productive fields or non-productive fields, and the effects of public expenditures on the level of
income distribution and level of output.

(iii)Public Debt: The government revenues are at times far less than the government expenditures, thus
leading to deficit which could necessitates borrowing. The government has to make the traditional
as well as the welfare expenditures. In some circumstances, the government expenditures may
exceed government revenues, thus necessitating government to depend on public debt. In Public
finance, therefore types of public debt that are available to the government are studied; the rate of
interest against each source available; the type of bonds the government can issue; and how the
government will repay the debt, among others.

(iv) Financial Administration: Financial management is studied in public finance. Financial

management deals with how the government prepares budgets, how the budgets are executed,
budgetary control process, prudence, transparency and accountability in budget execution and
public sector financial management.

A.C. Pigou and Hugh Dalton, in their own contribution to the development of the subject matter of
public Finance, proposed taxation principles, which are based on the theory of economic welfare.
Essentially, these principles of taxation required the government at the centre to levy taxes in such a
way that the overall marginal sacrifices of taxation would be equal to the overall marginal benefits of
public expenditure (OMST=OMBPE). The assumption behind this is that welfare would be maximized
when expenditure and taxation are carried out in a way such that the benefit obtained from an additional
unit of expenditure, is equal to the sacrifice that has to be made when an additional unit of tax is levied.

1.3 Functions of Public Finance

The scope of public finance is logically concerned with the operations of the public treasury. It deals with
how the public treasury operates as well as the repercussions of the various policies, which the treasury
might adopt. Public tax and expenditure measures, affects the economy in a number of ways and may be
designed to serve many purposes. The policy objectives which are set forth may be categorized into four,
namely:
(i) Allocation of resources: The resource allocation aspect in public finance deals with the role of
government in the allocation of resources as a result of market failure. It is a known fact that
externalities arise in the economy. Externalities arise because of action by one economic unit which
causes a gain or loss in either consumption or production by other non-involved economic units.
Clearly, the initiator of the action will not pay the external costs or receive the external benefits unless
―there is some form of coercive body‖ (such as a Government) to allocate either the costs or the
benefits. Public Finance is concerned with how Government allocates costs or benefits when
externalities arise.
(ii) Adjustment in the distribution of income and wealth: The income distribution aspect of public
Finance is concerned with how income is distributed in the economy. Factors of production such as
land, labour, capital and entrepreneurship are priced in the market place depending on competitive
circumstance and the value of the marginal product. Hence, an individual‘s income depends on demand
and supply of the factors he has available, plus in some cases, inherited wealth. The resulting income
distribution based purely on market pricing may or may not be in line with society‘s desires. In this
regard, society must determine somehow, the ―just‖ state of income distribution. Some economists have

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 suggested that in order for justice to prevail in the society, income distribution in the economy should
be such that a person should receive the fruits derived from his endowments, others argued that income
distribution should be such that total happiness should be maximized. Yet others argued that the aim of
income distribution should be egalitarianism, while still others feel that „„justice‟‟ would be obtained,
when the income of the least well off individual in the society is maximized. Public Finance in this
regard, is concern with tras1ating these ‗‗rules of justice‘‘ into a set of policies to distribute income.
(iii)Stabilization of prices and employment: The stabilization aspect in public finance is concerned with
how to achieve desirable levels of price stability as well as desirable levels of employment. Without
government involvement through fiscal and monetary policies, a typical capitalist economy tends to be
subjected to substantial fluctuations. Thus, the economy may be in equilibrium at a level of
employment far below what the government desires. When this happens, Government may use fiscal
and monetary policies to adjust the economy to the desired levels. Public Finance is concerned with
how Government does this.
(iv) Attaining balance of payment equilibrium: Balance of payment is the relationship between visible
and invisible import and export of a country over a considerable period of time usually one year.
However, when export (which is considered as a + because of the injection of foreign exchange into the
economy) is greater than import (which is considered as a- because of letting some part of the economy
to go as leakage due to deflation in foreign reserve) balance of a payment is said to be unfavorable.
This can be corrected through public finance by embarking on activities which can stimulate export and
discourage import to reverse the trend.

1.4 The Role of Taxation in Public Finance

The Government of almost every country engages in a number of activities which require the expenditure
of funds. In order for the Government to be able to undertake most of these activities, it raises funds
through a number of sources taxation. But, taxes are the most important reliable sources of revenue to the
government.

In every country, there are certain services which the government must provide to the citizens because of
their essential nature. The services are essential that, even where individuals are allowed to provide them,
they are not allowed to monopolize their supplies or production, so as to ensure their even supply and
distribution. The contributions made by individuals and corporate entities in form of taxes, fees and levies
therefore serve as the main source of revenue to the government for the supply of such essential services.

In this vein, Musgrave and Musgrave (1989) argued that taxation plays three major functions of
allocation; stabilization and distribution within an economy. By Allocative function, as spelt out in part 1,
section 4 of the Second Schedule of the 1999 constitution of the Federal Republic of Nigeria, provides for
the provision of social goods; ensure adequate sharing of resources between social and private goods and
creating proper mix of social goods provision. stabilization function is about maintaining price stability;
high level of employment; high and sustainable economic growth as well as the attainment of favorable
balance of payments. The 1999 constitution of the Federal Republic of Nigeria has outlined the procedure
for disbursing the ‗Distributable Pool Account to the three levels of government as per section 162,
subsection 1 and 2. So, distribution function promotes equity in income and wealth distribution thereby
attaining of a “just” or “fair” state of distribution.

To achieve these goals there is a need to adequately address the incidences of revenue leakages, excesses,
abuses and fraud by improving various revenues generating capacities and cash flows thereby minimizing
operating expenses.

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1.4.2 Theory of Taxation and Incidence of Taxation
Taxes are the most important source of revenue for modern economies. The theory of taxation explores
how taxes should be levied to enhance economic efficiency and to promote a ―fair‖ distribution of income.
Similarly, policy debates about taxation are usually dominated by the question of whether it burden is
distributed fairly. Suppose that the government levies a tax of one dollar on the sellers of a certain
commodity. Suppose that prior to the tax, the price of the commodity is N 20, and that after the tax is
levied, the price increases to N21. Clearly, the sellers receive as much per unit sold as he did before. The
tax has not made them worse off. Consumers pay the entire tax in the form of higher prices. Suppose that
instead, the price increases to N 20.25. In this case, sellers are worse off by 75 cents per unit sold;
consumers are worse off by 25 cents per unit sold. The burden of the tax is shared between the two groups.
Yet another possibility is that after the tax is imposed, the price stays at N 20. If so, the consumer is no
worse off, while the seller bears the full burden of the tax.

The statutory incidence of a tax indicates who is legally responsible for the tax. All three cases above have
exactly the same statutory incidence. But the situations differ drastically with respect to who really bears
the burden. The economic incidence of a tax is the change in the distribution of private real income induced
by the tax. The example above suggests that the economic incidence problem is fundamentally one of
determining how taxes change prices. In the conventional supply and demand model of price
determination, the economic incidence of a tax depends on how responsive supply and demand are to
prices.

1.4.2 Definition of Tax

Tax may therefore be defined as a compulsory contribution made by individuals and corporate entities for
the purpose of financing the expenditure of the government. Taxation is therefore the process of levying
and collection of tax from taxable persons.

A Tax is a fee charged or levied by a government on a product, income, or activity. If it is levied directly
on personal or corporate income, it is called a direct tax. If it is levied on the price of a good or service,
then it is called an indirect tax. The main reason for taxation is to finance government expenditure and to
redistribute income for economic development of a country

1.4.3 Classification of Taxes

There are several bases used in the classification of taxes. However, we shall recognize three broad
classifications as follows:
(i) Classification based on Tax base;
(ii) Classification based on Incidence; and
(iii) Classification based on Tax rate.

1.4.3.1 Classification Based on Tax Base

A Tax base is the object or item on which tax is collected. This could be income, capital, consumption etc.
Within the context of the Nigerian Tax Laws, three (3) bases are identifiable. These are:
(i) Income: These are taxes levied on the income of Individual and companies. In Nigeria, the
common classifications are: Personal Income Tax, Companies Income Tax and Petroleum Profit
Tax.
(ii) Capital: These are taxes levied on asset. The asset could be human or other forms of assets. The
Nigerian Tax Law recognizes two forms of Capital taxation i.e. Capital Gains Tax and Capital
Transfer Tax. However, the Federal Government of Nigeria has through the 1996 budget abrogated
the Capital Transfer Tax.
(iii)Consumption: These are taxes levied on goods and services. The most common forms of
consumption tax in Nigeria are the Value Added Tax, Excise Duties and Customs duties.

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1.4.3.2 Classification Based on Incidence of Tax
An incidence of tax is the impact of tax on the person who pays tax to the Government.
Under this classification of tax, two forms of taxes are evident.

(i) Direct Taxes: These are taxes collected directly from the income of individuals and companies
whose incidence and burden is on the individuals or the companies that paid the tax to the
Government. Examples are Personal Income Tax, Company Income Tax, Petroleum Profit Tax,
Capital Gains Tax, etc.
(ii) Indirect Taxes: These are taxes imposed on the value of goods and services, produced and
consumed within the country, imported into the country or exported to other countries, whose
burden can be shifted in part or in full by the taxpayer who has paid the tax to the government to
the final consumers who do not even know either when they pay the tax or the exact amount of the
tax they pay. Examples are Value Added Tax, entertainment tax, import duties, export duties,
excise duties, etc. Indirect taxes paid by a company usually reflect in the selling price of the goods
and Services to be payable by the consumers, depending on the nature of elasticity of demand of
the product and other factors.

1.4.3.3 Classification Based on Tax Rate

A Tax rate is the portion of tax base paid as tax. Under this classification, the following can be identified.
(i) Progressive Tax: This is a tax which increases as the tax base (i.e. income or stock of wealth being
tax) increases. It is commonly found in income taxation and the aim is to achieve equitable
distribution of tax burden. For example Mr. A earns N20,000 taxable income and pays 10% as tax
(i.e. N,2000) and Mr. B earns a taxable income of N80,000 and pays 20% as tax (i.e. 16,000). In
this situation, income tax is progressive, as the tax rate has direct relationship with the tax base (i.e.
they change in the same direction).
(ii) Proportional Tax: This is a tax that remains fixed regardless of change in the tax base. In
proportional tax, all tax payers, both the rich and the poor are made to pay the same percentage of
their income as tax. For example Mr. A earns N20,000 taxable income and pays 10% as tax (i.e.
N,2000) and Mr. B earns a taxable income of N80,000 and pays 10% as tax (i.e. 8,000). In this
case, the rich pays more than the poor in absolute terms, even thought the tax rate is fixed
percentage of the tax base.
(iii)Regressive Tax: This is the tax which decreases as the tax base (i.e. income or stock of wealth
being tax) increases. For example Mr. A earns N20,000 taxable income and pays 10% as tax (i.e.
N,2000) and Mr. B earns a taxable income of N15,000 and pays 20% as tax (i.e. 3,000). This tax
system is usually imposed as punishment for non-performance in situation where the government
created an enabling business environment but the citizens are inherently lazy.

1.4.4 Distinction between Tax and Other Levies

There are other payments which resemble tax but are not tax. These payments are:
1. Fees: This is a levy imposed with the aim of reducing the cost of each recurrent service undertaken
by the Government in public interest but conferring a significant advantage on the fee payer. E.g.
registration fees, court fees, school fees, etc.
2. Licenses: This is a charge by Government to grant permission to a person for the performance of a
service. E.g. motor vehicle license fees, broadcasting license fees, business registration fees, etc.
3. Fines: This is a levy imposed as a punishment for breach of law with a view to ensuring future
adherence.

However, all these levies above are similar to tax because they are compulsory payments and they also
serve as a source of income to the Government, but differ from tax in the sense that taxes are not levied in
return for any specific service rendered by the Government to the taxpayer.

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1.4.5 Purposes of Taxation
Government imposes tax for a number of reasons, which include but not limited to the following:
1. Revenue Generation: Government imposed tax to serve as a source of income which can be used
in order to finance the construction of schools, building of roads, bridges, hospitals and markets,
provision of pipe-borne water, provision of social, health and educational facilities, provision for
defense and protection of lives and properties and provision of funds for the day-to-day running of
government (namely salaries and wages, insurance premium, fueling of cars and generators,
maintenance of buildings, electricity and telephone charges, etc).
2. Income Re-Distribution: Tax is an important instrument used by the government income re-
distribution. Tax is normally charged at a progressive rate to take resources away from those who
have more than they need for good living to provide for those who need more than they have for
minimum sustenance. Through the income generated by the government, most of which come from
the rich, is used to finance the supply of social, health and educational facilities and services, just to
mention but a few, most of which is enjoyed more by the poor than the rich.
3. Economic Stabilization: In periods of cyclical trend in economic activities, tax serves as a means
of reducing or increasing the disposable income of the consumer, payment of unemployment
benefits, supporting ailing industries, changing the pattern of aggregate demand, aggregate supply,
national income and mopping-up excess liquidly to check inflation.
4. Discourage the Consumption of harmful goods and services: Tax is used to discourage the
consumption of harmful goods and services. In doing this, a higher rate of tax is imposed on such
goods as tobacco and alcohol.
5. Protect Infant Industries: The Government imposes tax on imported goods in the form of customs
duties, in order to make their prices higher than locally produced items, with a view to protecting
infant industries which are not matured enough to favourably compete with their foreign
counterparts.
6. Prevent Dumping: Tariffs are usually imposed by the Government on imported goods in order to
prevent deliberate attempt by foreign firms to kill local infant industries with a view to possessing
monopoly power in the supply of certain goods.
7. Correct Unfavourable Balance of Payment: Taxes are imposed on imported items with a view to
discouraging import and encouraging export so as to correct unfavourable balance of payment. For
balance of payment to be favourable it thus demands that visible and invisible exports of a country
should exceed her visible and invisible import over a period of time, usually one year.

1.4.6 Principles of Taxation

These are the rules, qualities, conditions, standards or yardsticks by which the goodness of a tax system is
measured and by which a good tax policy can be formulated. Adams Smith was noted to have been the first
person to mention the principles of taxation, but he called them cannons of taxation in his book ―The
Wealth of Nations‖ in 1776. Although Adams Smith mentioned only four principles, scholars that came
after him made some generally accepted additions. Some of these principles include the following:

1. Principle of Equity: This principle states that a good tax system should be as just as possible
by ensuring that all persons who ought to pay the tax are covered by the tax and that each
taxpayer pays exactly what is just and equitable considering his circumstance and ability. There
are two types of equity i.e. vertical and horizontal equity. Vertical equity is the unequal
treatment of taxable persons with varied taxable income. While horizontal equity is the equal
treatment of tax payers with the same taxable income.
2. Principle of Economy: This principle states that the cost of collecting tax should not be too
high so as to outweigh the benefits derivable from the imposition of tax. For example if it costs
a government N9milliom to collect tax revenue of N10million, the tax system is said to lack
economy.

