A basic responsibility of every government is the provision of public infrastructure and social services to its citizenry. Being a highly capital-intensive venture, generating adequate revenue to finance this crucial obligation is a major concern of the government. To boost revenue generation, certain tools of fiscal policy may be employed, two of which include taxation and offering tax incentives as a means of attracting investment.
Taxation is a major source of government revenue. It has been posited that the primary objective of a modern tax system is the generation of revenue to help the government finance the ever-increasing public sector expenditure. Despite its importance, taxation alone is usually inadequate to generate the requisite revenue for economic growth and development. Therefore, policymakers must look into alternative means of revenue generation, one of which is proffering tax incentives as a means of attracting investment. Tax incentives are tools of fiscal policy aimed at positively influencing investment in a country by lowering the tax burden of specific individuals and corporate bodies.
There has been dissensus on the efficacy of taxation and tax incentives as tools of fiscal policy and how best these tools can be employed to ensure optimum revenue generation. While there are no straitjacket answers to this conundrum, one thing is certain: for optimum revenue generation, policymakers must strive for a workable balance in the employment of both tools.
Taxation versus Tax Incentives: The Need for a Balance
At first glimpse, it would appear that taxation and tax incentives are opposites and consequently should be mutually exclusive, but this is not the case. Both tools of fiscal policy can be employed in a complementary manner to boost revenue generation. This is because the employment of taxation and tax incentives, independent of each other, cannot adequately cater to the massive level of revenue generation required for funding public sector expenditure.
As aforementioned, taxation is a major source of government revenue and can be considered the biggest source of government revenue. The primacy of taxation in revenue generation does not lie in the magnitude of income generated through taxes but in the certainty and consistency of taxation, owing to the inherent power of government to impose taxes and the corresponding obligation of citizens to pay taxes to the government. Due to this, policymakers continually seek means to upsurge tax revenue by making policies directed at increasing tax rates, broadening the tax net and base, levying new taxes and improving the efficacy of tax collection systems.
However, as much as policies supporting increment of taxes are pushed, factors such as tax evasion, tax avoidance and inefficient tax administration can undermine these policies. Furthermore, the Laffer Curve indicates that an increase in taxes can cause a decrease in incentive to work and invest, ultimately leading to a decrease in total tax revenue generated. It is thus apparent that a country cannot tax its way to prosperity.
Thus, the converse option of lowering the tax burden by offering tax incentives to attract more investors into various sectors of the economy is often considered by policymakers. This is not a bad option but the issue is that so far, tax incentives alone have not proven to be very effective in attracting a high level of investment. Furthermore, it has been argued that tax incentives are counterproductive to revenue generation as they deplete the amount of tax revenue that would otherwise be generated by the government. While this is no doubt a valid consideration, it is submitted that if tax incentives are strategically deployed in key sectors of the economy, there would be an increase in investment and by implication, an expansion of the tax net in those sectors. This will lead to an increase in the total tax revenue generated in the long run, offsetting any initial depletion.
It is thus apparent that there can be a complementary relationship between taxation and tax incentives, whereby the employment of the tax incentives increases the prevalence of taxation. To maximise the benefits of this complementary relationship, governments must strive for a workable balance in the employment of taxation and tax incentives as tools of fiscal policy.
Arriving at The Balance: Steps to Be Taken
It is incontrovertible that a workable balance in the employment of taxation and tax incentives is possible and can be achieved with careful planning and fiscal strategy on the part of policymakers. To arrive at this balance, the following steps are recommended.
Firstly, while there should be optimal taxation, the government should not impose high tax rates which put individuals and businesses alike in a chokehold, as this will typically lead to tax evasion and tax avoidance. Instead, tax incentives should be employed to reduce the incidence of tax evasion and tax avoidance and broaden the tax base. For instance, an incentive that rewards punctual filing of tax returns with the grant of a tax bonus will most likely engender a high level of tax compliance. An example of one such incentive is the one granted under the Nigerian Companies Income Tax Act, which grants large companies a bonus of 1% against income tax of future tax years when their income tax is paid 90 days before the due date for filing.
Secondly, more tax incentives should be rolled out to attract investment in developing sectors of the economy and encourage economic activity in such sectors. Fiscal policies aimed at broadening the tax base by lowering income tax rates with accelerated depreciation and eliminating unnecessary tax holidays should be pursued in these sectors. Policymakers would do well to borrow a leaf from Ireland's fiscal system, which has incorporated these policies, resulting in the country's enjoyment of an enviable influx of foreign direct investment and by implication, increased revenue.
Thirdly, the government should look into current tax incentives being offered and eliminate incentives that have lost their efficacy. A detailed evaluation of the opportunity cost of offering these tax incentives must be carried out, after which any incentive which has not been proven to ensure the generation of more taxable income in the long run, should be eliminated. Additionally, any tax incentives which have been tainted by abuse should be eliminated. For example, in Nigeria, there are various concerns regarding the abuse of pioneer status, a tax incentive that allows certain businesses a tax holiday for an initial period of three years, extendable for an additional two years. This abuse is said to stem from a mixture of factors, one of which is the discretionary powers of the Executive arm of government which enables it to grant pioneer status without the need for approval from the National Assembly. Another factor is the fact that too many agencies are involved in the administration of this incentive, resulting in duplication of duties and lack of coordination. Flowing from this, it would appear that the pioneer status incentive might have lost its efficacy and if indeed it has, it is recommended that it be scrapped.
Finally, more government effort should be expended in ensuring the stability of the tax regime, strengthening the economy, creation of more jobs, promoting the rule of law and provision of adequate public infrastructure, as these are factors that will boost the effectiveness of taxation as well as any tax incentives proffered to investors.
It is hoped that more governments, especially in developing countries like Nigeria, will continue to actively strive for a workable balance between taxation and tax incentives by maximising the complementary relationship between these tools to ensure optimum revenue generation.
1 L Soyode and S Kajola, Taxation: Principles and Practice in Nigeria (1st edn, Ibadan: Silicon Publishers.)
2 O Aguolu (2004), Taxation and Tax Management in Nigeria (3rd edn, Enugu: Meridian Associates.)
3 The Laffer Curve was developed by American economist Arthur Laffer, to illustrate the relationship between taxation rates and amount of tax revenue generated.
5 "We contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle."- Winston S. Churchill
7 Supra note 6.
8 Companies Income Tax Act, Cap. C21, Laws of the Federation of Nigeria , 2004.
9 The pioneer status incentive is provided for under the Industrial Development (Income Tax Relief) Act, Cap 17 Laws of the Federation of Nigeria, 2004.
10 Supra note 6
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