|
Getting your Trinity Audio player ready...
|
“Taxes are what we pay for a civilized society.” – Oliver Wendell HolmesJr.
In 2017, The Economist magazine reported that Swedes were deliberately overpaying on their taxes, by $4 billion in 2016, to be precise. Initially deemed further indication of the ultra-collectivist yet liberal nature of Sweden, closer investigation uncovered the truth: a combination of negative interest rates on bank deposits and positive interest rates (0.56%) on tax refunds made it more profitable to overpay in taxes and hope to get a refund (Sweden has now scrapped the interest rate). But you can understand why people were quick to conclude that Swedes were paying too much tax. The entire Nordic region is a global star in tax collection. Estimates from the Organisation for Economic Co-operation and Development peg Sweden’s tax-to-GDP ratio at 44%, Denmark’s at 46%, and Finland’s at 44%. In 2000, Sweden’s tax-to-GDP ratio was nearly 50%! This is a dream scenario for Nigeria, a country where taxes amount to less than 7% of GDP. Even after considering differences in the history, governance, and wealth of the two nations, what drives the differences in tax attitudes in Sweden and Nigeria? Or to put it simply, if Swedes are overpaying, why don’t Nigerians pay tax?
Economists have been studying tax for centuries and although optimal tax theory guides governments on how to structure their tax systems, the discipline has made little headway on how to get people to pay taxes. Nevertheless, we have theories that can give us insights and prescriptions, and understanding which of these apply to Nigeria would tell us why Nigerians don’t pay tax, and, crucially, how to address that.
We get the economic foundation for tax enforcement from the Allingham-Sandmo (AS) model which posits that people evade taxes because the expected benefit of doing so is greater than the expected cost. In the simplest version of the model, the taxpayer weighs up the added benefit of keeping his income if he fails to fully declare it (and isn’t caught) against the penalty he would pay (if caught). The model tells us what we are now familiar with; increasing the likelihood of the evader being caught (through better enforcement) disincentivizes evasion, and so would increasing the penalty of evasion. But it also reveals more subtle insights for Nigeria. As punishment is a function of the likelihood of being caught and the penalty, there is no point having high penalties if enforcement is weak. Moreover, most versions of the AS-model suggest that evasion levels are independent of a country’s tax rates but empirical evidence suggests that higher tax rates lead to more evasion. The lesson for Nigeria? Strengthen enforcement, set large fines, and leave the tax rate as it is.
The AS-model gives us a basic framework for analyzing a Nigerian’s decision to pay tax, but game theory helps us analyze the decision in a more realistic strategic context between the taxpayer and tax-collector. Within this framework, a Nigerian’s decision to pay or evade is a direct function of what the tax-collector does; if the tax-collector enforces (e.g. audits) then the best option is to pay, but if they don’t enforce, the best option is to evade. This set-up is particularly applicable to the Voluntary Assets & Income Declaration Scheme (VAIDS) which aims to entice previous evaders into the tax net by waiving the penalties they would have paid if they were caught. So, as a tax evader, should I come under VAIDS? Well, that depends on my beliefs about the government’s willingness and ability to catch and punish me if I evade. If I think it is going to be business-as-usual in tax collection post-VAIDS, then I stick to my tried and trusted formula of evading taxes. Realizing this, the government has tried to signal its intention to enforce post-VAIDS by touting the expertise of its international forensic experts and warning citizens that they already have a list of suspected evaders. The extension of VAIDS beyond the March 31st deadline suggests that Nigerians are calling this bluff.
There is another game-theoretic approach to tax that may be more relevant to Nigeria: modelling the situation as an interaction between taxpayer and public service provider. Nigerians often justify their non-compliance by arguing that public funds are wasted or looted. Regardless of the moral status of this assertion, you can see the economic logic; if the government has been unfaithful in little, why trust it with more tax revenue? In this model, there are two main equilibriums: a steady state where people pay high taxes because they know the government will spend judiciously, and a steady state where people pay low taxes because the government spends frivolously. If Nigeria is stuck in the latter scenario, we need to step out of it, but as we do so, we are confronted by a chicken-and-egg challenge. Citizens don’t trust the government enough to take a leap of faith by paying higher taxes, but because tax revenues are so low, the government is unable to demonstrate its faithfulness by boosting public services.
Other theories can help explain Nigeria’s tax misbehavior. Social theories suggest that the problem is a bandwagon effect and we simply need to get enough influencers paying tax for the critical mass of the population to follow suit. Meanwhile, lowtaxpayment could stem from ignorance, not malice. Many Nigerians don’t know or understand tax laws and end up unintentionally evading. In this case, education is key, both in matters of financial literacy and tax affairs.
Once we figure out which models reflect Nigerian behavior, we would be able to boost compliance by following the model’s prescriptions. Given Nigeria’s meager compliance rate and how diverse the evaders are, it is likely that all models apply. This means that we need a coordinated approach of trying each model’s prescriptions while keeping an eye on the cost, reach, and applicability of each measure. For example, stricter tax enforcement may discourage evasion,but taxpayers would only comply begrudgingly if it is not followed by better public service provision. Moreover, education is an essential element of any approach to boost tax compliance. Finally, what we learn from Sweden and other Nordic countries is that the social contract of a nation matters too; it sets the terms and lays out what is expected from each party – government and taxpayer. Without a clearly communicated social contract in Nigeria, we will continue to debate why we should pay tax (or why we don’t) and never get to the business of actually paying it.
*The views expressed in this article are personal to the author and may not reflect the opinion of Vetiva Capital Management Limited or any its affiliates
Michael Famoroti
Famoroti is Chief Economist at Vetiva Capital Management. He can be reached on m.famoroti@vetiva.com.