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 3. Principle of Certainty: This principle states that the amount to collect as tax, the time of
payment, the mode of payment and the place of payment must be made clear to the tax payer, so
that the tax payer is not left at the whims and caprice of the tax authorities. In other words, the
taxpayer should be fully informed about taxes to be able to arrive at a conclusion as to the
amount of tax payable by him with reference to the provision of the tax law, as well as, to
preventing him from being subjected to cheating by unwanted people and dishonest tax
officials.
4. Principle of Convenience: This principle states that tax should be imposed at a time, in a
manner and at a place that the taxpayer is in position to pay, so that collection of tax would be
easy for the tax administrators. E.g. salary earner should be asked to pay tax when he receive his
salary and not at the middle or the end of the month when the salary may have been exhausted.
This is why the PAYE (Pay-As-You-Earn) is deducted at source, because it is more convenient
than requiring the taxpayer to pay after collection of salary and a farmer should be asked to pay
tax when he harvest his crops and not when he is doing the planting or clearing the farm.
5. Principle of Simplicity: This principle states that a good tax system and the tax law should be
as simple as possible, both in interpretation and application. This requirement is particularly
important in developing economy where the rate of illiteracy is high and where the culture of
record keeping has not been imbibed by most small scale entrepreneurs.
6. Principle of Neutrality: This principle states that a good tax system should neither distort the
consumption habit nor the production decision of a tax payer. In other words, a good tax system
should not interfere with people‘s willingness to work, produce, consume, save and invest.
7. Principle of Efficiency: This principle states that a good tax system should make it difficult for
tax evasion (i.e. should make it difficult for nonpayment of tax or illegal reduction of one‘s tax
liability).
8. Flexibility: This principle states that a good tax system and tax law should be such that it can be
easily amended when the need arises, without unnecessary protocol.

1.4.7 Tax Laws

These are the various legal instruments put in place to ensure the realization of the tax policy objectives of
the Governments. The notable ones are:
1. Personal Income Tax Act (PITA) CAP P8 LFN 2004 (as Amended in 2011): This law imposes
tax on the income of individual, a partner in partnerships, an executor, a trustee, village or
community throughout the Federation.
2. Companies Income Tax Act (CITA) CAP C21 LFN 2004: This law applies in relation to
companies throughout the Federation.
3. Petroleum Profits Tax Act (PPTA) CAP P13 LFN 2004: This law applies to companies that
engage in petroleum exploration and production throughout the Federation.
4. Capital Gains Tax Act (CGTA) CAP C1 LFN 2004: This law imposes capital gains tax on any
capital gains i.e. gains resulting from the disposal of chargeable assets, by both chargeable
individuals and corporate entities throughout the Federation.
5. Value Added Tax Act (VATA) CAP V1 LFN 2004: This is a multi stage tax levied on the value
of some selected goods and services that are consumed within the country.
6. Education Tax Act (ETA) CAP E4 LFN 2004: This law imposes tax on the assessable profit of
all registered companies throughout Nigeria in order to raise funds for the educational sector.
7. Stamp Duties Act (SDA) CAP S8 LFN 2004: The law imposes tax on documents throughout
Nigeria.

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2.0 Government Revenue

2.1 Introduction
Government generates revenue from various sources to run its administration machinery and to provide the
development projects in all sectors of the economy. Such revenues are generated by the revenue generation
agencies and organizations through effective machinery, and allocated through the budgetary system to the
spending organizations for their operations. A good system of revenue generation is paramount to ensure
that government mobilizes enough financial resources to meet its expenditure programs.

2.2 Meaning of Public Revenue

Public revenue could be defined as the funds acquired by the government to finance its activities. Such
funds are generally obtained from various sources, such as taxes, borrowing, fees, fines, income from
public undertakings, sales of government assets, rents, mining and royalties, etc. It may be useful, however,
to make a distinction between public revenue and public receipts. While public receipt include all sources
of income available to the government, public revenue is of much narrower part and does not include
borrowing, sale of government assets or income from “printing press” (printing of more money by the
CBN).

Revenues accruing to an economy, such as Nigeria, can be divided into two main categories, namely oil
revenue (which include petroleum profit tax, rent, royalties, and Nigerian National Petroleum Company
earnings) and non-oil revenue( include trade income, company income tax, customs and excise duties, and
independent revenue sources which consists of fees, licenses, rent on government property, among others).

For most of the 1960s, federally-collected revenue was largely revenue from non-oil sources, accounting
for an average of 92 percent of the total receipts while revenue from the oil sources accounted for the
balance. As can be deduced from the narration of the oil disposition from the 1970s to this day, the non-oil
sector revenue accounted for the balance of about 20 to 30 percent receipts annually, to complement the oil
sector receipts which form the mainstay of the sources receipts of Federal Republic of Nigeria.

Since the 1970s oil revenue became the dominant source of government revenue, contributing over 70 per
cent of federally- collected revenue. For most of the 1960s, federally-collected revenue from oil sources
accounted for an average of 8 percent of total receipts. The oil boom of the 1970s propelled the sector to
become dominant, accounting for most of the foreign exchange earnings as well as federally-collected
revenue. The contribution of the oil sector to total receipts increased from average of about 46 percent
between 1970 and 1973 to about 77 percent between 1974 and 1980. Through-out the 1980s and 1990s, the
contribution of the oil sector to total revenue maintained its dominant position and contributed between 70
and 76 percent of the federally-collected revenue.

In addition to the above, Oshisami (1994) categorized revenue accruing to the Government into internally
generated revenue and revenue allocation from the Federation Account. There are two main sources via
which revenue accruing to the Federation gets to the States and Local governments. These are statutory
allocation and non-statutory allocation. The later takes the form of grants as may be deemed fit by the
Federal Government to help pursue a policy which in the opinion of the Federal Government should be to
the benefit of the country as a whole. Statutory allocation on the other hand is prescribed by law, specifying
the basis for distribution of the revenue amongst the three tiers of government, the formulae for distribution
and modes of distribution.

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2.3 Sources and Classification of Federal/State and Local Government Revenue
2.3.1 Sources of Federal/State Government Revenue
Sources of federal/ state government revenue in Nigeria are as follows:
(i) Taxes: These refer to the levy collected by the government mostly in the form of company income tax,
petroleum profit tax, value-added tax, education tax (applies to companies), capital gains tax
(individuals are under states while corporate bodies and Abuja residents under federal), stamp duties
(instruments executed by individuals are states and corporate bodies under federal), withholding tax
(individuals under states and companies under federal), personal income tax (residents of the state are
under states while personnel of the armed forces, police, external affairs ministry, and residents of
Abuja are under the federal), taxes on pool bets, lottery and casino wins, and customs and excise duties
(i.e., import and export duties). According to the principles of public finance, tax revenue should be the
main source of finance for the public sector. Citizens should be the main contributors of finance for the
development of the Nation.
(ii) Non-Tax Revenue: This is made up of all revenues, other than taxes, that are generated by
government to finance its expenditures. These include fines, fees and rates, licenses, earnings from
sales, rent from government properties, interest payment and repayment of loans, re-imbursement,
statutory grant and miscellaneous revenue.
a) Fines, Fees and Rates: This include fines imposed on individual, school fees collected from
students, water rate collected from consumers, etc.
b) Licenses: These cover amount received for issuance of licenses of various types by the government,
e.g. vehicle licenses, business premises and registration fees in urban and rural areas.
c) Earnings from Sales: These cover money realized from the sale of government properties e.g. sale
of government vehicles, houses, earnings from oil sales, etc.
d) Rent of Government Properties: These include rent of government houses / quarters and land etc.
e) Interest Payment and Repayment of Loan: These are interest payments by government
employees and government companies, on loans granted by the government, e.g. payment of
interest on motor vehicle loan and the repayment of the loan itself.
f) Re-imbursements: These are refunds for services rendered to another tier of Government, public
corporations and other statutory bodies by the Government.
g) Statutory Grant: This is the share received from the Federation Account and value added tax.
h) Miscellaneous: These are sources other than the sources mentioned above, e.g. dividend from
investment, stamp duties, business premises and registration fees, streets name registration fees and
fees for right of occupancy on urban land, mining, rents and royalties.

2.3.3 Sources of Local Government Revenue

These are other revenues that central government makes available to the local government or district
assembly apart from the Common Fund. Examples of these revenues are:
(i) Statutory and Non-Statutory Allocation: Revenue accruing to Local Governments from the Federal
government can be categorized into two, namely statutory and non-statutory allocation. The later takes
the form of grants as may be deemed fit by the Federal Government to help pursue a policy which in
the opinion of the Federal Government should be to the benefit of the country as a whole. Statutory
allocation on the other hand is prescribed by law, specifying the basis for distribution of the revenue
amongst the three tiers of government, the formulae for distribution and modes of distribution.
(ii) Grants-in-aid: These are donations received from foreign governments through the central
government.
(iii)Transfers: These are monies that the central government gives to meet other expenses and pensions of
district assemblies‘ staff
(iv) Ceded Revenues: These are sources of revenues which the federal government has given over to
district assemblies by the virtue of Decree No. 21 of 1998. These include tenancy rates, shops and kiosk
rates, fees for on-off liquor licenses, fees for butcher slabs, fees for marriage, birth and death
registrations, fees for street name registration (except in the state capital) motor park fees, market taxes

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 and levies (except in any market where state finance is involved), fees for domestic animal licenses,
fees for bicycles, trucks, canoes, wheelbarrows, carts and canoes, fees for right of occupancy on land in
rural areas (except those of federal and state governments) and cattle tax (applies to cattle farmers
only). Others are entertainment and road closure levy, fees for radio and television licenses, vehicle
parking and radio license fees, charges for wrongful parking, fees for public convenience, sewage and
refuse disposal, customary ground permit fees, fees for permits for religious establishments and fees
for permits for signboards, bill boards and advertisements.

2.4 Taxation as a Source of Government Revenue in Nigeria

The history of taxation in Nigeria goes back to the pre-colonial rule. There was a system of taxation in
existence in the form of contribution of compulsory service, money, farm produce, goods and labour,
which were essentially meant to support the various monarchies that existed in the present day Nigeria.
Mainly, these taxes were levied in the form of ground rent, palm fruit tax, farm produce tax, cattle
ownership tax, etc.

However, history has it that modern tax system as we have today in Nigeria was first introduced in the year
1904 by the late Lord Lugard as community tax in the then Northern Nigeria. He later made changes which
resulted to Native Revenue Ordinance of 1917 in Northern Nigeria and a provision for extension to western
Nigeria was made in 1918 and 1928. The ordinance was extended to the eastern part of Nigeria in 1929.
During the colonial rule taxes were imposed on individuals and corporate entities through a series of
promulgations by the Colonial power. In 1940 two major legislations were passed, these were the Direct
Taxation Ordinance No. 4 of 1940 and the Income Tax Ordinance No. 3 of 1940. The Direct Taxation
Ordinance of 1940 applied to all citizens except those in Lagos Township. The Income Tax Ordinance No.
3 of 1940 applied to expatriates and to Nigerians living in Lagos.

Income Tax Ordinance was passed in 1943 repealing the 1940 Ordinance. The 1943 Ordinance together
with Direct Taxation (Amendment) Ordinance, 1943 continued to apply until 1956. In 1956 Eastern Region
passed the Finance Law No. l of 1956. The basis of computation of tax provided in the Finance Law No. 1
of 1956 was basically the same as in the Ordinance of 1943. In 1956 tax allowances were provided for
married taxpayers, and additional allowances for families with children up to a maximum of three children.
It also introduced the Pay-As-Your-Earn (PAYE) system of taxation. The Eastern Region Finance Law
number 1 became operative in the Region on April 1 1956, thus ceasing the application of Direct Taxation
Ordinance in the Region. Another Law was passed in 1962 repealing the 1956 Law. The Western Region
departed with the Direct Taxation Ordinance by passing the Income Tax Law in 1957. The Pay-As- You-
Earn system was introduced in the Region by the Income Tax (Amendment) Law 1961.

To ensure uniformity in both the application and incidence of taxation on individuals throughout Nigeria,
the Income Tax Management Act (ITMA) was enacted in 1961, thus repelling all previous laws applicable
to individuals, and making main provisions applicable to all individuals throughout Nigeria. In the same
vein the Companies Income Tax Act (CITA) of 1961 was also promulgated. Subsequently, ITMA 1961
was repelled and replaced by Personal Income Tax Act (PITA) 1993, which came into being through
Decree No. 104 of 1993, while the Companies Income Tax Act (CITA) of 1961 was repelled by the
enactment of Companies Income Tax Act (CITA) of 1979. The tax Acts which suffered series of
amendments, reassessment and review, are now included in the Laws of the Federation of Nigeria, 2004.
Thus, codifying them as Personal Income Tax Act (PITA) CAP P8 LFN 2004 and Companies Income Tax
Act (CITA) CAP C21 LFN 2004.

Revenue from taxation include direct and indirect taxes. Direct taxes are taxes on individual and companies
e.g. companies‘ income tax, petroleum profit tax, capital gain tax, bark duty assessment, personnel income
tax, surcharge on pioneer companies, with holding tax capital transfer tax, etc. Indirect taxes are taxes
raised from goods and commodities in the form of customs and excise duties e.g. import duties export

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duties excise duty tariffs forfeiture penalty, VAT, etc. Taxation has been an important source of revenue in
Nigeria since its introduction in Northern Nigeria by Lord Lugard in 1904.

Table 1: Trend of Tax Revenue in Nigeria 2000-2012

COLLECTION
YEAR TARGET (=N= Billion) ACTUAL (=N= Billion)
2000 380.5 455.3
2001 500.7 586.6
2002 396.2 433.9
2003 572.9 703.1
2004 800.0 1,194.8
2005 1,304.4 1,741.8
2006 3,054.1 1,866.2
2007 1,753.3 1,846.9
2008 2,274.4 2,972.2
2009 1,909.0 2,197.6
2010 2,557.3 2,839.3
2011 3,639.1 4,628.5
2012 3,635.5 5,007.7

Import duties, sometimes called tariffs, are taxes levied on goods imported into a country. An import duty
has the effect of increasing the prices of such commodities in the importing country. Where imported
goods are elastic in demand, import duties on them tend to shift demand on locally produced goods as a
result of their prices (imported goods) skyrocketing.

Table 2: Tax Revenue as a Percentage of GDP in Nigeria 2004-2008

Year Tax Revenue as a % Tax Revenue as a % Tax Revenue as a
of GDP of GDP % of GDP
Nigeria Algeria Egypt
2004 0.2 **na 13.8
2005 0.2 **na 14.1
2006 0.1 40.7 15.8
2007 0.2 37.2 15.3
2008 0.3 45.3 15.3
**na indicates that data for the year is not available
Source: Adapted from World Bank Databank

The reason for selecting Algeria and Egypt as countries for comparison is based on the fact that these
countries are amongst the top oil producing countries in Africa. According to The Richest (September 16,
2011) Nigeria was ranked as the highest oil producing country in Africa, for year 2011, producing
approximately 2.2 million barrels of oil per day; Algeria was ranked 2 nd, producing approximately 2.1
million barrels of oil daily while Egypt was ranked 5th, producing about 0.68 million barrels of oil per day.
One begins to wonder why total tax revenue of Algeria and Egypt as a percentage of GDP is far higher than
that of Nigeria, given the fact that Nigeria produces more oil, not to mention that Nigeria exports more than
these countries.

