How the informal sector can solve Nigeria’s tax woes

We must look towards efficient taxation as an avenue to increase revenue. If not, we would continue digging our heels into debt and eventually be caught in a debt trap.

How the informal sector can solve Nigeria’s tax woes

In life, three things are certain: death, taxes, and Arsenal not qualifying for the Champions League. This article focuses on one of the trio — taxes, its relationship with our GDP, and how a slighted sector might hold the key to Nigeria's prosperity.

Gross Domestic Product (GDP) is the total monetary or market value of all the finished goods and services produced within a country’s borders in a specific period, according to Investopedia. As a broad measure of overall domestic production, it functions as a comprehensive scorecard of a country’s economic health.

There are three popular approaches to calculating a country’s GDP: Expenditure, production, and the income approach. In this article, I adopt the expenditure approach which calculates spending by summing consumer spending, government consumption expenditure, private investments, and net exports.

Let's consider government expenditure.

Government expenditure

Running a country is by no means an easy task. It takes commitment, hard work, and numerous resources to ensure the smooth day-to-day operation of the economy, provide standard infrastructure, and ensure people have adequate social welfare.

And finance is required to execute these tasks amongst many other responsibilities. There are two ways to raise the funds needed to run a country: Internal and external means. And one of the most popular ways countries raise funds externally is by taking up debt.

Countries often turn to debt to meet most of their obligations. They borrow money from organizations like the International Monetary Fund (IMF) and the Paris Club. Countries borrow for many reasons. From executing capital expenditure to even meeting existing debt obligations. The IMF currently estimates the global debt to be around $226 trillion.

Nigeria is not new to indebtedness with a debt profile projected to hit ₦50 trillion by 2023 from ₦37 trillion as of September 2021.

Internally, however, countries raise funds by selling natural resources (as Nigeria does with crude oil), privatizing national assets, and, arguably, the most critical revenue-generating mechanism for any economy and the reason I am writing this article , taxation.

An effective taxation system can be likened to the oil that greases the wheels of a working economy. According to a former Justice of the United States Supreme Court Oliver Wendell Holmes, "Taxes are what we pay for a civilized society".

Let's consider this example to understand the importance of taxation to the economy.

In May 2021, U.S. President Joe Biden released a $6 trillion-dollar federal budget proposal for the 2022 fiscal year. With a projected tax revenue of over $4 trillion, 66% of the U.S. budget would be funded by tax revenue. By extension, taxation would account for 16% of the projected 2022 GDP of $24 trillion.

Having established the relationship between taxation and a country’s GDP, let's bring it back to Nigeria and consider what taxation means to different people.

What is the first thought that comes to mind when you hear the word "tax"? As a Nigerian, your idea of taxation is likely to be influenced by your socioeconomic realities.

To the bus driver that plies the Yaba to Oyingbo route daily, tax is the ₦200 he has to forfeit to the green uniformed officers of the National Union of Road Transport Workers for every trip completed.

On the other hand, a working-class adult might see tax as the statutory 24% personal income tax deducted from her monthly salary and remitted to the state government.

Irrespective of the lens from which you view taxation, the underlying principle remains the same  —  it's a mandatory contribution levied on individuals or corporations by a government entity used to fund the expenditures of either the country, state, or even the local government.

Giant of Africa: How Nigeria compares with other countries in tax revenue

The tag "Giant of Africa" does not seem far-fetched for a country currently the most populous black nation on earth. The GOA tag did not come by chance. During the Nigerian oil boom, which lasted from 1960 till the early '70s, Nigeria was touted as an emerging market to look out for.

With an estimated GDP of $432 billion, Nigeria ranks as the largest economy in Africa. On paper, this looks to be a stellar achievement and enough reason for policymakers to make sensational statements about driving the nation in the right direction, considering that a high GDP can be used as a vanity metric used to signify "economic growth" (not to be mistaken for economic development).

However, a look at the tax-to-GDP ratio (the contribution of tax revenue to a country’s GDP) shows that taxation, which ought to be a significant driver of the country’s economy, is performing at an abysmal level.

The World Bank’s standard for the tax-to-GDP ratio is 15%. But Nigeria’s tax-to-GDP ratio is 6%. The journey to jettisoning the "poverty capital of the world" tag is going to be a long one. Moreso considering Nigeria’s GDP and the proposed expenditure for 2021 is ₦13 trillion. We can assume that the taxation element of Nigeria’s expenditure and, by extension GDP, is ₦780 million.

