A decent case for presumptive tax
Luigi Einaudi was the president of the Italian republic shortly after the Second World War and a prominent economist best known for his advocacy of presumptive taxation. He argued that tax should be levied on average, and not actual incomes. One advantage of such a system would be that all taxpayers have the incentive to work hard since above-average income would be free of tax. Another would be administrative simplicity.
Presumptive income tax (PIT) is applied in different forms in many jurisdictions. The authorities could assume that individuals and companies enjoy income equivalent to a set percentage of their net worth. Alternatively, they could assess a company’s tax liability as a set proportion of its gross receipts, making adjustments for the specific industry. In developed economies, the collection agency could assess the PIT due from a large landowner on the basis that he/she made the full productive use of the land. For other taxpayers, the agency could make a demand based upon visible signs of wealth. The permutations are numerous yet they share the advantage for the authorities that the taxpayer has to challenge the assumptions underpinning the demand.
In Nigeria the Federal Inland Revenue Service (FIRS) has expressed an interest in the principle of PIT. It is not difficult to see why. Federally collected revenue amounted to 7.4 per cent of GDP in 2018 according to provisional data from the CBN. This is less than half the rate achieved in Kenya and about one third of what is posted in South Africa. Some numbers quoted in January by Zainab Ahmed, the federal finance minister, are revealing. The gross oil revenue/oil GDP ratio stood at 39.0 per cent, and that for the non-oil economy at just 4.2 per cent. We may conclude that the oil industry in Nigeria is undertaxed relative to other jurisdictions and we can see why the FIRS, the largest collection agency in the country, will look at new ways to boost the tax take such as PIT.
It would look above all at small businesses and sole traders if it was to adopt PIT. There are an estimated 77 million such businesses in Nigeria, accounting for 60 million jobs and close to 50 per cent of GDP according to the industry, trade and investment ministry. Rather than assess net worth or search for visible signs of wealth in this case, the FIRS could examine cash book receipts, bank statements and business permits. It could set (presume) benchmarks for the profitability of types of business. In the absence of any other data, the FIRS could make a demand upon the basis of the location of the business and staff numbers.
There is an argument, popular with the audit industry and others, that such an approach is intrusive and restricts the rights of taxpayers. Many thinkers, not to mention those with the thankless task of having to govern a country, would reply that rights cannot be separated from responsibilities. If a business persistently ignores or underpays its tax obligations, there is a compelling case for the authorities to up their game by confiscation or the application of PIT for example. In some cases, the agency may collect more tax than is due: taxpayers who had ducked their obligations would then have to appeal.
The FGN has to take radical steps to boost its revenue generation. Its debt burden is currently sustainable in our view but will not be so in, say, five years. The only way to provide better services for its citizens is through higher tax collection. We can all pick data to highlight the pitiful state of basic services: ours are the recent finding that more Nigerians live in poverty than Indians although its population is one sixth of India’s, and that the housing deficit was 17 million units five years ago according to the Nigeria Mortgage Refinancing Company. Nigeria has a low government spending/GDP ratio because it has a low tax/GDP ratio.
Similarly, if the FGN does not transform its tax collection, it will not have access to the funds for major infrastructure spending. Over 20 years, up to US$3trn is required to make the infrastructure fit for purpose. Nigeria’s traditional external partners, the domestic private sector, the DFIs, the PFAs and others will play a part but the lead role belongs to the FGN. Without large-scale investment, it is very difficult to see the migration of the economy from the rentier to the productive model. Doubters are invited to pay a visit to South Korea or any of the East Asian success stories of the 1990s.
PIT could be one pillar of a broader strategy to push up tax generation sharply within a relatively short period. Others could be the doubling of the standard rate of VAT to 10 per cent; a review of the oil industry’s production sharing contracts; an increase in the staffing and remuneration of the large taxpayers’ office; an expansion of the electronic filing of tax returns; and a draconian review of tax waivers and exemptions.
The urgency of the FGN’s predicament does not allow for a dependence upon efficiency gains to deliver. The gains were impressive in the early years of democratic South Africa but were possible because a well-run revenue service with a track record already existed. This is not Nigeria’s current lot. A dramatic challenge requires a dramatic response in our view.