Then, the citizens are forced to ask questions like ―Is Nigeria too dependent on its natural resource (crude
oil) that it has neglected the importance of taxation to its economy growth?‖ One might argue that the GDP
of Nigeria is far greater than that of these countries; therefore Nigeria has more options in generating GDP.

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But, taking into consideration another oil producing country; say Canada, it has a far greater GDP than that
of Nigeria yet they have about 13.54%, on an average (from year 2004 to year 2008), of tax revenue to
account for their total GDP compared to Nigeria‘s average of 0.2%. If only the issue of taxation could be
critically considered by government, then Nigerians can say they are a step further in achieving their 20-20
vision.

2.5 Diversification of Nigeria’s Sources of Revenue for Sustainable Development

Dandago (2007) reported that in all the 36 states of the federations there are abundant natural resources to
be harnessed and utilized to trigger in one place and accelerate in another Nigeria‘s industrial development.
He also argued that Nigeria is the world largest country naturally endowed with different resources with
over four hundred and fifty (450) solid minerals.

Table 3: Potential Sources of Revenue in Nigeria

S/N Mineral Uses State/Locations
1 Gold Currency base, Ornaments Osun, Niger, Edo, Akwa Ibom, Borno, Kebbi, Lagos,
Ogun, Ondo, Plateau
2 Bentonite Drilling mud in the soil industry, Abia, Ebonyi, Borno, Akwa Ibom, Gombe
medicinal, cosmetic and
pharmaceutical preparations
3 Barities Filler in paint, rubber, plastic, Borno, Yobe, Plateau, Benue, Gombe, Nassarawa
weighing in drilling mud
4. Bauxite Raw material for aluminuim smelter Adamawa, Taraba, Cross River
plant
5. Lead Zinc Storage batteris, soler, pipes, brass Enugu, Abia, Ebonyi, Niger, Plateau, Kano Bauchi,
making galvanizing die-casting Gombe, Taraba, Benue.
6 Feldspar In ceramics as glass material. In Borno, Kogi, Ogun, Kwara, Oyo, Niger, Kaduna, Gombe,
enamels glass industry, tiles sanitary Katsina Nassarawa
wares and building construction
7. Brick Building industry Lagos, Enugu, Kano, Plateau, Oyo, Borno, Kogi
8. Tin Tin plating, bronzed brass, soler, Plateau, Nassarawa, Kano, Bauchi, Gombe, Benue, Taraba.
type maetal. Alloys, etc.
9. Calcium and In metallurgical industry Cross River, Anambara, Ebonyi, Sokoto, Kebbi edo Kwara,
Marble Delta, Adamawa, Bebue, Oyo, Plateau, Nassarawa, Kaduna
10 Ceramic thy In the ceramic industry Plateau, Nassarawa, Katsina, Bauchi, Gmbe.
11 Uranium Alternative energy sources Borno, Yobe, Cross River, Akwa Ibom, Gombe.
12 Iron Ore Iron and steel industry in most Kwara, Kogi, Borno, Bauchi, Kano, Kaduna, Eugu,
modern industries associated with Gombe, Anambra, Katsina Nassarawa
farming, building construction and
manufacturing
13 Phosphate For fertilizer Sokoto, Abia, Ogun, Bauchi, Gombe.
14 Gypsum Manufacture of cement, plaster of Sokoto, Kebi, Bauchi, Gombe, Abia, Enugu, Edo, Yobe,
paris (POP) and boards Anambra Borno.
15 Germstone Jewellery and ornaments Katsina, Nassara Kaduna, Bachi, Gombe, Kogi, Kano
Jigawa
16 Bitumen For production of asphalt, water Ondo, Ekiti, Ogun Lagos
roofing, insulation, road construction
and roofing
17 Diatomite As filter aids in the beverage and Borno Yobe
sugar industries for heat and sound
insulation, as abrasive in light weight
building materials and in ceramics
18 Clay Ball In cermac industries Imo, Edo, Delta, Katsina, Akwa Ibom Rivers, Cross River,
Ondo, Ekiti, Ebonyi, Nassarawa, Enugu, Anambra
19 Kaolin clay In ceramic plastic and point Delta, Imo, Edo Kwara Plateua Kaduna, Katsina ,Ogun
industries Kano, Sokoto, Kebbi, Borno
20 Fire-Clay In ceramic and pottery (refractory) Anambra, Enugu, Kwara, Ebonyi, Katsina Ogun Sokoto
Kebbi, Zamfara Nassarawa.

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 S/N Mineral Uses State/Locations
21 Dolomite In cermic industries Kwara Kogo, Oyo Osun, Niger, FCT, Nassarawa.
22 Limostone In cement industries Anambra, Ebonyi, Cross River, Akwa ibom, Benue, Ogun,
Sokoto
23 Sand (Glass In glass industries Edo, Delta, Ondo, Ekiti, Rivers, Bayelsa, Anambra, Enugu,
sand) Ebonyi, Imo, Abia Kogi, Lagos, Nassarawa
24 Salt For nutritional purposes Ebonyi, Benue, Imo Abia Enugu, Anambra, Cross River,
Plateau, Nassarawa Akwa Ibom, Kebbi.
25 Soda Ash For various purposes Borno, Yobe, Kano, Jigawa.
26 Talc In paint and cosmetic industries Oyo, Osun, Ondo, Ekiti, Niger, Kog, FCT, Kwara
Nassarawa
Source: Dandago (2007:106-111)

The analysis of Table 3 reveals that there are twenty six (26) mineral deposits endowed in virtually all 36
states of the Federal Republic of Nigeria that could be mined for various forms of utilization. These
mineral resources could be used as agents of industrializing Nigeria, accelerating the level of employment
by increasing the earning propensity of the citizenry which in the long term will trigger high level of
national output. The exploration of these resources will immensely contribute to credits of the Federation
Account by improving the revenue generation capacity of the states of their domain by the 13% share.
From the table it is reported that, for example, Anambra, Ebonyi, Benue, Cross River, Akwa ibom, Benue,
Ogun, Sokoto have deposited in their areas Limostone used in producing cement. In another revelation, the
table shows Delta, Imo, Edo Kwara Plateua Kaduna, Katsina ,Ogun Kano, Sokoto, Kebbi, Borno with
adundant deposits of Kaolin clay for ceramic, plastic and point industries. Katsina, Nassara Kaduna, Bachi,
Gombe, Kogi, Kano Jigawa states have Germstone for Jewellery and ornaments. Furthermore, there is
large gold endowment in Osun, Niger, Edo, Akwa Ibom, Borno, Kebbi, Lagos, Ogun, Ondo, Plateau states.
Evidently, surveys reported that such resources are in large quantities could be explored for quite a long
period.

Central Bank of Nigeria (CBN, 2012) reported that oil revenue accounted for up to 80% of the composition
federation account with contribution to the country‘s Gross Domestic Product (GDP) of 25.9%, 12.9%,
15.9%, 23.7% and 19.8% in 2008, 2009, 2010, 2011 and 2012 respectively. The report also showed that
non-oil revenue accounted for the average of 6.06 contributions to GDP over the period under review. This
is not plausible enough to rely on oil alone as the major source for Nigeria‘s revenue even without the
associated challenges. There is an urgent need for the government to identify and explore other potential
revenue generating avenues dominant within the jurisdiction of Nigeria. For instance, there are abundant
natural resources endowed in various locations across the 36 states of the federation untapped. It is
evidently established that if these resources were to be tapped could not only generate sufficient revenue
for the country to facilitate the realization of vision 20:20:20, the project could launch Nigeria among the
most industrialized countries.

In addition to the mineral exploration, the country is blessed with large wealth of agricultural products both
for food and cash crops as well as animal products. These products could make Nigeria self sufficient in its
own food production and self reliant in the provision of the necessary raw material for industrial
consumption. For example, Dandago (2007) argued that if Nigeria adequately harness its agricultural
potentials in food cultivation could favorably compete with Thailand in Rice Production from 17 states
alone (Akwa ibom, Benue, Gombe, Kano, Kogi, Ebonyi states among others). In Cotton could compete
with Indonesia, Malaysia for raw material provision to Textile and milling industries of the country from
only 10 states. In Palm produce Nigeria could enjoy competitive advantage over even Malaysia from 21
states of South-south, South-east and west including some states from the North.

Nigeria has edge in tourism industry. Much a lot of revenue can be generated from tourism. Revenue
centers can be created in various states‘ tourist sites. For example, in Akwa Ibom, Wildlife park, Oron
National Meseum etc, Anambra: Nkisi stream Onitsha, Ofala Festival, igbo ukure, palace of Oba, Cross

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River: Ogbudu Cattle Ranch, Ekpe Masquerade. With all abundant tourist attractions Nigeria is endowed,
yet revenue generation and exchange earning are insignificant in the aggregate revenue of the country. It is
on record that there are other countries of the world that relied on tourism as a major source of revenue and
that it accounts significantly in their national income. For example Egypt, United States of America,
Kenya, South Africa and the rest. Even in the area of taxation a lot is desired to be done to develop other
forms of taxes to improve the complexion from taxation. Jimoh (2007) argued that some reasons are
against proper generation of revenue from taxation in Nigeria. Some of the reasons, according to him,
include subsistent nature of the economy; Tax avoidance and evasion; level of income; tax revenue
leakages among others.

3.0 Public Expenditure

3.1 The Meaning of Public Expenditure
Public expenditure refers to the expenses which Government incurs in the performance of its operations. With
increasing State activities, it may be difficult to judge what portion of public expenditure can be ascribed to the
maintenance of Government itself and what portion to the benefit of the society and the economy as a whole.

3.2 The Theory of Public Expenditure

Two notable theories of public expenditure are examined, viz:
(a) "The Law of Increasing State Activities": A German Economist- Adolph Wagner in 1890 postulated this
theory. According to him, there are inherent tendencies for the activities of Government to grow, both
intensively and extensively. He added that there exists a functional relationship between the growth of an
economy and that of Government activities, and that the Governmental sector grows faster than the
economy. All categories of Governments, irrespective of their levels, intentions and sizes, had exhibited the
same kind of tendencies of increased expenditure.
(b) "The Displacement Theory": Jack Wiseman and Allan T. Peacock put forth the theory in 1961. Their
main argument was that public expenditure does not increase in a straight or continuous manner, but in
"Jack or Stepwise" fashion. At times, some social or other disturbances occur which show the need for
increase in public expenditure, which the existing level of revenue cannot meet. Therefore, public
expenditure increases will make the inadequacy of the existing level of revenue clear to everyone. The
movement from the initial and low level of expenditure and taxation to a new and higher level is known as
the "displacement effect," while the inadequacy of the revenue as compared with the required expenditure
creates the "inspection effect." Both Government and the people would attain a new level of "tax tolerance"
by reviewing the revenue position and finding solution to the problem of inadequate finance. Since each
major disturbance always leads Government to assume a larger proportion of the national economic
activities, the net result is the 'concentration effect'. Therefore, 'concentration effect' is the tendency for
Government activities to grow faster than the economy.

3.3 Classification of Expenditure

Public expenditure may be classified on the following basis:
(i) Nature of Expenditure Incurred: Under this basis Government expenditure is broadly divided in to
two (2) main categories, namely recurrent expenditure and capital expenditure:
(a) Recurrent/revenue expenditures: Recurrent expenditure is the type of expenditure that happens
repeatedly on daily, weekly or even monthly basis. This includes for example payment of
pensions and salaries, administrative overheads, maintenance of official vehicles, payment of
electricity and telephone bills, water rate and insurance premiums etc.
(b) Capital or development expenditures: Capital expenditure on the other hand refers to
expenditure on capital projects. This includes construction of houses, roads, schools and
hospitals, human capital development (expenditures on education and health), purchase of
official vehicles, construction of boreholes and electrification projects, etc.
(ii) Economic Purpose for Expenditure: Under this basis we have three classes, namely:
(a) Government consumption: Government purchases of goods and services for current use.

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 (b) Government Investment: Purchases of goods intended to create future benefits e.g. infrastructure,
education and research and development.
(c)Transfer payments: Transfers that do not involve purchase of any good or service, eg.
unemployment benefits, scholarships, social welfare support, interest on public debt, etc.
(iii) Unit of government involved: Under this basis we have:
(a) Federal government and its MDAs
(b) State government and its MDAs
(c) Local government
(d) Separate Government bodies
(iv) Basis of function at which expenditure is directed:
a) justice and public order;
b) infrastructure (roads, railways, etc);
c) military;
d) Education;
e) health care;
f) support for the poor, the old, the disadvantaged;
g) support for firms, export and production in general;
h) special policy expenditure (e.g. foreign aid, fight against
drugs, etc). –
(v) Kinds of goods and services purchased. This gives rise to three sub-classifications:
a) capital goods;
b) consumption goods;
c) personnel expenditure.
(In national accounts, public expenditure does not include transfers among social groups, such as
pensions, and interest payments of public debt).

3.4 Models of a State

The starting point is to understand that public spending nearly corresponds to three general models of state
to which a government may subscribe. In other words, how much a government spends, overall, depends
on which of these political frameworks it has chosen as the foundation for running its affairs. These models
are:
1) The minimal state: This is the model where justice, public order, foreign policy and some basic
functions should be carried out by the state; relaying on private sector for the rest. The minimal state is
currently the trend and is manifested in the drive towards less- government and greater privatization in
what advocates call public sector reforms;
2) The welfare state: This is the model where the state cares about the people‘s well being directly, also
through expenditure in education, health, and support for the poor, the old, and the disadvantaged;
3) The developmental state: This is the model where the state takes the responsibility of promoting
economic development; also through expenditure in infrastructure, support for firms, export and production
in general.

Items of the minimal state are found in both welfare and developmental states. However, military and
special spending is common to all three models, even though in different proportions. Government
expenditure virtually depends on the model of state chosen.

3.5 Determinants of Public Expenditure

Determinants-Public expenditure is determined, generally, by:
(a) The political will of those at the helm of affairs of the government;
(b) their priorities,
(c) chosen state-model
(d) interpretation of current economic and political trend.

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 (e) other factors: Urbanization; Population; Economic growth; Depreciation; Technological change;
and Reduction in inequality.

3.6 Reasons for Increase in Government Expenditure

A number of factors have been identified as causing increasing in public expenditure in various countries
over time. Some of these are general, having relevance to all countries, while others are specific to certain
countries. These factors include the following:

(i) Increase in Costs of Providing Security: The traditional functions of government such as
defense, maintenance of law and order, etc. are becoming extensive and cumbersome. Defense
is becoming expensive more than ever. Within the country administrative set up is increasing
both in coverage and intensity, that is, government machinery has to be manned by experts in
their respective fields. In addition, various complexities of economic and social measures
develop which make an efficient administration complex and expensive as well.

(ii) Increase in Public Awareness: Besides the traditional functions of the state, there is growing
awareness of additional responsibilities. The government is expanding its activities in the area
of various welfare measures which include measures to enrich the cultural life of the society and
those designed to provide social securities to the people such as pensions, old peoples‘ home
etc.

(iii) Growing Population: Increasing population may also be a determinant of public expenditure
growth. The share scale of various public goods and services has to rise in conformity with the
growth of population. The need for more schools, hospitals and such likes cannot be over-
emphasized is the light of increasing population.

