Effects of Taxation and Its Theories on Economic Growth

Theories of Taxation

Ability to pay theory: The Ability to pay theory of taxation (Pigou, 1920) also called the principle of equity or justice in taxation. This theory states that People with higher incomes should pay more taxes than people with lower incomes. It appears more reasonable and just that taxes should be levied on the basis of the taxable capacity of an individual. The major drawback inherent in this theory is the definition of one’s ability to pay.

The Socio-Political theory of taxation: presented by Wagner (1883), this theory suggests that social and political objectives should be the major factors in selecting taxes. The theory advocated that a tax system should not be designed only to serve individuals, but should be used to cure the ills of society as a whole. Wagner, in other words, was advocating a modern welfare approach in evolving and adopting a tax policy.

Benefit received theory: This theory proceeds on the assumption that there is basically an exchange relationship between tax-payers and the state. The state provides certain goods and services to the members of the society and they contribute to the cost of these supplies in proportion to the benefits received Bhartia, (2009). Anyanfo, (1996) argues that taxes should be allocated on the basis of benefits received from government expenditure. Cost of Service Theory: According to Chigbu et al. (2012) and Ogbonna and Ebimobowei, 2012) this theory is very similar to the benefits-received. It is centred on the relationship that exists between the state and the citizens to a greater extent. The theory aimed at a balanced budget policy.

Expediency Theory: As cited in Ogbonna and Ebimobowei, 2012, Bhartia (2009) explained that expediency theory asserts that every tax proposal must pass the test of practicality. That it must be a factor that should be considered in choosing a tax proposal.

Concepts, Nature, and Principles of Taxation

According to the (black law dictionary, 1999), tax is a ratable portion of the produce of the property and labor of the individual citizens, taken by the nation, in the exercise of its sovereign rights, for the support of government, for the administration of the laws, and as the means for continuing in operation the various legitimate functions of the state.

Anyanwu (1993) pointed out several objectives of taxation. These are:

• To put a curb on consumption and thus transfer resources from consumption to investment • To raise revenue for government • To reduces economic inequalities • To control income and employment.

According to Anyanwu (1997), taxation can be defined as the compulsory transfer or payment (or occasionally of goods and services) from private individuals or groups to the government. The purpose and importance of taxation is to raise funds with which to promote the general welfare and protection of its citizens, and to enable it to finance its multifarious activities and to redistribute wealth and management of the economy (Jhingan 2004, Bhartia, 2009; Ola (2001) cited in Ogbonna and Ebimobowei,2012). Tax is that enforced proportional contributions from persons and property levied by the law-making body of the state for the support of the government and all private needs.

As the Economic Bulletin for Asia and the Far East cited in Jhingan (2002) stated that “Taxation, therefore remains as the only effective instrument for reducing private consumption and investment, and transferring resources to the government for economic development. Nzoha (2002) cited in Ogbonna and Ebimobowei (2012) and Patonov and Stuiolova (2012) noted that taxes have allocational, distributional and stabilization functions. In Nigeria taxes are not necessarily earmarked to those expenditures most conducive to economic growth, either because of political “inefficiencies” or because of redistribution policies that may yield benefit for society but will not be reflected in robust GDP growth rates (Atkinson, 1985) The truth is that in Nigeria taxes are not earmarked to boost economic development because of corruption and other factors that affect the role of taxation as argued by Nwezeaku (2005). He stated that the scope of these functions depends, among other things, to the political will and economic orientation of the people, their needs and aspirations as well as their willingness to pay tax.

The Institute of Chartered Accountants of Nigeria, (2006) and the Chartered Institute of Tax Revenue of Nigeria, (2002) view tax as an enforced contribution of money, enacted pursuant to legislative authority. If there is no valid statute by which it is imposed, a charge is not tax. Tax is assessed in accordance with some reasonable rule of apportionment on persons or property within tax jurisdiction.

Roja (2011) in his article titled The True Nature of Taxation narrated that nobody likes paying their taxes. However, as the adage about “death and taxes” conveys, there is a sense that taxes are as legitimate and as inevitable as death itself. Tax is a lawful and inevitable levy imposed on a subject or upon his property by the government to provide security, social amenities and create conditions for the economic well-being of the society (Appah and Oyandonghan, 2011, Appah, 2004).

