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Closing the 'tax gap'

Will creative incentives improve compliance?

As a fiscal tool, government may need to improvise and seek ways to incentivize voluntary tax compliance as application of force would achieve very little results. Some initiatives that could be adopted by government may include providing incentives to voluntary taxpayers and access to revolving loans for Small and Medium Enterprises. The incentive will be tied to evidence of good tax standing.

Tax gap is used here to refer to the difference between taxes collected by government and what could ideally be collectible. Without a doubt, the gap is wide in Nigeria. There is a significant level of non-compliance by individuals and corporates who are either operating in the informal sector and out of the tax net or just paying lip service to tax obligations.

While it may be difficult to ascertain the exact level of tax gap in most developing countries, there are studies with generic information that may provide some hints. Some of these pieces of information suggests that most developing countries collect between 10% and 20%  of their GDPs as tax revenue compared to their OECD counterparts who collect between 30% and 40%. In Nigeria, the ratio of non-oil tax revenue to GDP is far below 10%, which makes Nigeria's case even worse than most developing countries.

Over the years, government's focus on taxation of individuals has been on personal income tax (PIT) through the pay-as-you-earn (PAYE) system. This is due to ease of monitoring, by relying on employers as unpaid collection agents offering gratuitous service to the various Revenue Boards. Several “brief-case” professionals, well accomplished sole proprietors and very important personalities all go around, earning millions of Naira in income but paying no tax. This concentration on PAYE has left a huge tax gap ranging from non-payment of PIT on other sources of income to non-payment of PIT by individuals not covered by the PAYE system.

Other rationale for the PIT tax gap may include the following:

  • innate attitude of man not wanting to pay taxes and levies, especially where the risk of detection is low and/or little or no penalty for non-compliance
  • non-availability of relevant records (to ascertain taxable profits, especially in the informal sector)
  • perception of poor public service – where there is a strong view that the funds collected are not being used for public interest. The vicious cycle of “chicken and egg” analogy

Considering the current focus on non-oil revenues, it has become imperative to focus on increasing tax revenue. The keys to closing the tax gap would be a combination of many actions, all of which may have to be implemented simultaneously. This could be grouped into short term actions aimed at plugging the low hanging fruits and long term actions.

The short term steps will include raising the level of effectiveness of tax administration, widening the tax base by ensuring more taxpayers are brought into the tax net. Monitoring and enforcement actions must also be strengthened to drive compliance. Public enlightenment and sensitization campaigns would also be required. It is interesting to note that tax payment is seen by many as an exclusive obligation of civil servants and those in paid employments. Some of the long term measures may include review of the tax policy and laws with a view to bringing them up to current realities.

As a fiscal tool, government may need to improvise and seek ways to incentivize voluntary tax compliance as application of force would achieve very little results. Some initiatives that could be adopted by government may include providing incentives to voluntary taxpayers and access to revolving loans for Small and Medium Enterprises. The incentive will be tied to evidence of good tax standing.

Government may also introduce an incentive based health scheme for all Nigerians which would be directly linked to tax compliance. A similar scheme exists in the United States of America where taxpayers get up to 30% of their health insurance payment as tax credit which is available to offset future tax liabilities. This serves a dual purpose of assisting the government achieve universal health coverage while encouraging payment of taxes.

Although there is a similar incentive in place which benefits members of the National Health Insurance Scheme, it does not apply to all Nigerians. For this to work effectively, there is need for considerable improvement in healthcare infrastructure.

Another incentive could be to link tax payments to lotteries like what is done in China and Mauritius. In the two countries, Tax Lotteries were introduced in an attempt to change taxpayers' behavior. Tax receipts serve as lottery tickets which entitled taxpayers to participate in lotteries and win certain sums. This could easily be pulled off in Nigeria in collaboration with the Federal and/or State Lottery Boards. Tax receipts such as PAYE, Value Added Tax, Withholding Tax receipts could be used as lottery tickets and taxpayers get the opportunity to win simply by filing and paying their tax returns. This initiative depends on the records maintained by government and would thrive where it is only made open to taxpayers.

Further incentives may be tied to the Bank verification number (BVN) as widely anticipated by many Nigerians. It is common knowledge that before opening a corporate bank account in Nigeria, applicants are required to present their tax identification numbers. Consequently, Government, through the Central Bank of Nigeria (CBN) may request for corresponding tax identification numbers for every BVN within the banking system. The incentive may then be provided at a graduated scale which applies based on certain minimum threshold of tax payment or compliance. This addresses several issues such as increased tax base, better tax collection and increased employment for tax officials who would be required to monitor data supplied by CBN.

As plausible as the above measures may seem, driving compliance through these incentives will come with challenges in Nigeria. There is need for proper re-orientation geared towards attitudinal change of taxpayers. Enabling environment must be created to positively position the tax system. Strong political will is required to ensure that the system treats every taxpayer equally and fairly. The government and its revenue collection agencies must continue to display transparency in the collection and utilization of taxes.

The need for these is best captured in the words of Colleen Kelley – “It has long been clear that most taxpayers want to comply with the tax code, but they need help to do that. Cutting off that help will not increase compliance.”

Closing the 'tax gap' – Will creative incentives improve compliance?
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