FOREIGN DIRECT INVESTMENTS AND TAX REFORMS THE NIGERIAN EXPERIENCE (1990 – 2017)

ABSTRACT

This study examined the impact of recent tax reforms on Nigeria‟s foreign direct investment (FDI) net inflow from 1990-2017.  Under  the right  policy  environment, FDI  encourages  the transfer    of economic   productive   technology    and    know-how between economies   through spillover channels and linkages as  is  the  case  with  China and the Asian Tigers. The drivers of FDI flow include policy factors such as taxation and non-policy factors like availability of natural resources, market openness and size. Nigeria FDI-experience presents a paradox as she has not had a fair share of the world‟s FDI flow despite her huge non-policy related potentials thus raising critical question on the role policy factors such as taxation may have played over the years especially since the country recently embarked on tax reforms. Despite the reforms, Nigeria Tax System still have complexities which appear to deter the critically needed FDI. There is therefore need to carry out a diagnosis of Nigeria tax system, the impact of the reform and what ought to be done for an impactful and sustainable FDI inflow. The study also derives justification from the apparent dearth of empirical works on the Nigeria FDI-Tax Nexus particularly with the use of Effective Corporate Tax Rate as the tax (independent) variable. The ordinary least square method of multiple regression analysis, at 5% Level of Significance was used to analyze the data and hypotheses proposed. The study employed annual time series secondary data spanning the years (1990-2017) sourced from the Central Bank of Nigeria Statistical Bulletins and the World Bank/PWC Annual Ease of Doing Business Survey Reports in carrying out its statistical analysis. Diagnostic test result showed that the variables were not stationary at same levels hence the use of the Autoregressive Distributed Lag (ARDL) method of Regression Analysis since it accommodates a combination of 1(1) and 1(0) variables. The result of the various analysis tallies with the apriori expectation that Recent (1990 – 2017) Tax Reforms in Nigeria though not effective have impacted positively and significantly on her FDI (Net Inflow). The study also found a marginal FDI-Tax Rate Elasticity of 0.2% indicating that for every one percentage point change in Nigeria‟s Effective Tax Rate, her FDI (Net Inflow) is affected by 0.2 per cent. This, the study ascertained as the elasticity or responsiveness of FDI to changes in Nigeria‟s Effective Corporate Tax Rate. This result is consistent with Alli (2015), Okoi and Edame (2013) and similar to Hartman (1984) which found out that tax rate elasticity for retained earnings is significant while for transfers the results are insignificant.  The result is also particularly significant for this study which emphasizes the effect of taxation on not just the inflow of FDI but also its retention, hence the use of FDI (Net Inflow) as proxy for FDI variable. Moreso, as affirmed by this study and a recent World Bank Survey reports, investors are now more concerned with the predictability, certainty, simplicity, and the overall integrity of a tax system rather than just the tax rate hence the positive correlation and high coefficient of regression (0.195) between EPTD Index (a measure of investors‟ perception of tax systems) and FDI. This study strongly recommends that the Government of Nigeria should embark on a more drastic reform of her tax system in order to boost her FDI (Net Inflow). A continuous and concerted effort that yields the optimal balance between a tax regime that is simple, business friendly and one which can leverage enough revenue for public service, is what is urgently needed

CHAPTER ONE INTRODUCTION

1.1       BACKGROUND TO THE STUDY

In the words of Steinmo (1993), ―Modern government needs lot of money for development. How they get it and from whom they get it are two of the most difficult political issues faced in any modern political economy‖.  Governments the world over especially developing economies such as Nigeria hardly have sufficient funds to finance their economic growth and developmental needs, hence the need for private sector participation, particularly via foreign direct investment (FDI) what with its enormous benefits to the host economy. Several studies, for instance De Gregorio (2003), Carkovic and Levine (2002), Asiedu (2001); Obwona (2001), Sjoholeu (1999), Bende, Nabende and Ford (1998), Caves (1996),   Egbo (2010), etc., as well as several World Bank, IMF, OECD and UNCTAD periodic trade and investment reports affirm that FDI is most preferred  of  all  external  financing  means.    It  is  now  a  common  knowledge  that  foreign investment is indispensable for sustainable industrial development in most developing and poor countries of the world. This underscores the importance of a conducive global investment environment, characterized by open, transparent and non-discriminatory investment policies.