(iv) Urbanization: It has been suggested that urbanization and the resulting congestion has
increased the need for more infrastructure and public goods and services. Also quite a number
of incidental services like those connected with traffic, roads, pedestrian bridge etc. has to be
provided.

(v) Increase in prices: The tendency for prices to go up has equally contributed to the growth of
public expenditure. The increase in prices of input and other goods purchased by public sector
has resulted in an increase in public expenditure. It is the responsibility of the government to
protect the citizenry against the evils of price mechanism. Consequently, anti-cyclical and other
regulatory measures are put in place. Efforts are made to reduce income and wealth inequalities
and bring about social and economic justice.

(vi) Increasing Cost of Debt Servicing: Increasing public expenditure can also he explained in
terms of increasing cost of debt servicing. Since states are related to one another through
various economic transactions, there are tendencies to run into debts, which must be settled.

3.7 Purposes/Functions of Public Expenditure

The effects of public expenditure include the following:

1. Economic Stabilization: The philosophy of laisser faire leaves much to be desired in terms of
economic results. The more advanced and free the market mechanism, the more prone the economy is
to the vagaries of income, employment and price fluctuations. Public expenditure as an anti-cyclical
tool can be devised in such a manner as to create effective demand thereby stimulating investment
activities. It may be emphasized that the total demand need he regulated so that the demand flows
match the supply flows otherwise the stimulating effect would result in inflationary pressure.

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2. Production: Public expenditure can help the economy to attain a higher level of production. Through
stimulation of investment, it can create conditions favourable for market forces to push up production.
It can be used to create human skills through education and training and maintenance of social
overheads. Public sector investment can be specifically directed towards creation of particular supplies
and facilities, which may form an important and necessary input for other industries. Through research
and development, new and effective methods of production can be found whereby local resources are
used.

3. Economic Growth: Economic growth can be defined as an increase in a country‘s physical output
over a long period of time. A country is said to have experiment economic growth, when the real output
of goods and services is increasing at a faster rate than the rate of growth of its population. Countries
pursue economic growth in order to enjoy the benefit of a greater output, hence improve their standard
of living. In a developed economy, through economic stabilization, stimulation of investment activities
and so on, public expenditure helps to maintain a smooth growth rate. In an under-developed economy.
Public expenditure has important role to play in reducing regional disparities, developing social
overheads, creation of infrastructure for economic growth in terms of communication and
transportation facilities, education and training, growth of capita] goods industries, research and
development etc. When expenditure is incurred, it may be directed towards a particular investment or it
may be used to bring about re-allocation of investible resources in the private sector of the economy.
An important way in which expenditure can accelerate the rate of economic activities is by reducing the
divergence between the social and marginal productivity of certain investment.

4. Economic Development: Economic development cat be defined as the elimination or reduction in

poverty, inequality and unemployment within the context of a growing economy, there may be growth
without economic development.

5. Distribution: An important evil of the market mechanism is the inequalities of income and wealth,
which arise on account of it and get widened through the institution of private property and inheritance
Furthermore, such income and wealth disparities not only result in social and economic injustice but
also distort production and employment patterns. Suffice to say that lesser income and wealth
inequalities contribute towards economic stability. Welfare consideration favours an equitable
distribution of income and wealth since the purpose of economic policy is to attain the maximum level
of social benefits possible. A shift towards equality may be achieved through various forms of public
expenditure especially those that are meant to help the poorer sector of the society. Items of common
consumption may be subsidized and production of those, which are in short supply, can be taken up by
Public Sector. Left for the market mechanism the supply of merit goods tiny in be possible. Public
Expenditure through direct purchase production or subsidies can ensure that their supply is augmented
to the desired level and can reduce unemployment and improve income and wealth distribution.

6. Price Stability: Price stability refers to a situation where the general level of prices of goods and
services changes very little or no changes at all. Price level stability exists when the annual rate of
increases in prices measured by appropriate indexes is less than 2%. Common measures of price
stability are: (i) Consumer price index (measure of level of prices of all new domestically produced
goods and service); (ii) Wholesale price index; and (iii) National product deflator (an economic metric
that accounts for the effect of inflation in the current year‘s GNP by converting its output to a level
relative to a base period).

7. Full Employment: Full employment is a concept that cannot be precisely defined. Full employment
does not mean that everyone has a job. This is because there shall always be people, such as babies,
under-aged kids, very old people who cannot work even if they are willing to do so. This situation
makes every government to define its full employment level e.g. in US full employment level is 97%.
In Canada it is 96%, then the balance being the unemployment rate.

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 In Nigeria, however, full employment policy has not been given a place of prominence and specific
target has not been mentioned, Unemployment is a welfare loss to the society in terms of total output
that is being forgone. It is equally a welfare burden borne by individuals.

8. Balance of Payment (BOP) Equilibrium: Balance of Payment (BOP) equilibrium is a record of a

country‘s transaction with the rest of the world over a period of time in respect of visible and invisible
items. The balance of payment provides an indicator of a country‘s international economic position.
Because of the importance of the above, balance of payment equilibrium becomes an important
objective of economic stabilization policy.

9. Equitable Distribution of Incomes: This has to do with how income is being distributed in the
economy in a fair and equitable manner. Unfortunately in less developed countries, the income
distribution pattern is an asymmetrical one, i.e. it is not evenly distributed. This accounted for the
widespread poverty in these countries. The policy investment usually used to achieve the above macro-
economic objective are: (i) Monetary Policies (cost, allocation and distribution of credit to change the
level of money supply); (ii) Fiscal Policies (government spending and levying taxes to achieve
macroeconomic objectives); (iii) Incomes Policy (regulation of reward to factors of production,
minimum and maximum prices, minimum wages, rent and interest). The monetary policy is a measure
designed to influence cost, allocation and is tribulation of credit in order to change the level of money
supply in the economy. This fiscal policy refers to the deliberate action, which the government of a
country takes in areas spending money and/or levying taxes with the objective of achieving macro-
economic variable. The income policy on the other hand relates to the regulation of the rewards that go
to the factors of production such as labour (minimum wage legislation). It equally includes the
registration of product prices (minimum and maximum price legislation).

3.8 Standards of Public Expenditure Decisions

Expenditure decisions should be guided by the following standards, among others:
a) Economy: The nation's resources are scarce, compared with the needs of the society. It is therefore
important that no wastage is allowed in public expenditure. The process of public spending should not
involve the use of more resources than are actually necessary wasteful usage of public fund must be
avoided. Scientific approach towards assessment of required expenditure must be adopted. Budgeting
techniques such as Planning and Programming Budgeting System and Zero-Base Budgeting System could
be adopted.
(b) Benefit: Every public expenditure should be viewed against the benefits that will accrue there from. It
should be incurred only if it is beneficial to the society.
(c) Surplus: Government should avoid persistent deficit budgeting. It should be consistently prudent and
aim at meeting its current expenditure needs out of current revenue. Government should not over- spend
and eventually run into debt. Moderate surpluses over some years will take care of any unavoidable deficit
during any other year.
(d) Sanction: All public expenditure should be subjected to legal appropriations and authorisations. Any
contravention of expenditure procedure and due process should be sanctioned. As required by law all
unspent appropriations should be returned to the Treasury at the financial year end.

3.9 Public Expenditure Management and Control: The management and control of public expenditure is
a responsibility that falls on government institutions and individual public servants. As an institutional
duty, both executive and parliamentary arms of government have constitutional roles aimed at ensuring the
proper disbursement of public fluids. Individually, all civil servants who handle government funds and
properties are required to observe certain rules and guidelines in ensuring appropriate custody and spending
of public monies. For clarity, expenditure management and control are discussed separately, although they
are inter-related.

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3.9.1 Principles of Public Expenditure Management (PEM): Due to the scarcity of resources in the face
of unlimited demands, the need for an economic utilization of these resources by the management of
organizations becomes imperative. For this reason, certain guidelines, in the form of basic truths or
principles, ‗have been evolved to assist in the effective and efficient management of public expenditure.
Before embarking on spending any of public funds, officials should examine the Ten Principles of Public
Expenditure Management contained in Table below.

Table 4: Guidelines for dealing with Public Finances

Principles to be
observed by Public
S/No. Officials Action Required from Public Officials
Budgets must encompass all financial operations of
1 Comprehensiveness government; off-budget expenditure and revenue are prohibited.
Decision-making must be restrained by resource realities over
the medium term; the budget should absorb only those
resources necessary to implement government policies, and
2 Discipline budget allocations should be adhered to.
Policymakers who are in a position to change policies during
implementation must take part in the formulation of the original
3 Legitimacy policy and agree with it.
Decisions should be defend until all relevant information has
4 Flexibility become available.
There must be stability in general and long-term policy and in
5 Predictability the funding of existing policy.
All sectors must compete on an equal footing for funding during
6 Contestability budget planning and formulation.
The budget must be derived from unbiased projections of
7 Honesty revenue and expenditure.

There should be medium-term aggregate expenditure baseline

8 Information
9 Transparency
10 Accountability
against which the budgetary impact of policy changes can be
measured; accurate information on costs, outputs and outcomes
should be available.
Decision-makers should have all relevant information before
them and be aware of all relevant issues when they make
decisions; these decisions and their bases should be
communicated to the public.
Decision-makers are responsible and accountable for the
exercise of the authority provided to them.

In addition to the ten principles outlined, civil servants are required to be cost-conscious. The following
ways could check extravagance:
a) Every officer or employee should justify his employment by giving efficient services in return for his
earning,
b) Every official expenditure should be duly authorized by an appropriate authority, as required by
regulation,
c) The expenditure should be in accordance with the Financial Regulations (Instructions/Memorandum),
d) Staff recruitment should be dictated by real needs so that underemployment and over-establishment are

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avoided,
e) Economy should be exercised in buying office furniture, equipment and stationery,
f) Made-in-Nigeria goods should be preferred to imported goods,
g) No officer should condone wasteful spending of public funds by other civil servants.

3.10 Financing Government Expenditures

How a government chooses to finance its activities can have important effects on the distribution of income
and wealth (income redistribution) and on the efficiency of markets (effect of taxes on market prices and
efficiency). The issue of how taxes affect income distribution is closely related to tax incidence, which
examines the distribution of tax burdens after market adjustments are taken into account. Public finance
research also analyzes effects of the various types of taxes and types of borrowing as well as administrative
concerns, such as tax enforcement.

(i) Taxation: Taxation is the central part of modern public finance. Its significance arises not only from
the fact that it is by far the most important of all revenues but also because of the gravity of the
problems created by the present day tax burden. The main objective of taxation is raising revenue. A
high level of taxation is necessary in a welfare State to fulfil its obligations. Taxation is used as an
instrument of attaining certain social objectives i.e. as a means of redistribution of wealth and
thereby reducing inequalities. Taxation in a modern Government is thus needed not merely to raise
the revenue required to meet its ever-growing expenditure on administration and social services but
also to reduce the inequalities of income and wealth. Taxation is also needed to draw away money
that would otherwise go into consumption and cause inflation to rise.
(ii) Public finance through state enterprise: Public finance in centrally planned economies has
differed in fundamental ways from that in market economies. Some state-owned enterprises
generated profits that helped finance government activities. The government entities that operate for
profit are usually manufacturing and financial institutions, services such as nationalized healthcare
do not operate for a profit to keep costs low for consumers.
(iii) Non-Tax Revenue: This is made up of all revenues, other than taxes, that are generated by
government to finance its expenditures. These include fines, fees and rates, licenses, earnings from
sales, rent from government properties, interest payment and repayment of loans, re-imbursement,
and miscellaneous revenue.
(iv) Donations: Donations received from foreign governments and donors agencies.
(v) Public debt: Public borrowing from the capital market by way of bonds or from local and
international financial institutions.

4. Fiscal Policy

4.1 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 either centralised or decentralised, depending on whether the political structure is federalist or unitary.

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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 5 presents the allocation of
responsibilities in Nigeria between the federal, states and the local governments.

Table 5: Allocation of responsibilities by government in Nigeria (1989)

Source: 1989 Constitution of the Federal Republic of Nigeria

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Table 6: Nigeria’s major taxes, jurisdiction and right to revenue

Source: Anyanwu et al (1997)

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4.2 Objectives of the Nigerian Fiscal Policies
The objectives of fiscal policy at a particular time period may differ from objectives to be achieved at
another time period. The Nigeria‘s fiscal policy objectives include the following:
(i) Generation of significant government revenues;
(ii) Diversification of revenue sources away from crude oil-based revenues;
(iii) Reduction of the tax burden on individual and corporate bodies;
(iv) Maintenance of economic equilibrium through reduction in inflationary pressures, acceleration of
economic growth, reduction in unemployment rate, and reduction in balance of payments deficits;
(v) Effective protection of domestic industries;
(vi) Promotion of self-reliant development process;
(vii) Progressive reduction and elimination of government budget deficits;
(viii) Cost recovering activities by social services and public enterprises;
(ix) Integration of the informal sector into the country‘s economic mainstream;
(x) 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;
(xii) Reduction of internal and external debt burdens;
(xiii) 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.
(xvii) Influence the rate of growth of the economy;
(xviii) Raise the level of national income, output and employment;
(xix) Protect local industries from ‗unfair‘ competition from abroad

4.3 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 industry. 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.

4.4 Instruments of Fiscal Policy

The two key instruments of fiscal policy are:
(i) Government Expenditures and
(ii) Taxation

4.4.1 Government Expenditures

During the course of a 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
(c) To provide housing for the people
(b) To promote agriculture and allied activities
(d) To improve educational facilities
(e) To protect the citizens against aggression -

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(f) To maintain law and order
(g) To create jobs indifferent sectors of the economy
(h) To service a nation‘s debt

4.4.2 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 Circle

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To see the effect of changes in Government expenditures, consider an economy which is in equilibrium at a
recessionary phase. The Government, in order to stem the tide, may increase its spending. This is a fiscal
measure. The increased government spending from say, G1 to G2 (G2 higher than G1), will raise the level
of aggregate demand (see figure 2).

Figure II: Effect of Increase in Public Expenditure on the Economy

AD1 (C+I+G1) to AD2 (C+I+G1). 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 to which national income will rise, will
depend on the marginal propensity to consume. If the marginal propensity to consume is say 4/ 5 then, the
marginal propensity to save will be (1- 4/ 5)= 1/ 5 . The multiplier coefficient will then be 5 the reciprocal of
the marginal propensity to save. Consequently, if the initial government spending were increased by say,
N20 million, then the increased level of income that would result, would be N20 million x 5 = N00 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 effects. Thus, the effect of increased Government
spending will be to stimulate the economy towards the path of growth only. It can also be used to reduce or
moderate inflationary pressures. To do this, the Government has to reduce its expenditures. A reduction in
Government expenditure will reduce aggregate demand for goods and services. This reduction in aggregate

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demand, in 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.

4.5 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:
(a) 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.

4.6 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.

4.7 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.

4.8 Transfer Payments

Another set of automatic stabilizers are transfer payments. As already mentioned earlier, transfer payments
are expenditures such as unemployment benefits, pensions, etc which are 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 to compensate automatically for the 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 previously unemployed reduces. Also, some of those who probably retired
earlier may now wish to go back to work. Transfer payments therefore fall this time around. The reduction
in expenditure as a result of the fall in transfer payments may generate a fail in income in the 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.

