The issues concerning State budgets, especially between Zamfara and Lagos State, provide an opportunity to discuss fiscal federalism in Nigeria.
Fiscal federalism refers to the division of financial responsibilities, revenue-raising powers, and expenditure authority among different levels of government within a federal (or multi-tier) political system.
It concerns how revenues are generated and shared among the federating units.
Nigeria’s fiscal and political systems, particularly the fiscal relationship between the Federal and State Governments, are intertwined through the Federation Account.
All revenues earned by Nigerian federating units, apart from Personal Income Taxes, are paid into the Federation Account. Therefore, Petroleum Profit Tax (PPT), Royalties, Oil & Gas rents, Company Income Tax, Value Added Tax, Customs Duty, and other taxes are all directed into the Federation Account.
The horizontal revenue allocation formula is determined and periodically reviewed by the Revenue Mobilization Allocation and Fiscal Commission (RMAFC) and approved by the National Assembly.
The current formula, in use since February 2023, allocates funds from the Federation Account as follows:
- Equality of States 40%
- Population 30%
- Derivation or IGR 10%
- Land mass 10%
- Education 4%
- Health 3%
- Water 3%
Based on this formula, as a State Governor, the more children your state has, the higher your allocation—70% of your pro-rata Federation Account share, combining 40% equality and 30% population. The federation account itself is a key issue.
States cannot tax companies’ revenues nor set VAT rates within their borders. This should be a fundamental aspect of federation.
Nigeria’s fiscal federalism structure does not encourage or incentivize states to generate wealth, mainly because of how funds are shared from the Federation Account.
A governor has little motivation to attract investors, since that only yields 10% “ROI” through derivation or provides schools and water supply, earning 4% from the Federation Account.
Cross River State attempted to grow revenue by investing in Tinapa to attract commerce. However, if Tinapa had succeeded, all the businesses established there would have paid taxes to Abuja, leaving just 5% PAYE for Cross River to earn and retain. VAT would also be shared.
The pyramid of groundnuts disappeared because Nigeria replaced agricultural income with oil and altered fiscal laws, leading to regions and states losing their powers to attract and tax companies. Why would a state government that no longer profits majorly from excise duties on groundnuts bother to attract groundnut-processing firms? The state can instead wait for other States to generate corporate income Tax and VAT, so it shares.
Zamfara possesses Lithium. Suppose the State government attracts an investor for its Lithium deposits. In that case, the Federal government will register and tax the company, and the income from Lithium mined in Zamfara will flow into the FAAC.
Of course, Zamfara retains 13% of that. Similarly, Lagos has attracted a deep-sea port, an international water-sports franchise, and a VAT-producing consumption activity. This VAT will be shared among all states, with Lagos.
When a hunter goes into the forest to kill an elephant, but a village committee shares the elephant meat, there is little incentive for the farmer to risk his life hunting elephants. The farmer can also sit back on his farm and wait for another hunter to kill an elephant.
The solution is to reform Nigeria’s fiscal federalism by gradually phasing out the federation account introduced in 1981. This will allow states to tax and retain the business they attract within their borders. This reform would put states in control of their budgets and destinies, enabling them to create budgets based on their economic potential rather than relying on tax collections that flow to Abuja.
No state in Nigeria is deprived of natural resources, yet the Federation Account has made states complacent and merely appendages of the center.
Nigeria can do better.
Federal government can equally explore all the state driven business with the cooperation of the governors, because federalism is a key factor to one Nigeria.Give it a try don’t criticize even before it came into effect.