Jarkir, (2011) stated that tax is a contribution exacted by the state; it is a non-penal but compulsory and unrequited transfer of resources from the private to the public sector, levied on the basis of predetermined criteria. The classical economists were of the view that the only objective of tax revenue was to raise government revenue. But with the changes in circumstances and ideologies, the aim of taxes has also been changed. These days apart from the objective of generating. revenue, taxes is levied to affect consumption, production and distribution with a view to ensuring the social welfare through the economic development of a country. Ogbonna and Ebimobowei (2012) added thus the extent to which a government can perform its functions depend largely on the ability to design tax plans and administration as well as willingness and patriotism of the governed. The level of willingness and patriotism of the governed anchored on the political will power of the government to fight corruption and embark on expenditures that will boost the economy.

Board Basing: Taxes should be spread over as wide as a possible section of the population, or sectors of the economy, to minimize the individual tax burden.

Compatibility: Taxes should be coordinated to ensure tax neutrality and overall good governance.

Convenience: Taxes should be enforced in a manner that facilitates voluntary compliance to the maximum extent possible. Bhartia (2009) noted that the time of payment, the manner of payment, the quality to be paid ought to all be clear and plain to the tax payer and every other person.

Earmarking: Tax revenue from a specific source should be dedicated to a specific purpose only when there is a direct cost – and- benefit link between the tax source and the expenditure, such as the use of motor fuel tax for road maintenance and also education tax for buying educational materials. However, what we are experiencing today in Nigeria is fiscal indiscipline, corruption and misappropriation of funds.

Efficiency: Tax collection efforts should not cost an inordinately high percentage of tax revenue.

Equity: Taxes should equally burden all individuals or entities in similar economic circumstance. Equity Principle states that tax payer should pay the tax in proportion to his income (Anyanfo (1996) cited in Ogbonna and Ebimobowei, 2012)

Neutrality: Taxes should not favour any one group or sector over another, and should not be designed to interfere with or influence individual decisions making.

Predictability: Collection of taxes should reinforce their inevitability and regularity.

Restricted Exemptions: Tax exemptions must only be for purposes (such as to encourage investment) and for a limited period.

Simplicity: Tax assessment and determination should be easy to understand by an average tax payer. On both equity and simplicity principles, Anyanfo (1996) “states that it is only when a tax is based on the tax payer’s ability to pay can it be considered equitable or just”. He argued that tax law should be transparent.

Incentive Tax: Deduction, exclusion or exemption from a tax liability offered as an enticement to engage in a specified activity such as investment in capital goods for a certain period of time.

Income Tax: Tax imposed by the state on any earned income by a company.

Individual Tax: A tax that governments impose on financial income generated by all entities within their jurisdiction. By law, businesses and individuals must file an income tax return every year to determine whether they owe any taxes or are eligible for a tax refund. Income tax is a key source of funds that the government uses to fund its activities and serve the public.

Inpatriates: These are individuals who are citizens of other countries but spent a portion or all of their tax year in the U.S. working and earning income. International Tax: International tax issues include all tax rules that are imposed by a government regarding an international corporation that has a presence within that country’s borders (either a headquarters location or another type of entity such as a manufacturing plant, sales office, regional or country headquarters, or a distribution center).

Empirical Review

Anyanwu (1997) in his study of the effects of taxes on Nigeria Economic Growth (1981-1996) reveal that companies’ income tax positively and significantly affects GDP, also customs and excise duties significantly affects economic growth in Nigeria. While petroleum profit tax positively and insignificantly affects Nigeria’s GDP. The same is true of other direct taxes (capital gains and stamp duties). However, all direct taxes positively and significantly affect Nigeria’s GDP.

Ajakaiye (2002) in his study analysed the impact of VAT on key sectoral and macroeconomic elements of Nigeria's economy by combining a survey of Nigerian manufacturers, service providers and Other VAT able organizations with simulations of the impact of VAT under various scenarios. The study was a survey of manufacturers, service providers and other VAT able organizations to determine precisely how they treat their input VAT liabilities. Some 61 organizations were surveyed out of a possible sample of 70 of these, 49 pay taxes on inputs. The implication is that the VAT on inputs is magnified by the mark-up rates, leading to considerable cascading contrary to expectations. Consequently, consumers respond to the price increase by reducing demand, and producers respond by reducing their output rather than their mark-up rates in a bid to lower prices. Reduced production may ultimately have devastating economy-wide effects because production in every sector of the economy depends directly or indirectly on imported intermediate inputs, all of which are VAT can be levied.