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4.9 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 to a fall in income.

4.10 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‘s 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, stabilization 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 country. 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 tax 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 dominated by oil revenue. The most veritable tax handles are
under the control of the federal government while the lower tiers are responsible for the less buoyant
ones—the federal government taxes corporate bodies while the states and 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

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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;
(ii) 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.

4.11 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 economic 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 recent
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

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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.

With poverty alleviation in mind, the government is paying attention to tax relieves and allowances, for
instance, in order to enhance workers‘ disposable income for better living standards. In 1996, the
government also increased children allowances from N 1,000 to N 1,500 per child up to a maximum of four
children. This was increased to N 2,500 in 1998. A dependant relative allowance of N 1,000 (up to two
dependants) was introduced in 1997, to be farther increased 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
earned 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 tax-free income was raised from N 7,500 in 1995/6 to N 10,000 and to N
30,000 over the next two years. All these measures were geared towards increasing the disposable income
of low-wage earners and strengthening aggregate demand.

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 diversif3r the tax structure, not much has

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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 ana expenditure. For instance, revenue and expenditure have increased sharply
during periods of high oil prices as in 1979-82, 1991-92 and 2000-2002. But as prices decline, scaling back
of expenditure is the order of the day. The implications of such boom-bust fiscal policies include the
transmission of oil volatility to the rest of the economy as well as distortions to the stable provision of
government services. This has added to the failures over the years of public spending neither facilitating the
diversification and growth of the non oil sector nor reducing poverty. Effects of the boom-bust cycle are
numerous; in addition to affecting the wages of public sector employees, particularly at the state and local
government levels, it also influences the implementation of development projects and maintenance of the
existing infrastructure.

Discussion Exercises
(1) (a) What is Fiscal Policy? How is taxation used as an instrument of fiscal policy?
(b) What are the objectives of fiscal policy?
(c) Explain the two instruments of fiscal policy and how they are used by the government.
(d) What is the effectiveness and criticisms of fiscal policy?
(2) (a) Explained how taxation was used as an instrument of fiscal policy during the Structural Adjustment
Programme (SAP) introduced in Nigeria in 986.
(b) How .was taxation used as an instrument for promoting foreign investment and poverty alleviation in
Nigeria, in the past years?
(c) Briefly explain the factors that cause the intensification of smuggling and the under-utilization of the
Nigerian ports leading to loss of revenue in terms of import duties to neighboring countries.
(d) Discuss 5 issues surrounding the use of taxation as an instrument of fiscal policy in Nigeria, over the
last 20 years.

5. Government Activities and Economic Development

The proper role of government provides a starting point for the analysis of public finance. In theory, under
certain circumstances, private markets will allocate goods and services among individuals efficiently. If
private markets were able to provide efficient outcomes and if the distribution of income were socially
acceptable, then there would be little or no scope for government. In many cases, however, conditions for
private market efficiency are violated. For example, if many people can enjoy the same good at the same
time (non-rival, non-excludable consumption), then private markets may supply too little of that good.
National defence is one example of non-rival consumption, or of a public good.

5.1 Economic Development

Economic growth and economic development, like any other terms, have been defined in different ways by
a number of individuals and institutions. However, what is clear from the various definitions is that, while
economic growth is measured by looking at the increase in the market value of goods and services produce
in a country over a period of time, usually one year, which is represented by the Gross Domestic Product
(GDP), economic development is measured by looking at the overall improvement in the general wellbeing
of the citizenry. In other words, while economic growth refers to sustained increase in the per capita output
or income of a country over a specific period of time, economic development refers to the manifestations
(i.e. translations) of economic growth in terms of improvement in the general well being of the citizenry,
typically involving improvements in literacy rates, life expectancy, poverty rates, employment
opportunities, living standards, environmental quality, freedom and social justice. National development,
therefore, is the ability of a county to improve the social welfare of the people by providing social
amenities like good education, health facilities, goods roads, pipe born water, power supply, employment
opportunities, freedom of speech, etc. A country's economic development is related to its human

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development, which encompasses, among other things, health and education, hence, the term socio-
economic development.

The term ―development‖ according to the WCS (1990), refers to the modification of the biosphere and the
application of human, financial, living and non-living resources to satisfy human needs and improve the
quality of human life. Similarly, the UN-DRD (1986) contends that development is a comprehensive
economic, social, cultural and political process, which aims at constant improvement of the wellbeing of
the entire population and of all individuals on the basis of their active, free and meaningful participation in
development and in the fair distribution of benefits resulting therefrom. In essence, development is about
change for the better, and such change should involve adequate and acceptable improvement in the general
wellbeing of the society, economically, socially and educationally. According to Hugo (1995) true
development cannot be measured in solely economic terms, but must also include changes in the quality of
lives, which are less tangible. Similarly, Rodney (1982) suggests that development in human society is a
many-sided process. At the level of the individual, it implies increased skill and capacity, greater freedom,
creativity, self-discipline, responsibility and material wellbeing. In Rodney‘s view, the term ‗development‘
is used exclusively to describe economic progress in that the nature of a country‘s economy is indicative of
other social variables.

An economy is regarded as having recorded economic growth if there are sustained significant
improvements in quantitative and qualitative terms respectively. Thus, an economy may be growing
without really developing. For instance, if there is a sustained increase in the level of national output or per
capita income, the economy is described as having recorded economic growth. However, Seer (1969)
perhaps best posed the basic questions about the meaning of economic development by asserting that: ―the
questions to ask about a country‘s development are therefore: What has been happening to poverty? What
has been happening to inequality? What has been happening to unemployment? If all the three have
declined from high levels, then beyond doubts, this has been a period of development for the country
concerned. If one or two of these central problems have been growing worse, especially if all the three
have, it would be strange to call the result development, even if per capita income double. Development
goals must be defined in terms of progressive reduction and eventual elimination of
malnutrition, disease, illiteracy, squalor, unemployment, and inequalities.

5.2 Relationship between Government Activity and Economic Development

The relationship and the rising trend between government spending and economic growth have called for
different arguments among scholars and policy makers. There are two basic roles of the government in any
society; maintaining law and order (i.e making and enforcing) as well as providing public goods such as
good roads, education, health, defence, power and so on. Over time, scholars have argued that increase in
government expenditure on socio–economic and physical infrastructure fosters economic growth. For
example, expenditure on education and health raises the level of national output through improved quality
of labour and productivity. Similarly, spending on infrastructure such as roads, communications, power and
so on reduce production costs and increase profitability o firms, thus fostering economic growth.

Series of arguments and studies have emerged on the platform that increase in government spendings do
not actually promote growth and development, rather reduce overall performance of the economy.
Buttressing this is the fact that an increase in government spendings may result from increase in taxes or
borrowing. Particularly, when higher taxes are imposed, individuals get discouraged because income is
reduced and number of hours worked also reduces. On the side of the firm, higher profit tax increases
production cost and reduces investment expenditure as well as profitability. If the government in a different
dimension results to borrowing to finance projects rather than taxes, then private sector investment will
definitely reduce and growth will also be deterred.

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Looking at the trend of public expenditure in Nigeria from 1979 to 2008, it can be seen that the amount has
been on the increase throughout, with the exception of 1983 to 84, 1994 and 2000. Figure I shows the trend
of public expenditure in Nigeria.

Figure I: Public Expenditure Trend in Nigeria from 1979-2008

3500000
3000000
Million Naira

2500000
2000000 Series2
1500000 Series1
1000000
500000
0
1 3 5 7 9 11 13 15 17 19 21 23 25 27 29
1979-2008

Source: CBN (2008), Statistical Bulletin: 50 Years Special Anniversary Edition

Similarly, as proved by empirical evidence, there is a significant relationship between public and real Gross
Domestic Product (GDP) in different parts of the world, and Nigeria is not an exception. From figure II
below, series one (which is green line) is the trend in public expenditure in Nigeria, while series 2 represent
the real GDP. As can be seen from the diagram, from 1975 up 1995, Nigeria‘s real GDP is above public
expenditure, thereafter up to date, real GDP is below public expenditure, with the margin deteriorating
further year-in year-out. The decline in the Nigeria‘s real GDP despite increase in public expenditure may
not be unconnected with public fraud, contract over-valuations, reckless spending, corruption and poor
public expenditure management in Nigeria in recent years. However, it may be said that the situation can
be reversed for a better if government id to enhance judicious spending, curtail public fraud and corruption
and enhanced public expenditure management in Nigeria.

Figure II: Relationship Betwen Public Expenditure and Real GDP

in Nigeria 1979-2008

3500000
3000000
in Million Naira

2500000
2000000 Series1
1500000 Series2
1000000
500000
0
1975 1980 1985 1990 1995 2000 2005 2010
Years
Source: CBN (2008), Statistical Bulletin: 50 Years Special Anniversary Edition

In Nigeria, government expenditure has always been at the increase due to the flow of revenue production
and sales of crude oil. This is however accompanied by huge demand for public goods such as roads,
electricity, education, health, external and internal security and so on. Within this context, statistics has it

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that government expenditure (capital and recurrent) have continued to rise in the last forty (40) years.
Similarly, the increase in expenditure feature more on education, internal and external security, health,
agriculture, construction, and transport and so on.

Following this scenario, the huge government expenditure has not translated into reasonable growth and
development because the country is still ranked as one of the poorest in the world. In the last few years, her
balance of payment, inflation and exchange rates, national savings and other macroeconomic indicators
have not been behaving well. Also, there has been serious collapse of many industries partly because of
breakdown in infrastructure and the result in high rate of unemployment.

According to the classists model, government fiscal policy does not have any effect on the growth of the
national output. Converse to this view, the Keynesian model argued that increase in government
expenditure will lead to higher economic growth. The implication of this is that government fiscal policy
(through intervention) will help improve the failure that might arise from the inefficiencies of the market.
According to Easterly & Revelo (1993), government activities influence the direction of economic growth.
This same view was however shared by Baro & Sala (1992), Brons et‘ al (1999) and Baro (1990). In the
same vein, Dar Atul & Amirkhalkhali (2002) emphasized in the endogenous growth model that fiscal
policy is an important determinant of economic growth.

Amassoma, Nwosa and Ajisafe (2011) stated that over the past thirty years, there has been a continuous
contention between development economist as to the relationship that exists between economic growth and
public expenditure. They observed that some scholars believe that public expenditure enhances economic
growth while other scholars believe that increased government spending has a way of slowing down the
performance of an economy. However, Economics Concept identified accelerating economic growth to be
one of the causes of increase in government expenditure; the government of any economy has the
responsibility of accelerating economic growth in order to raise the standard of living of the people.
Therefore, it can be deduced that for the acceleration of economic growth the government has to ‗spend‘ to
meet social needs of its citizens and in order to carry out the function of spending the government has to
strategize different means of sourcing for funds.

Public expenditure management is an important determinant of real Gross Domestic Product and the level
of national development of a country. However, in Nigeria, public expenditure has not been able to trigger
the desire GDP and economic development due to a number of factors resulting in poor public expenditure
management in the country.

6. Tax System and Value Added Tax

6.1 Nigerian Tax System and VAT
Tax is a compulsory payment made on different basis and rates by citizens (corporate bodies and
individuals) to government, non-negotiable but obligatorily. This payment is not on the basis of direct
exchange for the payment for goods and services. It is non-negotiable because none the citizens have any
direct contribution to the composition of the basis and rates of payment. Government only classifies the
items on which the tax is to be paid, and the category of citizens that should be subjected to the payment.

The decision is however, based on the cost of the projects or programmes government intends to execute,
which is the principal determinant of the budget -size. Government also judges the basis, rates, the category
of citizens, and the time period to pay the tax, on the direction of the economy desired and government‘s
perception of the standard of living of the citizens. This is why tax is defined as a tool for government
revenue and fiscal policy tool for directing the economy. Taxes are not paid directly on the basis of
exchange contract like any other payments except subsidies paid by government. It is paid by any citizen
whether or not the citizen benefits from the government projects and programmes financed by the taxes.

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Consequently, the usefulness (effectiveness and/or efficiency) of taxes can be measured by several
parameters, some which are its revenue generating capacity and its impact on the consumption and savings
patterns in the economy. Even if the totality of tax system cannot be comprehensively measured, the
various types of tax can be subjected to this measurement. In Nigeria, there are at least three types of taxes
that are commonly applied to qualifying citizens and items. These are the Personal Income Tax, the
Company Income Tax, and the Value Added Tax. The assessment of these forms of tax independently or
otherwise becomes more necessary given the multiplicity of taxes in Nigeria, together with the problems of
tax evasion and avoidance.

Taxation is one the oldest economic phenomena by which the cost of providing essential services for the
generality of a given set of people within a geographical area, is funded. In some countries, taxation is as
old as their history while in others taxation predates their existence. In the early days of civilization, taxes
were collected to maintain the Kings/Queens, provide security and fight wars. It could be a direct surcharge
on the citizens of the kingdom or empire, or tributes paid by ―conquerees‖ to show their unflinching loyalty
to masters/conquerors. These forms of taxes did not necessarily depend on richness or the ability to pay
concept.

Historically, therefore, it can be asserted that the Sumerian empire could be the first place where taxes were
levied and accounts for the utilization made. Other than this, several empires and kingdoms have levied
taxes for the purposes stated above without any control or account of utilization. Examples include the
Kingdoms of Israel, Judah, Babylon, Egypt and the Roman Empire. The primary use of taxes to fund wars
continued to the modern times as could be seen from history of countries like Britain and USA. In
particular, Britain levied taxes between 1799 and 1816 to fund the Napoleon War, while USA taxed her
citizens to finance the Civil War (1861 – 1863). In most cases, this style of taxation was temporary because
the levies were either relaxed or cancelled upon the realization of the purpose(s). Economic history has it
that permanency of taxes was not common until 1874 when Britain made income tax a permanent levy on
its citizens. This was followed by the USA in 1913. This means that it took about 50 years in both Britain
and USA to sell the idea of regular income tax (US Department of Treasury, 2003; Kiyosaki, 1995).

In Nigeria, and indeed some parts of Africa, the payment of taxes is not strange. This is because, even
before independence, taxes were collected either by t he colonial masters or emirs/chiefs in different
names. However, legislation of tax was first made in 1939 with the enactment of the Income Tax
Ordinance of 1939. The second legislation was in 1940 due mainly to the inadequacies and ineffectiveness
of the 1939 Ordinance. The 1940 Ordinance specified that both individuals and corporate organizations be
subjected to tax payment. Ever since, there has been one enactment or the other, as well as amendments.

Generally, there are certain conditions against which taxes are judged to be efficient or effective. These
conditions are referred to as the canons or principles of taxation and include fairness, equity, convenience,
certainty, economy, flexibility, and certainty.

Accordingly, there are several objectives for the imposition of any tax. These objectives are called
economic and social goals of taxation. Therefore a tax system‘s efficiency could be judged against these
goals, i.e. whether the goals are achieved and the extent of accomplishing these goals. These goals include
revenue generation, ability to influence and control economic behaviour, transferability of resources from
private to public sector, ability to distribute cost of governance, and ability to promote economic growth.