Nigeria’s tax-revenue situation is a far cry compared to that of South Africa, which ranks as the second-largest economy in Africa with a GDP of $301 billion and 60 million people. South Africa boasts of 28% tax-to-GDP, 12% higher than the Sub-Saharan Africa average and almost five times that of Nigeria.

With a labour force more than the South African population, the question on everyone’s lips is how Nigeria still struggles to match up in terms of tax revenue.

Introducing Nigeria’s informal sector

Simply put, the informal sector is that category of the workforce that is neither taxed nor monitored by the government. It includes the POS lady (banking agent) at the junction and the security guard who also owns a one-stop shop.

In developing countries like Nigeria, the informal sector comprising micro, small and medium scale enterprises (MSMEs) is pivotal to economic growth and development. MSMEs account for most of the country’s workforce, and their activities drive critical economic sectors like agriculture and manufacturing.

A joint survey by the Nigerian Bureau of Statistics and Small and Medium Enterprises Development Agency of Nigeria revealed that there are 41.543 million MSMEs in Nigeria (41.4 million micro-enterprises and 73,081 small and medium enterprises). The survey also revealed that small and medium scale enterprises (SMEs) accounted for about 50% of factory jobs and close to 90% of all the activities in the manufacturing sector.

In a 2021 report by the World Bank, it was reported that Nigeria’s informal sector contributes 49.7% to Nigeria’s GDP and is responsible for 80.4% of the country’s workforce.

With Nigeria’s unemployment rate projected to hit 40% by 2022, the number of people moving into the informal sector is expected to increase in the coming months as young and vibrant adults would take advantage of other opportunities outside the formal sector.

Can the informal sector provide some respite?

Despite the economic strength the informal sector wields, a poor and corrupt tax administration has made it almost impossible to harness the inherent revenue potential in the informal sector.

A fair argument is that the informal sector pays taxes through indirect taxes like the stamp duty paid on USSD transactions or the burden of VAT they bear as final consumers of some products and services.

As much as these taxes contribute to the total tax revenue, direct taxes make up the lion’s share.

In the United States, the individual income tax has been the largest source of federal revenue since 1950, amounting to about 50% of the total government revenue in 2019. Company income tax (CIT) contributes around 7%.

According to available data, CIT accounts for 45% of Nigeria’s total tax revenue; VAT comes behind with 14%, then Personal Income Tax with 11%.

With over 40 million individuals in the MSME space not remitting direct taxes, it is evident that tax collection is a pain point for the federal government of Nigeria.

One might argue that these MSMEs intentionally evade tax. However, the PwC MSME Survey in 2020 provided valuable insights that dilute the rigidity of such an argument.

After interviewing over 1,500 MSME owners, paying multiple taxes and levies emerged as the top challenge faced with the tax remittance of MSMEs. The apparent lack of coordination from federal and state tax agencies came in as a close second, and the absence of technology platforms for all taxes and levies charged completes the top three challenges MSMEs face with tax payments. All of which led to an apathetic approach towards taxation.

So, MSMEs do not intentionally evade tax. Instead, the system is set up to prevent them from paying taxes.

Emmanuel, a former tax consultant with one of the Big Four, opined that the lack of organization in the informal sector also contributes to the lack of accountability concerning taxation.

"Most employees in the informal space do not have employers that serve as tax collection agents for tax bodies like Lagos Internal Revenue Service (LIRS) and Federal Inland Revenue Service (FIRS). The lack of a well-organized database in place also makes tax collection difficult. Either way, the buck stops at the table of the tax administrators".


The chairman of FIRS Muhammed Nami, at the ‘Public Presentation and Breakdown of the Highlights of the 2022 Appropriation Bill’, disclosed that Nigeria has 41 million taxpayers but still struggled to match up with other African countries in the area of tax generation. He highlighted tax evaders as the reason for the disparity.

"If you also compare that with South Africa where they have a total population of about 60 million people, with just four million taxpayers, the total personal income tax paid in South Africa last year was about ₦13 trillion. You can now see that these things are not adding up".

The Nigerian government must begin to look towards efficient taxation as an avenue to raise revenue levels. If not, we would continue digging our heels into debt and eventually be caught in a debt trap.

Tax payment is a civil responsibility bestowed on every taxable Nigerian by the constitution with penalties clearly stated therein. The failure to effectively administer the responsibility of tax collection is a slap to the face of any country that touts itself as the giant of the continent.

Featured images courtesy Getty Images

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