Although African countries have witnessed an increase in government revenue since the year

2000, these have been dominated largely by resource rents that are quite volatile and influenced heavily by fluctuations in international commodity prices (African Development Bank, 2015) Most countries of the world see attracting FDI as an important element in their quest and strategy for economic growth and development OECD (2008).  This is because according to Olusanya (2013), FDI is seen as an amalgamation of capital, technology, marketing, and management – critical  factors  for  meaningful  economic  development  of  any  modern  economy.  This  is  in addition to the equity-based risk-sharing benefit of FDI finance.

Moreso, efforts by several African countries including Nigeria, to improve their business climate stem from the growing desire to attract FDI, NEPAD (2009). The importance of FDI to developing economies and Africa in particular is further substantiated by its prime recognition as a critical factor in the New Partnership for Africa‘s Development (NEPAD) Initiative.   It is

perceived to be a key resource for the translation of NEPAD‘s vision of growth and development into reality.   This is because Africa like many other developing economic blocs needs a substantial inflow of external resources in order to fill the savings and financing gaps and thus leapfrog itself to substantial growth levels in order to eliminate its current pervasive poverty (NEPAD-OECD, 2009).

Unfortunately, the efforts of most countries in Africa to attract impactful FDI appear to yield little result contrary to the perceived and obvious need for FDI in the continent. The development is  disturbing,  sending  very  little  hope  of  economic  development  and  growth  for  African countries. Further, the pattern of the FDI that does exist is often skewed towards extractive industries, meaning that the differential rate of FDI inflow into sub-Saharan African countries has been adduced to be due to natural resources, although the size of the local market may also be a consideration, (Morisset, (2000); Asiedu (2001).

The high cost of accessing foreign debt financing as well as the stringent and near neocolonial conditions  of  foreign  aids  has  made  foreign  direct  investment  increasingly  attractive  to developing countries most of whom are facing declining domestic investment and higher cost of foreign borrowing.   Moreso, foreign direct investment seems an attractive form of capital inflow because it involves a risk-sharing relationship with the suppliers of this type of foreign fund. This kind of risk sharing does not exist in the formal contractual arrangements for foreign aid and borrowing (OECD, 2014).  Furthermore, as the World Bank World Economic Outlook of May 1994 summed it: ―Foreign Direct Investment is a large and growing source of finance that may help developing countries close the technology gap with the high-income countries, upgrade managerial and technical skills, and develop their export markets‖.

Emphasizing the immense importance of inbound FDI in modern economies,   (OECD, 2008) Policy Brief that focused on ―Tax effects on FDI‖, submitted as follows: ―Given the enormous potential benefit of FDI inflow, policy makers and researches alike, continually re-examine their tax rules (via reforms) to ensure they are attractive to inbound Foreign Direct Investment‖ and optimal resource mobilization locally. For governments, tax reform is one important instrument to adapt to a changing international environment. In recent years, many countries have implemented tax reforms which reduce the effective tax burden on investment – both foreign and

domestic investment with the added benefit of fostering domestic investments. Given that the border crossing mobility of capital and firms increases, it is reasonable to consider a reduction of the tax burden on domestic investment. But lowering the tax burden on investment necessarily implies a cut in public expenditure or a shift of the tax burden to other tax bases like e.g. labor or consumption. Sound tax policy has to carefully weigh the benefits of a corporate tax reduction to the economy as a whole against the cost

There appears to be a consensus in the literature about the main factors affecting foreign investment location decisions, see Dunning (1993); Globerman and Shapiro (2002); (2003); (OECD-MENA, 2010).  The most important ones are market size, real income levels skill levels in the host economy, the availability of infrastructure and other resources that facilitate efficient specialization of product, trade policies, taxation and political and macroeconomic stability of the host country.  The relative importance of the different factors varies – depending on the type of investment (OECD-MENA, 2007).  This study focuses on the role of tax reforms in attracting FDI. Fundamentally, tax policy shapes the environment in which international trade and investment take place, (OECD, 2008). The ability to offer internationally competitive tax system is increasingly seen today as core factor influencing FDI, (OECD, 2003 & 2007). Thus a core challenge for African countries is finding the optimal balance between a tax regime that is business and investment friendly and one which can leverage enough revenue for public service delivery, which also enhances the attractiveness of the economy, (NEPAD-OECD, 2009).  This is because investors routinely compare tax burdens in different locations, as do policy makers with comparisons typically made across countries that are similar in terms of location and market size (UNCTAD, 2014). A widely held view is that taxes are likely to matter more in choosing an investment  location  as  non-tax  barriers  are  removed  and  as  national  economies  converge, (OECD, 2008). The paper further submitted that another factor is how business-friendly the tax administration is perceived to be because Investors look for certainty, predictability, consistency, transparency, simplicity and timeliness in the application of tax rules and in many cases these considerations are as important, if not more important than the statutory tax rate paid, (OECD,2008). The desire to tax MNEs and other foreign investors‘ income while not discouraging investors raises critical questions concerning the sensitivity of FDI to taxation and the appropriate setting of various tax provisions that determine the host country‘s tax burden and