Comparing the two measurement approaches mentioned above, it would be seen that generation of revenue
and productivity are very similar and form the nucleus of any tax administration, and by far the most
tangible assessor of the efficiency of an y tax system. This is because policy makers would want to enact
tax laws with purpose of being an unfailing source of funding public activities as well as achieving other

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socio-economic motives as specified. It therefore believe on the policymakers to employ control by
comparing the outcome of the imposition of tax against expectation. And the two most prominent
assessment could therefore be to examine the revenue generated against budgeted, and the impact of the tax
on consumption, production and disposable income.

Another way of measuring the efficacy of the system is to evaluate any of the approaches of assessing the
tax burden. The approaches include the Expedience approach, the Socio-Political approach, the Benefits-
Received approach, the Cost of Service approach, and the Ability to Pay approach (Handley &
Maheswaran, 2008; Laily & vanZijl, 2003; Bhatia, 2006). In most third world countries (Nigeria inclusive),
measuring the effectiveness and the efficiencies of tax especially with regards to the economic and social
goals or the socio-political and benefits received approaches has been difficult.

Certain reasons account for this difficulty. One is the problem of record-keeping where there is insufficient
record of the amount of tax levied and paid as a result of corruption.
In this case, government activities seem to be financed from sources other than taxation. Therefore, while
the public groans under the burden of taxation, government alleges that the public has little contribution to
the implementation of public projects and governance, hence should not hold government accountable to
the public. Using the benefit -received approach, taxation might be adjudged to be inefficient since the tax
payers can hardly trace the taxes paid to any meaningful project that positively impacts on their welfare.
On the basis of economy, tax system could be judged effective and efficient if the cost of administering the
tax is lower than the revenue derived from the imposition. This measurement is also difficult because there
is an existing tax collection machinery imbedded in the civil service whose costs are part of the recurrent
cost of public administration.

In Nigeria, the ―rich‖ who control about 90 percent of the economy but are estimated to be between 5
percent and 10 percent of the population and, in most cases pay very little or nothing as tax, there are also
some government officials that earn respectable incomes but exempted from tax. For instance, the Third
Schedule of the Personal Income Tax Act of Cap C20 LFN 2004 provides that the official emoluments of
the President of the Federal Republic of Nigeria, the Vice President, State Governors and their Deputies,
Local Government Chairman, Government institutions, incomes of Charitable and Ecclesiastical
institutions of a public character in so far as such income is not derived from a trade or business carried on
by such institutions, gratitude payable to a public officer by the government of the federation or state, and
incomes of cooperative societies registered under the Cooperative Societies Decree of 1993, are tax
exempted. So, if these incomes as well as the personal reliefs and allowances of other taxable persons are
considered, the questions will then be whether enough revenue is generated for the functioning of the
public sector, and whether the relief and allowances reasonably even-out the gap between the different
income brackets, so that the tax system can be said to be equitable. Consider for example, that in year
2007, more than N200 billion will be paid to only federal legislators as allowances, excluding their seating
allowances and salaries as well as the salaries and allowances of the President, the Vice President, the
Governors and their Deputies, Ministers, Commissioners, Special Advisors, etc. The exclusion of these
legitimate incomes from tax could seriously reduce the value of tax revenue, but increase the consumption
expenditure.

It therefore means that if a tax system is efficient and effective, given the measures of productivity and
fiscal policy goals, the revenues generated as a proportion of the national income should be close to or
more than 100 percent of the standard rate of that tax. For instance, if the effectiveness of Personal Income
Tax System were to be judged, then the tax revenue accruing from personal income divided by the national
income should be divided by the average personal income tax rate subsisting. The higher the resulting
quotient or ratio the more effective the tax system is (Ebrill, et al, 2001). The idea is that since tax is paid
out of the total income, the amount of tax generated should be equal to the tax rate multiplied by the total
income of the country (National Income). Where the proportion is smaller than the standard rate, it follows

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that the tax system is not productive and hence not effective. On the other hand, if the proportion is less
than the standard tax rate where the revenue generated is divided by the total consumption expenditure,
then the tax system can be said to be inefficient because it has not been able to influence consumption as it
would have been originally intended. This latter measure is used to appraise the efficiency of tax system as
an economic (fiscal) tool.

Countries introduce a Value Added Tax (VAT) because they are dissatisfied with their existing tax
structure. The Value Added Tax (VAT) was introduced in Nigeria in 1993 by the Federal Military
Government. VAT is imposed ―on the supply of all goods and services other than those goods and services
listed in the First Schedule to this Act‖ Before then, Sales tax was under the jurisdiction of the States and
generally poorly administered with marginal contribution in terms of revenue. It is proposed to have a shift
from direct to indirect taxation within the non-oil sector in order to stimulate economic growth in the
sectors, whilst still meeting revenue requirements. This is particularly necessary, given that oil revenues are
no longer viewed as a sustainable source of revenue and there is the urgent necessity to diversify tax
revenue. In this regard, it is proposed that there should be lower rates of direct taxes such as Companies‘
Income and Personal Income tax to reduce the cost of doing business in Nigeria by increasing cash flow
and disposable income for corporate entities and individuals alike. Nigeria adopts the single rate of 5 per
cent of the value of all taxable goods and services which is the world lowest VAT rate. A recent attempt by
the National Assembly to increase the rate of VAT to 10% was unsuccessful. Despite the avowed policy of
the Federal Government to increase the VAT rate the implementation has proved to be Herculean and
unachievable so far due to social and political environment. The arguments of those who are opposed to the
rate increment have always been that FIRS should strive to expand the coverage of VAT to those who are
presently out of the tax net and generally increase the compliance level.

Schedule 3 of the Act states that the following goods are exempted from VAT:
(i) Medical and pharmaceutical products
(ii) Basic food items
(iii) Books and educational materials
(iv) Baby products
(v) Agricultural equipments and products, and vet erinary medi cine
(vi) Fertilizers
(vii) Agricultural chemicals
(viii) Exported goods (like Crude Petroleum and Natural Gas)

VAT is collected through registered persons who are known as ―taxable persons‖. A taxable person is
obliged to register with the FIRS for VAT collection ―within six months of the commencement of the Act
or within six months of the commencement of business, whichever is earlier.‖ Failure to register attract a
penalty of N10, 000.00 for the first month in which the failure occurs; and N5,000.00 for each subsequent
month. Since a period of six months has elapsed after the promulgation of the Act, it presupposes that
every taxable person is now obliged to register as soon as it commences business. There has been a
suggestion that all new businesses should be granted a period of six months‘ grace after the commencement
of business to register for VAT. If the suggestion were to be adopted, it might lead to the unintended effect
of denying taxable persons the opportunity to set off their inputs against the output VAT. Since VAT can
only be lawfully collected after registration it means that until then the taxable person will not have any
output VAT against which the input tax can be offset. Although, the Act imposes an obligation on every
taxable person to register, there was the initial concession, which allowed retailers a period of three years to
register. Going by the bare statutory provisions, every retailer is obliged to register for VAT be collecting
tax due upon the supply of goods and services to its customers since 1996 after the expiration of the
concession period.

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Taxable persons are obligated to keep such records and books of all transactions, operations, imports and
other activities relating to taxable goods and services as are sufficient to determine the correct amount of
the tax due. No particular accounting standard is prescribed. Hence books and records which a taxable
person is expected to keep will depend on the nature and size of its business provided that they are
―sufficient to determine the correct amount due‖. A writer had opined that it is sufficient if a taxable person
keeps the usual account books such as Cashbook, Sales and Purchase Daybooks, Trial Balances, Profit and
Loss Accounts and Balance Sheets. Taxable person shall render a monthly return of all the taxable goods
and services to the FIRS on or before the 30th day of every month. Failure to render a return within the
stipulated period of time attracts a penalty of 5 per cent of the sum due per annum plus interest at the
commercial rate in addition to the tax.

A taxable person who fails to render a return or renders an inaccurate return is liable to be assessed by the
FIRS based on its best of judgement (BOJ). VAT is largely a self-assessed tax. Assessment by the FIRS
will only be made as a last resort. Although no specific time is prescribed within which a taxable person is
required to respond to the BOJ, it is submitted that the taxable person is nevertheless entitled to reasonable
notice failing which the assessment may be voided.

The question of how much VAT is payable may be straightforward for the final consumer (who simply
pays without obligation to do anything else) but this is not so for a taxable person who is an agent of
collection. While a taxable person has obligation to collect tax on taxable goods and services he is also
under obligation to pay VAT on taxable goods and services supplied to him. The tax collected by a taxable
person is called output VAT while the tax paid by him is called input VAT. The VAT system is structured
in such a way that a taxable person is able to take credit for the VAT paid by it on its inputs. The processes
are contained in sections 12, 13, 14, 15 &-16 of the VAT Act. There are three steps leading to the
ascertainment of the VAT due or refundable. First, a taxable person will ascertain the VAT collected by
him on his supplies during the reporting period. Second, he will ascertain the VAT paid by him on
purchases used by him to provide the taxable goods during the same reporting period. Third, find out the
difference between the VAT on supplies made and VAT paid on purchases made towards such supplies to
determine the amount of VAT either payable to FIRS or refundable to the registered person. The taxable
person is thus allowed to indemnify itself against any loss and the rate of VAT that is ultimately borne by
the final consumer is kept at 5 percent. In this way, the registered person acts as a mere unpaid agent of the
FIRS without bearing the tax burden.

If VAT system is in reality as simple as shown in the above example, each taxable person would sustain no
economic burden on the goods and services purchased by it, and all the tax burden would be shifted down
the chain to the ultimate consumer. However, due to the immense complexity of transactions, inadequate
record keeping, dishonesty and lack of adequate knowledge of its operations, VAT may not be as simple as
it seems.

VAT system in Nigeria has been effective in generating more than expected revenue but not efficient in
directing or influencing the consumption expenditure of the Nigerian citizens. a great extent, VAT has
been a veritable source of revenue to some states in Nigeria where industrial activities are very low. The
allocation of VAT revenue as part of federally allocated revenue is indispensable to these states. One
perceives that in the event of a global threat to revenue from oil and gas, especially with the debt –free
posture of Nigeria, VAT rate could be increased so that allocatable revenue will increase. The alternative
might be the justification for the reduction of the VAT exempt list. Although the tax-base of VAT is
expanding, inefficiency in the system has resulted in low VAT revenue. This means that efforts should be
made to improve the collection and accounting machinery of VAT in order to make it more efficient, due to
poor attention paid to tax revenue because of the over-reliance on sale of oil and gas.

6.2 Challenges Facing Tax System, in Nigeria

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The Nigeria tax system is beset by a myriad of challenges, some of which are highlighted below:
(i) Non availability of Tax Statistics: Lack of adequate statistics on tax payers and their detail
particulars.
(ii) to Prioritize Tax Effort: The political economy of revenue allocation in Nigeria does not prioritize
tax efforts. It is, instead, anchored on such factors as equality of states (40 percent), pollution
(30percent) landmass and terrain (10percent), social development needs (10 percent), and internal
revenue effort (10percent). The approach, discourages a proactive revenue drive, particularly for
internally generated revenue, makes all government tiers heavily reliant on unstable oil revenues
which are affected by the volatility of the international oil markets.
(iii) Poor Tax Administration: Tax administration and relevant tax agencies suffer from limitations in
manpower, money, tools and machinery to meet the ever increasing challenges and difficulties.
(iv) Multiplicity of Tax: A major problem facing the country is the multiplicity of taxes. Individuals and
corporate bodies complain about the ripple effects associated with the duplication of tax, this problem
arose from the states‘ complaints about the mismatch between their fiscal responsibilities and fiscal
powers or jurisdiction.
(v) Structural Problems in the Economy: The potential for maximizing the benefits of this taxation
from however, is constrained by structural problems in the economy. The predominance of the
informal sector, constituting more than 50 percent of the country‘s economy, enables most domestic
production to circumvent VAT.
(vi) Underground Economy: The hidden or underground is usually taken to mean any undeclared
economic activity. The major issue is how inland revenue authorities would tackle hidden economy
covering these groups:
(a) Business that should be registered to pay tax, such VAT, but are not;
(b) People who work in the hidden economy such as the rural areas with difficult terrain and
pay no tax at all on their earnings.
(d) People who pay tax on some earnings but fail to declare other additional sources of income
(vii) Tax Evasion and Corruption: Tax evasion and corruption undermines revenue generation drive of the
government.

6.3 Challenges Militating Against VAT

It is important to note that in Nigeria the administration of VAT has been beset with problems, namely:
(i) Tax evasion and avoidance;
(ii) Inadequate finding for the revenue services
(iii) Limited or lack of independence of revenue services;
(iv) The lack of the VAT tribunal, as recommended under VAT Act Decree No. 102 of 1993
(v) Proposals by some state governments (e.g. Lagos) to re-introduce sale tax;
(vi) Practical problems related to the implementation of VAT‘s dual elements (input and output).

6.4 Ways of Addressing the Challenges

(i) Autonomy. With autonomy, the revenue boards will be responsible and responsible to what they are
supposed to do, and we can be talking about professionally tax administration in Nigeria.
(ii) Efficient and effective Tax Administration
(iii)The use of computer technology
(iv) Strengthening Auditing and back duty investigation
(v) Tax Rates and Use of Tax Money
(vi) Public Enlighment

7. Monetary Policy
Monetary Policy refers to the specific actions taken by the Central Bank (Monetary Authority) to regulate
the value, supply and cost of money in the economy with a view to achieving predetermine macroeconomic
goals. The Central Bank of Nigeria, like other central banks in developing countries, seeks to achieve price

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stability through the management of money supply. Money supply comprises narrow and broad money.
Narrow money (M1) is defined as currency in circulation with non-bank public and demand deposits or
current accounts in the banks. The broad money (M2) includes narrow money plus savings and time
deposits, as well as foreign currency denominated deposits. Broad money measures the total volume of
money supply in the economy. Thus, excess money supply (or liquidity) may arise when the amount of
broad money is higher than the level required to sustain non-inflationary output growth in the economy.

The need to regulate money supply is based on the knowledge that there is a relatively stable relationship
between the quantity of money supply and economic activity and that if the supply of money is not limited
to what is required to support productive activities, it will result in undesirable effects such as inflation or
deflation. Several factors influence the supply of money, some of which are within the control of the
central bank, while others are outside its control. The specific objectives and focus of monetary policy may
change from time to time, depending on the level of economic development and economic fortunes of the
country.

7.1 Objectives of Monetary Policy

In Ngeria, the major objectives of monetary policy include:
(i) attainment of price stability and sustainable economic growth
(ii) full employment (or a low unemployment rate),
(iii) high output (or a high output growth),
(iv) a stable price level (or a low inflation rate),
(v) a stable exchange rate (or a desirable balance of payments).

These goals are usually achieved indirectly by the monetary authorities (central banks) through its use of
monetary policy instruments including open market operations (OMO), changes in discount/bank rate (both
of which determine the monetary base), and required reserves (the minimum reserves the commercial
banks must hold against the public‘s deposit with them).