Ekeocha (2010) analyses the economics effects of tax policy reform in Nigeria using the computable general equilibrium analysis. From the analysis, it is clear that the policy strategy of increasing the rate of Value Added Tax from 5% to 15% will improve government revenue and nominal GDP but at the expense of real GDP and worsening level of unemployment. Even though more industries will gain in the sale of their commodities, but this is very minimal. The implication of this result is that the tax incentive structure must be looked into properly and should be such that will boost production in all the industries as to improve the real GDP and boost the level of employment, production and welfare in Nigeria.

Izedonmi and Okunbor (2010) empirically examined the contribution of VAT to the development of the Nigerian economy. Time series data on the Gross Domestic Product (GDP), VAT Revenue, Total Tax Revenue and Total (Federal Government) Revenue from 1994 to 2010 sourced from Central Bank of Nigeria (CBN) were analyzed, using both simple regression analysis and descriptive statistical method. Findings showed that positive and insignificant correlation exists between VAT Revenue and GDP. Both economic variables fluctuated greatly over the period though VAT Revenue was more stable. This paper therefore recommends that all identified administrative loopholes should be plugged for VAT Revenue to continue to contribute more significantly to economic growth of the country. Adereti et al. (2011), in their study on Value added tax and economic growth in Nigeria, using the regression model revealed that a strong positive relationship exists between value added tax and economic growth in Nigeria within the period under review (1994-2008).

Ebiringa and Emeh (2012) examined the empirical forms of tax on the economic growth in Nigeria. Secondary data were sourced within the periods of 1985-2011and model was specified and estimated using some econometric. The result showed that the determinant factor of economic growth in the country through tax, only custom and exercise duties is capable of influencing but has an inverse relationship and significant to the GDP. It is observed that economic instability were experienced between 1986-1987 and 1993 to 1995 but evident in the stability in the economic growth from the graph in the rest of the years of the study around bench mark value of zero line of the GDP predicted graph based on tax generations in Nigeria. The study therefore recommended that the company income tax system should be generally structured to bring about more yielded revenue results capable of contributing more significantly to the Nigerian economic as it is done in the advanced countries of the world. Custom service operations and revenue generations in the border was not practically reflected in the economic due to no accountability, transparency and leakages in the system.

Ebiringa and Emeh (2012) examine the empirical forms of tax on the economic growth in Nigeria. Secondary data were sourced within the periods of 1985-2011 and Model was specified and estimated using some econometric. The result showed that the determinant factor of economic growth in the country through tax, only and custom and exercise duties is capable of influencing but has an inverse relationship and significant to the GDP. It is observed that economic instability were experienced between 1986-1987 and 1993 to 1995 but evident in the stability in the economic growth from the graph in the rest of the years of the study around bench mark value of zero line of the GDP predicted graph based on tax generations in Nigeria.

Ergete and Dahlby (2012), in their study “The Impact of Tax Cuts on Economic Growth: Evidence from the Canadian Provinces” revealed that a negative relationship exist between taxation and economic growth in Canada. The finding concludes that reducing corporate income tax 1 percentage point raises annual growth by 0.1 to 0.2 points. Karel and Ravn (2012) studied the exogenous changes in personal and corporate income taxes and how they affect USA economy. The study revealed a negative relationship existing between the dependent variable and the explanatory variables. They concluded that A 1 percentage point cut in the average personal income tax rate raises real GDP per capita by 1.4 percent in the first quarter and by up to 1.8 percent after three quarters. A 1 percentage point cut in the average corporate income tax rate raises real GDP per capita by 0.4 percent in the first quarter and by 0.6 percent after one year.

Akintoye and Tashie (2013) examined the effect of Tax compliance on economic growth and development in Nigeria. Tax compliance here is proxy in willingness of the citizens to pay tax. The conclusion is that compliance through the Willingness of citizens to pay tax is very important and cannot be ignored. It is suggested that Government should pay attention to the factors that influence the willingness of citizens to pay Tax and improve on them, thereby improving peoples‟ willingness to pay tax, government Revenue and economic growth and development of the nation generally.

Onaolapo et al. (2013) investigated the Effect of Petroleum Profit Tax on Nigerian economy, the study covered the period between 1970 and 2010. Their study revealed that Income from a nation’s natural resource has a positive influence on economic growth and development. They recommended that Government should transparently and judiciously account for the revenue it generates through PPT by investing in the provision of infrastructure and public goods and services.