7.2 Stance of Monetary Policy

The stance of monetary policy refers to either expansionary or contractionary actions of the central bank to
control money supply. Expansionary Monetary Policy is a set of actions by the monetary authority to
increase money supply in the economy. It is conventionally used to stimulate economic activity, usually in
a recession. Contractionary Monetary Policy on the other hand seeks to reduce the level of money supply in
the economy. It is conventionally used to reduce inflationary pressures in the economy.

7.3 Instruments of Monetary Policy in Nigeria

Monetary policy guides the central bank‘s supply of money in order to achieve the objectives of price
stability (or low inflation rate), full employment, and growth in aggregate income. This is necessary
because money is a medium of exchange and changes in its demand relative to supply, necessitate spending
adjustments. Fiduciary or paper money is issued by the central bank based on an estimate of the demand
for cash. To conduct monetary policy effectively, the central bank the monetary aggregates, the policy rate
or the exchange rate in order to affect the variables which it does not control directly. The instruments of
monetary policy used by the central bank depend on the level of development of the economy, especially
the financial sector. These instruments could be direct or indirect.

Direct Instruments of Monetary Policy

(i) Direct Credit Control
The central bank can direct Deposit Money Banks on the maximum percentage or amount of loans (credit
ceilings) to different economic sectors or activities, interest rate caps, liquid asset ratio and issue credit

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guarantee to preferred loans. In this way the available savings is allocated and investment directed in
particular directions as desired by the authorities.
(ii) Indirect Instruments of Monetary Policy
(a) Reserve Requirements: This instrument is used by the central bank to influence the level of bank
reserves and hence, their ability to grant loans. Reserve requirements are lowered in order to free
reserves for banks to grant loans and thereby increase money supply in the economy. On the other
hand, they are raised in order to reduce the capacity of banks to provide loans thereby reducing
money supply in the economy.
(b) Open Market Operations (OMO): The most important and flexible tool of monetary policy is
open market operations. It is the buying and selling of government securities in the open market
(primary or secondary) in order to expand or contract the amount of money in the banking system.
By purchasing securities, the central bank injects money into the banking system and stimulates
growth whereas by selling securities it absorbs excess money. Thus, if there is excess liquidity in
the system, the central bank will in a bid to reduce the money supply sell the government securities
such as Treasury Bills. On the other hand, in periods of liquidity shortages, the central bank buys
government securities so as to increase money supply. Instruments commonly used for this purpose
include treasury bills, central bank bills, or prime commercial paper. OMO enables the central bank
to influence the cost and availability of reserves and bring about desired changes in bank credit and
money supply. This important instrument of monetary policy has a number of advantages because it
is flexible and precise, it is implemented quickly and easily reversed and the central bank has
complete control. The effectiveness of OMO, however, depends on the existence of well developed
financial markets that are sensitive to interest rate movements.
(c) Discount Window Operations: This instrument is a facility provided by the central bank which
enables the DMBs to borrow reserves against collaterals in form of government or other acceptable
securities. The central bank operates this facility in accordance with its role as lender of last resort
and transactions are conducted in form of short term (usually overnight) loans. The central bank
lends to financially sound DMBs at the policy rate. This rate sets the floor for the interest rate
regime in the money market (the nominal anchor rate) and thereby affects the supply of credit, the
supply of savings (which affects the supply of reserves and monetary aggregate) and the supply of
investment (which affects employment and GDP).
(d)
(ii) Other Instruments
(a) Exchange Rate: The balance of payments can be in deficit or in surplus and this can affect the
monetary base, hence the money supply, in one direction or the other. By selling or buying foreign
exchange, the central bank ensures that the exchange rate is at an optimal level. The real exchange rate
when misaligned affects the current account balance because of its impact on external competitiveness.
(b) Prudential Guidelines: The central bank may require DMBs to exercise particular care in their credit
operations in order to achieve specified outcomes. Key elements of prudential guidelines remove some
discretion from bank management and replace them with rules.
(c) Moral Suasion: The central bank issues licenses to DMBs and regulates the operation of the banking
system. Thus, it can persuade banks to follow certain policies such as credit restraint or expansion,
increase savings mobilization and promote exports through financial support, which otherwise they
may not do, on the basis of their risk/return assessment.

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Figure III: Framework for monetary policy in Nigeria
Source: Anyanwu et al (1997)

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Table 8: Monetary and other aggregates (1960 to 2005) (Nm)

Notes: COB = Currency Outside Banks

DD = Demand Deposits
M1 = Narrow Money supply
QM = Quasi-Money
NCB = Number of Commercial Banks
Sources: (1) National Bureau of Statistics, Statistical Abstract, 2006
(2) CBN Statistical Bulletin, 2006.

8. The Federation Account

Sources of revenue refer to the various ways and or procedures by which individuals, organizations or
government adequately generate the necessary incomes to meet numerous impending expenditures.
Government revenue sources are constitutionally provided especially for a republic like Nigeria. The
constitution of the federal republic of Nigeria identifies different sources from which revenues could be
sourced for each tier of government. Thus, the Constitution created Federation Account by section 162.
Furthermore, Section 80 of the Constitution established Consolidated Revenue Funds (CRF). Federation
Account is a special account into which shall be paid all revenue collected for the government of the
federation (Federal, States and Local Governments). It is designed to distribute the monthly collectables
between Federal, States, Local Governments and special fund in accordance to a stipulated formula
provided and sanctioned by the Constitution. Federation Account has a revenue composition consisting

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―Oil and Oil‖ and Taxation except personal income tax of Armed Forces personnel, Police personnel,
Foreign Service personnel and residents of the federal capital territory.

Consolidated Revenue Funds (CRF) is the individual account that can be maintained by the Federal
government and States Governments. CRF records revenues derived by the government and brought in by
the government from all sources except those specify for other accounts (Federation Account,
Development Fund Etc.). The revenue composition of this account includes: share from the federation
account, Direct taxes ( personal income tax of Armed Forces personnel, Police personnel, Foreign Service
personnel and residents of the federal capital territory), licenses and internal revenue, Mining (Gold etc),
Fees, Earning and Sales, Rent, Interest and Repayments, Armed Forces Receipt, Miscellaneous Income.

In broad terms, the Nigeria‘s sources of revenue have been classified into oil and non oil revenue. The oil
revenue consists of sales of crude oil, sales of petroleum products in Nigeria, pipeline license fees, rent of
mining rights, rent of oil well, rent of oil ground, Royalties, penalty for gas flared etc. the non-oil
constituent encompasses all other sources from which government generate income other than oil. For
example, Taxation, agriculture, fees, fines, etc. In this category, disequilibrium exists between the
contribution of oil and non-oil revenue to the aggregate revenue of the country. For instance, oil revenue
for 2008-2012 accounted for up to 80% while non oil revenue contributed only 20% for the total revenue
from the category (CBN, 2012).

According to Section 162(1) of the 1999 constitution, the federation account is a special account required
to be maintained by the Federation of Nigeria. Into this account shall be paid all revenue collected by the
government of the Federation except the proceeds from the personal income tax of the Armed Forces of the
Federation, the Nigeria Police Force, the Ministry or Department of Government charged with the
responsibility of Foreign Affairs and the residents of the Federal Capital Territory, Abuja. The Federation
Account is the account from which all the accruing revenue will be shared among the three tiers of
Government namely Federal, State and Local Government using the existing Revenue Allocation Formula.

8.1 Revenue Allocation in Nigeria

The Statutory Allocation Formula is the recognized and acceptable yardstick by which all revenue accruing
to the Federation Account is to be distributed among the Federal, State and Local Government Councils
and any other beneficiary as may be specified by law. This varies from time to time based on the terms and
procedures as may be prescribed by law.

Federalism is the decentralization of the administrative system designed to cope with the size, differences,
peculiarities of the regions or state and/or ethnic groups. Specifically, Nigerian fiscal federalism structure
involves the allocation of taxing power, federally collectable revenue and federal expenditures, to the
different levels/components of government in the federation so as to enable them discharge their
constitutionally assigned functions and responsibilities to the citizens.

In Nigeria since 1946, the country accepted the principles of federalism. As at 2015, there are three
distinct levels of government in the country. These are the federal government at centre in Abuja, the 36
state governments as at 1999 and the 774 local government units including the six Area councils within the
federal capital territory, Abuja. Each of these levels of government has its sphere of influence and
functional competence.

The allocation of functions among component units of the Nigerian Federal system (i.e. Federal, state and
local Governments) is spelt out in part 1, section 4 of the Second Schedule of the 1999 constitution of the
Federal Republic of Nigeria. In like manner, the 1999 constitution of the Federal Republic of Nigeria has

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outlined the procedure for disbursing the ‗Distributable Pool Account to the three levels of government as
per section 162, subsection 1 and 2.

Resource allocation within the context of this paper refers to allocation of revenue between the 3-tiers of
government in Nigeria, namely the federal, the states and the local governments according to the provisions
of the Nigerian constitution.

The problem of how best to allocate or share the revenue in the Federation Account among the component
parts is a controversial issue in all countries that practice the federal system of government like Nigeria.
Revenue sharing in Nigeria is faced with series of problems. This situation arises from the fact that States
lack the authority to either raise certain types of tax or collect the proceeds. Consequently the problem
centres not on who should raise taxes but how the proceeds should be shared. This problem of revenue
sharing is not peculiar to Nigeria. Older Federations such as Australia, Canada and United States have
faced similar problems. These older Federations were able to solve their problems in their own way given
their stable economic and political environment.

Furthermore, these Federations have settled constitutional history as none is still undergoing the kind of
changes in the number of fiscal units as it is the case in Nigeria where the number has risen from 3 to 4, 12
to 19, 21 to 30 and to 36 States within a space of three and a half decades. The primary motivation of
revenue sharing in older Federations is economic. It is to assist those States which are financially and
fiscally weak, with the federally collected revenue. In these Federations, federally collected revenue forms
a small fraction of the State resources. Consequently, federally generated revenue is a supplementary rather
than a primary source of resources for the States.

In Nigeria, the above scenario is not the case since revenue sharing reflects to a great extent the political
power of the parties to the bargain. Besides, many States are economically weak to fund their activities. To
solve this problem of revenue sharing, a number of Commissions and ad-hoc Committees were set up at
various times in the past.

8.2 Causes of Revenue Allocation Problems in Nigeria

The factors causing perennial revenue allocation problems in Nigeria include:
(a) Political and Economic Instability: The political and economic instability in Nigeria has led to the
absence of planning. This situation slows down economic growth and development. The instability is
evidenced by the large number of Heads of State who had governed the country from the time of
independence to date.
(b) Constitutional Framework: The absence of a stable Constitution is a significant aspect of the problem
of revenue allocation in Nigeria. The situation has not abated as there has been continued call for
constitution review. This is one of the key issues which the National Assembly is now grappling with.
(c) Financial Weakness: Since most of the physical units were created without guiding political and
economic philosophy, they are financially weak to stand on their own. Consequently, the States are always
agitating for increase in the share of the proceeds of the Federation Account.
(d) Insincerity: There is an observation insincerity on the part of the Judiciary, Legislature and the
Executive to address the problems of revenue allocation once and for all. The issue of the goose that lays
the golden egg can also not be wished away.

8.3 Nigeria's Experience in Revenue Allocation

Successive governments realised that revenue allocation is always a thorny issue in the country hence the
setting up of several revenue allocation Commissions and committees to design an ideal formula for
revenue distribution among the component parts of Nigeria. Notable revenue allocation Commissions are:

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(a) The Philipson Commission - 1946
The constitutional change to be introduced in 1946 by Richardson created the need to formulate proposals
to enable the newly created regions of West, East and North, perform their new political and economic
functions. The Philipson Commission was charged with the responsibility of formulating financial and
administrative procedures to be adopted under the new Constitution. The Commission divided regional
revenues into two categories, namely: "DECLARED" and "NON-DECLARED."

'Declared revenues were those locally collected by the regional authorities, such as direct taxes (personal
income tax), licences, fees, income from property and rent. It was the central Government that determined
what portion of the non-declared revenue was to be shared among the Regions. For the sharing of the non-
declared revenues among the Regions, Philipson considered three basic principles: DERIVATION, EVEN-
PROGRESS AND POPULATION.

(b) The Hicks-Philipson Commission - 1951

The changes envisaged by the 1951 McPherson Constitution and the dissatisfaction with the Philipson's
scheme led to the appointment of Prof. John Hicks and Sir Sidney Philipson to develop a new scheme that
would achieve a more equitable sharing of revenue. The Commission recommended that the Regions
should have power to raise, regulate and appropriate to themselves certain items of revenue. The
commission proposed that revenue should be shared on the principles of DERIVATION, NEED AND
NATIONAL INTEREST.

(c) The Chick Commission - 1953

The Constitutional conference of 1953 gave an opportunity for the review of the previous allocation
scheme. Sir Louis Chick was then appointed to ensure that the total revenue available was allocated in such
a way that the principle of derivation was followed and compatible with the needs of the Central as well as
the Regional Governments. Chick did not merely adhere to the instruction, he expanded the allocation
scheme to include not only import and excise duties, but also export duties, mining, rent and royalties and
personal income taxes.

(d) The Raisman Commission - 1958

The Commission was appointed to review the tax jurisdiction as well as the allocation of revenue from
these taxes such that the Regions could have the maximum possible proportion of the funds within their
exclusive competence. To facilitate the sharing of some federally collected revenues, the Commission
created the 'Distribution Pool Account' now called Federation Account, for the purpose of equitable sharing
among the Regions. However, two principles were proposed, namely: DERIVATION AND NEED.

(e) The Binns Commission - 1964

The Commission was set up under Section 164 of the 1963 Republican Constitution. The terms of
reference of the Commission were to review and make recommendations with respect to the allocation of
mining rent and royalties, and the sharing of funds in the distributable pool account among the Regions.
The Commission applied the principle of financial comparability which was somewhat of a hybrid between
NEED and EVEN-DEVELOPMENT.

The Military Era - (1967/1975) and beyond

The period of 1967 to 1975 was characterized by series of military pronouncements. Act No.15 of 1967
resolved the problem of revenue sharing by allocating equally the percentage that belonged to the Northern
Region, among the six new States created. The problem of the East and West appeared resolved among the
new States, on the basis of population.

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(a) Dina Interim Revenue Allocation Review Committee - 1968
The Committee was appointed in 1968 to probe into the existing system of revenue allocation as a whole
and make necessary suggestions. The Committee was also to determine new revenue sources for both the
Federal and State Governments. The Committee renamed the distributable pool account as "State Joint
Account." It established a special grants account and recommended a permanent Planning and Fiscal
Commission to administer the account, undertake continuous study and review of revenue allocation
schemes. The report was rejected by the Federal Military Government and was therefore not published. Act
No.13 of 1970 adopted a two-factor formula, namely: population and equality of States, while Act No. 9 of
1971 gave to the Federal Military Government absolute right to revenue from 'off-shore' rent and royalties.
Act No. 6 of 1975 emphasized that all revenue to be shared by the States had to be passed through the
distributable pool account, except 20% of the 'onshore' mining rents and royalties due to the State of origin,
on the basis of the principle of derivation.