Omolapo, Aworemi and Ajala (2013) perform a data analysis with the use of regression analysis. Findings show that Value Added Tax has a significant effect on revenue generation in Nigeria. The results from their analysis revealed that Value Added Tax (VAT) is beneficial to Nigeria economy. From the findings it also shows that for Nigeria to attain its economy growth and development, Nigeria should able to generate enough revenue in other to meet up her challenges in provision of social amenities and cost of government administration. The result from the analysis indicates that if more goods and services are taxed more revenue will be accrued to the government.

Osundina and Olanrewaju (2013) studied welfare effect of taxation on Nigerian economy using consumption theory function. Total consumption expenditure was used to measure the welfare effect of taxation while private investment level and total federally collected revenue were used to capture the economy. Ordinary least square method regression analysis was used to measure the possible effect. The study conclude that the negative and significant effect of total federally collected revenue on total consumption expenditure can be as a result of mismanagement of funds, lack of implementation of policy and corruption which is very rampant in Nigeria. Cletus and Love (2014) investigated State Government Taxation in Nigeria with a view to determine its impact on economic growth. The data for this study were generated from the Central Bank Nigeria (CBN) Statistical Bulletin for a period of 13 years (1999-2012). The data were analyzed with multiple regression analysis. The findings revealed that state government taxation has a significant impact on economic growth in Nigeria.

John, Ebieri and Emmanuel (2014) this study therefore examines the dynamic causal relationship between tax revenue components and economic growth in Nigeria. The objective is to provide justification for policy adjustments necessary for broadening the narrow revenue base of the government and enhancing economic growth using time series data on different types of Taxes and real gross domestic product from 1986 to 2012. Bounds testing technique was used in analyzing the data. The results indicate that total tax revenue has a significant effect on economic growth; explaining about73.4% of the total variation in real gross domestic product, company income tax, education tax and other tax revenue were each found to have significant influence on economic growth; sustaining long-run equilibrium relationships with real gross domestic product.

Margaret, Charles and Gift (2014) on an empirical analysis of Taxation and economic growth in Nigeria, covering the period 1994-2012. Taxation was disaggregated into: Value Added Tax, Personal Income Tax, Company Income Tax and Petroleum Profit Tax, while the Gross Domestic Product was used as a parameter for measuring economic growth in Nigeria. In order to establish causality between Taxation and economic growth in Nigeria, secondary data were collected from the Central Bank of Nigeria Statistical Bulletin and the Federal Inland Revenue Services Bulletin. The data collected were analyzed using the Granger Causality Approach. The hypothesis one was tested using F-Ratio, while hypotheses two, three, four and five were tested using T-Statistics. The results of the analysis reveal that a significant positive relationship exists between Taxation and economic growth in Nigeria.

Akenbor and Arugu (2014) this paper investigated state government taxation in Nigeria with a view to determine its impact on economic growth. To achieve this purpose, it was hypothesized that state government taxation has no significant impact on economic growth in Nigeria. In line with the above, related literature were critically reviewed. The data for this study were generated from the Central Bank of Nigeria (CBN) Statistical Bulletin for a period of 13 years (1999-2012) the data were analyzed with multiple regression analysis. The findings revealed that state government taxation has a significant impact on economic growth in Nigeria. Based on the above, it was recommended that state government should rise to the challenge of boosting its revenue base by ensuring that all available sources of revenue are adequately tapped and also ensure that tax administration and collections become more effective and efficient in Nigeria.

Lababatu (2014) examined tax revenue and economic growth in Nigeria. The main objective of this study is to explore the relationship between taxation and economic in Nigeria. The study covered the period between 1981 to 2010. The study employed petroleum profit tax, company income tax, custom and excise duty and value added tax while gross domestic product was employed as the dependent. Multiple linear regression analysis was used to analyze the data by employing the use of Vector Error Correction Model. The findings reveal that petroleum profit tax, company income tax and value added tax have a positive impact on Nigeria’s economic growth while custom excise and duties impacted negatively but overall, a significant relationship between tax revenue and the Nigeria economic growth exists. The study recommends that only skilled and professionals and trustworthy hands are responsible for tax administration.

Okoli, Njoku and Kaka (2014) examined taxation and economic growth in Nigeria using Granger causality approach. The study covered the period 1994-2012. Taxation was disaggregated into: Value Added Tax, Personal Income Tax, Company Income Tax and Petroleum Profit Tax, while the Gross Domestic Product was used as a parameter for measuring economic growth in Nigeria. The data collected were analyzed using the Granger Causality Approach and regression analysis. The results of the analysis reveal that a significant positive relationship exists between Taxation and economic growth in Nigeria. The study also found significant relationship between the disaggregated tax revenue (Value Added Tax, Personal Income Tax, Company Income Tax and Petroleum Profit Tax) and gross domestic product.

Eyisi. Chioma and Nwaorgu (2015), the study aimed at ascertaining the effects of taxation on microeconomic performance in Nigeria from 2002 to 2011. Data were collected from secondary sources. Three hypotheses were tested using ordinary least squares regression method. The implication of the findings showed that government earnings from taxation will affect consumer spending and boost output production level. The study recommends that to ensure rapid economic growth in Nigeria, there is need for government to encourage local manufacturers of output through provisions of incentives from taxation. And through the increase of import duties as to discourage importation of foreign goods which competes with local goods thereby increasing income generation from taxation which enhances economic growth. Government should continue to show fairness in fixing income tax of consumers so as to encourage consumers spending tax system using a time series data of 20 years. All the data for the analysis were collected from central bank.

Chigbu and Njoku (2015) examined taxation and the Nigerian economy using time series data from 1994 to 2012. The dependent variables used in the model includes: Gross Domestic Product (GDP) as a parameter for measuring economic growth, inflation and unemployment. The objective of this study is to determine how taxation affects these macroeconomic variables. Ordinary least square analysis was employed to analyze the data. The results of the statistical analysis reveal that positive relationships exist between the explanatory variables (Custom and Excise Duties, Company Income Tax, Personal Income Tax, Petroleum profit tax and Value Added Tax) and the dependent Variables (Gross Domestic Product, Unemployment). But, the individual explanatory variables have not significantly contributed to the growth of the economy; also the explanatory variables have not significantly contributed to the reduction of the high rate unemployment and inflation in Nigeria for the period under review.

Salami, Apelogun, Omidiya and Ojoye (2015) empirically investigated the impacts of taxation on the growth of the economy between 1981 to 2012. Gross Domestic Product (RGDP), is specified to depend on the taxation indicators which are the petroleum profit tax (PPT), company income tax (CIT), customs and excise duties (CED), value added tax (VAT). The study employed the use of both simple and multiple linear regression analysis of the ordinary least square method. These were used to determine the impact and relationship between the endogenous variable, RGDP, and the exogenous variables, PPT, CIT, CED and VAT. It was discovered that if all the exogenous variables were tested individually on the economic growth, they show a significant impact individual on economic. The F-statistic shows that the overall model is statistically significant.

Akhor and Ekundayo (2016) examined the impact of indirect tax revenue on economic growth in Nigeria. The study uses value added tax revenue and custom and excise duty revenue as independent variables and economic growth was proxy with real gross domestic product as the dependent variable. The study employ secondary data collected from Central Bank of Nigeria statistical bulletin for the period covering 1993 to 2013 for the empirical analysis using the convenient sampling techniques. Error correction model regression was employed in analyzing the data. The result revealed that value added tax had a negative and significant impact on real gross domestic product. In the same vein, past custom and excise duty had a negative and weakly significant impact on real gross domestic product. The Error Correction Model (ECM (-1)) coefficient had a correct negative and statistically significant sign. This shows that short-run deviation can be quickly corrected. The Durbin-Watson positive value indicates the absence of autocorrelation in the model.

Ojong, Ogar and Oka (2016) examined the impact of tax revenue on economic growth: Evidence from Nigeria. The objectives of the study were; to examine the relationship between petroleum profit tax and the Nigeria economy, the impact of company income tax on the Nigerian economy and the effectiveness of non-oil revenue on the Nigerian economy. Ordinary least square of multiple regression models was used to establish the relationship between dependent and independent variables. The finding revealed that there is a significant relationship between petroleum profit tax and the growth of the Nigeria economy. It showed that there is a significant relationship between non-oil revenue and the growth of the Nigeria economy. The finding also revealed that there is no significant relationship between company income tax and the growth of the Nigeria economy.

Review of Related Literature

Following the research I have conducted concerning this research work, I discovered that most researchers focused on effects of Value Added Tax and not taxation as a whole. Also, during the time of this research, the latest work was made in 2016 but this is 2019, a lot has changed in this area of study. To the best of my knowledge I am not aware of any study yet on the effect of taxation on the Nigerian Economy up to 2019. This research work seeks to fill these gaps mentioned above.