(b) The Aboyade Technical Committee - 1977

In line with the political programme, the Technical Committee on revenue allocation was set up in 1977 to
review the existing allocation scheme. The Committee recommended that all federally collected revenue
without distinction be paid into the Federation Account and that the proceeds of the account be shared
among the Federal, State and the Local Governments, in the following proportions:
(a) Federal Government 60%
(b) State Government 30%
(c) Local Government 10%
The Committee created a special grants account (3% from the Federal Government's share) to be
administered by the Federal Military Government to the benefit of mineral producing States and other areas
in need of rehabilitation from emergencies and disasters. The principle for sharing among the States was
built into five-factor formula, as follows:
(a) Equality of access to development opportunities.
(b) National minimum standards.
(c) Absorptive capacity.
(d) Independent revenue and tax effort.
(e) Fiscal efficiency.

(c) The Okigbo Commission - 1979 was inaugurated on 23 November, 1979, to device a method of
allocation that would be understood and equitable. For this reason, the Commission deliberated on the
meaning of "revenue" in Sections 149(1) and 149(6) of the 1979 Constitution and concluded that receipts
from repayment of loans, sales of Government capital assets and reimbursements cannot be regarded as
revenue and therefore should not form part of the Federation Account or the total revenue of the Federal
Government,

The 1979 Constitution accorded the Federal Capital Territory, Abuja, the status of a State as from 1st
October, 1979, participating with other States in the share of money from the Federation Account. Section
149 of the 1979 Constitution also provided that all revenue collected by the Federal Government should be
paid into the Federation Account, except for the proceeds of personal income tax of the Armed Forces
personnel, the Nigerian Police personnel, the Ministry of External Affairs and the residents of the Federal
Capital Territory, Abuja.

The Commission recommended that the proceeds of the Federation Account should be shared among the
Federal, State and the Local Governments, as listed hereunder:
(a) Federal Government 53%
(b) State Government 30%
(c) Local Government 10%
(d) Special Fund 7%

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The 7% Special Fund was to be applied as follows:
(a) Initial development of the Federal Capital Territory 2.5%
(b) Special problems of mineral producing areas 2.0%
(c) Ecological and similar problems: Flood, erosion, etc. 1.0%
(d) Revenue Equalization Fund 1.5%

The Commission further recommended the use of four-factor formula for allocation to the State
Governments, using the following weights:
a) Minimum responsibility of government 40%
(b) Population 40%
c) Social development factor:
Direct primary school enrolment 11.25%
Inverse primary school enrolment 3.75% 15%
d) Internal revenue effort 5%
100%
3-tiers of Government prior to and mid-way into Ibrahim Babangida's regime, shared the proceeds of the
Federation Account, thus:
(a) Federal Government 55%
(b) State Government 35%
(c) Local Government 10%

The 35% accruing to the States which was paid into "States Joint Local Government Account" was in turn
shared thus:
(a) Direct to the States 30.5%
(b) Mineral producing areas on derivation basis 2.0%
(c) Amelioration of ecological problems 1.0%
(d) Development of oil producing areas 1.5%

The respective shares of the various Governments out of the Federation Account are known as "Statutory
Allocation." In his speech on the eve of his fourth year in office, Ibrahim Babangida announced a new
revenue allocation formula approved by the Armed Forces Ruling Council (AFRC), as follows:
(a) Federal Government 50%
(b) State Governments 30%
(c) Local Governments 15%
(d) Special Funds 5%

The Armed Forces Ruling Council also decided that any surplus arising from the sale of gas should be
separately accounted for and lodged in the Federation Account.

(d) The National Revenue Mobilization Allocation and Fiscal Commission (NRMAFC)
The Commission headed by Lt. Gen. T. Y. Danjuma (Rtd) was established in 1989 as a permanent revenue
allocation body. It was charged with the regular review of allocation formula.
The Commission applied the following basis, viz:
(a) Federal Government 48.5%
(b) State Government 24.0%
(c) Local Government 20.0%
(d) Special Funds 7.5%

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The 7.5% of the special funds is utilized, thus:
(a) Ecological problems 2.0%
(b) Emergency problems 2.5%
(c) Mineral producing areas 3.0%

8.4 The Principles of Revenue Allocation

The various principles of revenue allocation which have been suggested and/or adopted over the years are
summarised below:
a) Derivation: The principle was mainly applied to the proceeds of exports and taxes on agricultural
products. It asserts that the State from which the bulk of revenue is obtained should receive an extra share
above what other States receive. This principle is hinged on the need to be just.
b) Even Development: The goal of Government is that the Federation itself should grow and develop at an
optimal rate and that each constituent State should develop at that benchmark (but necessarily equally) rate.
The principle requires that growth and development be spread so that serious inequalities or imbalances are
reduced in the Federation. These may be achieved by sacrificing efficiency in the form of reduced overall
growth.
c) Need: The rate of development which a State is able to achieve depends on the revenue it can generate.
The States require financial as well as other resources to maintain existing facilities and develop additional
capacities. Given a set of these other resources, a State requires funds to enable it realise its potentials.
When the needs of a State are put against those of others, it may require transfer of financial resources from
one State to another.
d) National Interest: This principle is used residually by the highest level of Government to intervene and
transfer funds to lower levels or Units to serve various considerations. It lies therefore in the sphere of
discretionary grants to be administered by the highest tier, the Central Government of the Federation.
e) Independent Revenue: The principle is that each level of Government should be able to raise and keep
some revenue for its use. The bulk of the revenue of a State comes from what is raised and collected by the
Federal Government. The main sources left to the State Governments are those on personal income taxes,
capital gains tax from individuals, withholding tax and stamp duties, all of which should be exploited.
(f) Continuity of Government Services: The principle suggests that each level of Government has certain
minimum responsibility and that the level of services provided should not be allowed to fall below that
minimum.
(g) Equality of State: All men are created equal, but are endowed differently. Similarly, States are created
equally but they emerge at creation and through passage of time, with different endowments of economic,
financial and political power. The principle asserts that revenue sharing among the States should be done
on equal basis.
(h) Equality of Access to Development Opportunities: This principle was introduced to correct unequal
endowments of the States. The principle asserts that preferential treatment should be given to those States
which by some measure of development, lag behind others or fall below certain norms.
(i) Absorptive Capacity: It represents the capacity of a State to make proper use of funds. That means that
funds should be released to those States which could best make use of them.
(j) Population: The principle asserts that since Government is about people, development is about people
and that the purpose of Government is the welfare of the people. Therefore, States with larger population
should receive extra share over and above others with smaller population.
(k) Tax Effort: The principle applied in most Federations, is designed to encourage States to exploit their
tax capacities. The realization of a State's potential in respect of tax revenues will widen its development
possibilities.
(I) Fiscal Efficiency: This principle asserts that States would minimize the cost of fiscal administration or
obtain the maximum revenue from a given cost. Fiscal efficiency reflects not only on the ability to raise
taxes and collect them, but the structure of tax base itself and the overall administrative machinery of
government.

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8.5 Structure for Revenue Allocation from the Federation Account
The allocation principles of revenue sharing formula that are in use at the inception of the present
democratic dispensation are: Population, Equality of States, Internal Revenue Generation, Land mass,
Terrain, Population density and Derivation. These principles are expressed in the Nigeria‘s 1999
Constitution under Section 162 (2), which provides that ―in any approved formula, derivation accruing to
the area which is home to natural resources being exploited for foreign exchange earnings, takes a
magnitude of not less than thirteen percent of the revenue accruing to the Federation Account. So far, a
revenue allocation formula was proposed by the Revenue Mobilisation, Allocation and Fiscal Commission
in 2003 and submitted to the National Assembly through the Presidency, as prescribed by the 1999
Constitution. There emerged a structure of sharing of revenue from the Federation Account as typified
below:

Vertical Formula
This shows the structure of allocation to the three tiers of government.
1. Federal Government 46.00%
2. State Government (including FCT) 33.33%
3. Local Governments (including Area Councils) 21.00%
Total 100.00%
Horizontal Formula
This shows the structure of allocation among State Governments (including FCT) and among Local
Governments (including Area Councils) to the three tiers of government.
i. Equality 45.00
ii. Population 25.60
iii. Population Density 1.45
iv. Internal Revenue Generation Effort 8.31
v. Land Mass 5.35
vi. Terrain 5.35
vii. Rural Roads/Inland Waterways 1.21
viii. Portable Water 1.50
ix. Education 3.00
x. Health 3.00
Total 100.00

8.6 Revenue Sharing in Nigeria

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The first resource allocation and control commission in Nigeria was the Sydney Philipson‘s commission of
1946. Philipson adopted the principle of derivation and even progress. By which a region received
according to the proportion of the resources the region produced. This later led to criticism and
disagreement as the principle favored some states at the detriment of others. This criticism led to setting
up another commission called Hicks commission which introduced the principles of (i) needs (2)
independent (3) national interest (4) special grants. There emerged subsequent criticisms and disagreement
on the subsequent commission set up even till the end of colonial rule. After the colonial rule, the question
of how resources/revenue is to be controlled and allocated also generated problem continuously. The
Dina‘s commission of the 1962 introduced another formula whereby the north was given 42%, east 30%,
west 20% and Midwest 8% . This still did not address any problem in the federation.

In 1979, Okigbo‘s commission was established and having done a thorough review of past allocations, it
came up with 58.5% of resource allocation to the central government, 31.5% to the state government and
local governments 10%. But what we have in place as an arrangement of resource control/allocation today
in Nigeria as codified in the 1999 federal republic constitution section(162-168) are principles of (1)
population (2) equality of states (3) internally generated revenue (4) landmass (5) terrain (6) population
density (7) the principle of derivation.

Presently, after the deduction of the 13 percent provision for the oil producing states, the remaining 87
percent of national revenue is distributed as follows;
Federal Government is allocated 52.7 percent,
States Government 26.7 percent
Local Governments 20.6 percent.

9. Monitoring Government Allocation and Expenditures

The principles for managing public resources run through many diverse organizations delivering public
services. The requirements for the different kinds of body reflect their duties, responsibilities and public
expectations. The standards expected of public services anywhere in the world are honesty, impartiality,
openness, accountability, accuracy, fairness, integrity, transparency, objectivity and reliability, carried out

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in the spirit of, as well as to the letter of, the law in the public interest to high ethical standards achieving
value for money.

Expenditure control could be defined as the strings of coordinated actions which have to be taken to ensure
that all expenditures are 'wholly', 'necessarily', 'reasonably' and 'exclusively' incurred for the purposes for
which they are meant. The following are the basic controls exercised over Government expenditure:
(a) The Executive Control.
(b) The Legislative Control.
(c) The Ministry of Finance Control.
(d) The Treasury Control (Office of Accountant - General of the Federation)
(e) The Departmental Control.
(f) Office of the Auditor - General for the Federation.

9.1 The Executive Control

The Executive comprises the President and his cabinet members who have the responsibility for the
efficient and effective control of the administration of the country - politically and economically. The
Constitution created two other arms of government, called the Legislative and the Judiciary for purposes of
checks and balances. All measures and policies taken by the President are subject to the approval of the
Legislature within the ambit of the Constitution. Consequently, in accordance with Section 75(1) of the
Constitution, "The President shall cause to be prepared and laid before each House of the National
Assembly at anytime in each financial year, estimates of revenue and expenditure of the Federation for the
following financial year." The President, in order to satisfy the provisions of the Constitution also appoints
a Cabinet Committee on Estimates, to advise him on the contemplated policy measures. The policy
measures contemplated are then transmitted to the Budget Department in the Presidency. This development
in turn leads to the issuance of guidelines on the preparation of the Budget. As a result, effective
supervision is exercised on all the Agencies involved in budget operation. Any Unit of the Government
whose requirements are higher than the 'control figures' already issued, is invited to defend the excess
request.

9.2 The Legislative Control

The National Assembly is the Supreme Authority on matters of the Nation's finance. The control exercised
by the Legislature is both 'antenatal' and 'post-natal'. The 'ante-natal' control is in the sense in which the
Legislature considers and approves the Estimates submitted to it by the President. 'Post-natal' control is the
review of transactions after payment. No amount of public fund may be spent without the approval of the
National Assembly. However, Section 82 of the 1999 Constitution empowers the President to spend from
the Consolidated Revenue Fund to carry on the administration of Government of the Federation for not
more than six (6) months or until the coming into operation of the Appropriation Act, whichever is earlier.

9.3 Ministry of Finance Control

When Ministries/Departments require money to pay for services, they normally apply to the Minister of
Finance, for such funds. The tradition is that once a year the Ministries and Parastatals present Estimates to
cover their needs and requirements which are expected to be prudent, necessary and reasonable, in
accordance with the Financial Regulations and Appropriation Act. The Minister passes the Consolidated
Revenue and Expenditure Estimates to the President who will present them to the Federal Executive
Council for approval before they are forwarded to the National Assembly as Appropriation Bill.

9.4 The Treasury Control - Office of the Accountant-General of the Federation (OAGF)
The Accountant-General has overall responsibility for the total expenditure of Government. His office
would keep necessary books of accounts to record all the receipts and expenditure of the various Ministries
and Departments. The Treasury Department exercises some measure of supervision and checks over the
accounting records of the Non-Self Accounting Units.

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9.5 Inspectorate Officers from the Office of the Accountant - General of the Federation visit the various
Ministries and Departments to evaluate the system of internal control. They do this to ensure that the
accounting system and maintenance of various books of accounts conform to the approved regulations and
procedures.

This is another aspect of control exercised in any organisation. The Treasury dispatches Internal Auditors
to the Ministries and Self-Accounting Departments to appraise the effectiveness of the existing internal
checks and report upon any inadequacy discovered.

9.6 Controls by Warrants

Although the Estimates and Appropriation Acts guide the disbursement of public funds, the release of
money is subject to issuance of relevant Warrants by the Finance Minister, for the expenditure. The
Warrant authorizes the Accountant-General to release fund from the Consolidated Revenue Fund or
Development Fund. The system of Warrant gives the Executive greater control over the issuance of funds
than would be offered by a system which relies solely on the provisions of the Appropriation Acts.

9.7 Departmental Control over the Budgeted Expenditure

A Departmental Vote Expenditure Allocation Book (D.V.E.A. Book) is a record of payments made and
liabilities incurred under the Votes or Funds approved for each Ministry or Extra-Ministerial Department.
A Vote Book is maintained for each Head or Sub-Head of expenditure. It is an integral part of the
Budgetary Control System. The Book is designed to facilitate vote watching to ensure that expenditure
incurred are not in excess of appropriation. Over-expenditure of departmental vote amounts to reckless use
of public funds and is seriously frowned at by Government. It is the duty of the Officer who is controlling
the Vote to thoroughly investigate, without delay, payments or charges which appear in the schedules
drawn up by the Accountant-General, which do not appear in the Vote Books particularly with a view to
the prevention and detection of fraudulent payments.

9.8 Auditor-General for the Federation

The Auditor General for the Federation scrutinizes all accounts and records of the money collected and
spent and reports to the National Assembly appropriately on the instances of waste, extravagance,
inefficiency or fraud. It is observed that the Auditor-General's duty is post-payment audit, except in the
matters relating to pension and gratuity payments on which he performs pre-payment audit. This is in
addition to the regularity and compliance audit that he carries out as a duty.

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