influence on investment and financing behavior, (OECD, 2008). Succinctly put, Tax competition

for FDI is a reality in today‘s globalized world economy!

This study looks at the role of tax reforms on Nigeria Tax System and her potential to attract

Foreign Direct Investment, in the light of her recent tax reforms.  It focuses on the period 1990 –

2017.    A  period  of  time  Nigeria  tax  system  and  by  extension  business  environment  has undergone seeming remarkable and unprecedented reforms as championed by the Federal Inland Revenue Service (FIRS) and successive democratic governments (especially since the return of democracy in 1999).   The choice of the topic is particularly against the back drop that most economic reforms by sub-Saharan Africa countries and Nigeria, in particular, hardly have remarkable and sustainable effects, (World Bank, 2010) and the apparent dearth of research work in this area. Hence, effectively and extensively, this study is an attempt at measuring the extent of the on-going tax and general investment climate reforms in Nigeria as it relates to attracting and retaining FDI in her economy.

1.2       THE PROBLEM OF THE STUDY

Nigeria tax system despite the recent reforms still has complexities and which appear to deter domestic and foreign investments and offer loopholes for tax evasion, especially by MNEs. Nigeria tax revenue as a percentage of GDP has remained less than 7% compared to Sub-Sahara Africa average of 15%, European Union average of 35.7%, and OECD‘s 34.8%, (OECD, 2014; Bickersteth, 2016). The problem of this study derives from the fact that despite the numerous efforts  (especially tax  reforms)  of the Nigerian  government  to  improve on  her business  or investment climate as to attract FDI since the advent of democracy in the country in 1999, the gap between her investment need and the FDI response has remained very wide (UNCTAD,

2014; OECD, 2014).  These efforts include improvements on her fiscal policy framework, repeal of old and moribund Laws, overhaul of her tax administration machinery, conclusion of bilateral investment and double taxation treaties, etc. Noteworthy, (African Development Bank, 2015); Alli (2015); Mukolu et.al. (2013); Ugwoke (2010); Egbo (2010), Oseghale & Amorchienan (1987); Akinlo (2004), have all confirmed a positive linkage between FDI and economic growth in Nigeria – hence the need to create attractive and motivating economic environment for it.

According to UNCTAD World Investment Report 2011, Nigeria falls below average in Africa and other developing economies when FDI inflows are adjusted to take into account the size of the domestic market and measured in terms of inflows per capita or per 1000 of GDP.   It is curious why Nigeria is still largely by-passed by the current world FDI boom in spite of her highly encouraging credentials of being the biggest economy (by GDP) and largest market in the continent of Africa in addition to tax reforms to transform the political, regulatory, business and investment environment of the country

The main research question of the sensitivity of FDI to taxation is an inconclusive empirical issue (OECD, 2012). This is because of the variableness of previous empirical work, Mooij and Ederveen (2003 & 2005), Edozien (1968); Ugwoke (2012), (OECD, 2012 & 2014), Alli (2015) etc. Moreso, extant literature tend to suggest that the influence of tax on FDI is complex and depends on a number of difficult to measure factors, hence additional empirical works are required to better understand the role of taxation amongst key factors influencing FDI attraction or location decisions by investors, (UNCTAD, 2015).

1.3       OBJECTIVES OF THE STUDY

The  main  objective  of  this  study  is  to  examine  the  effect  of  taxation  on  Foreign  Direct Investment inflow to Nigeria during the period (1990 – 2017), a period of time during which the country returned (in 1999) to her present democracy with its attendant conscious efforts to improve on the country‘s investment climate.  It aims also to measure the impact of the ongoing major tax reforms anchored by the Federal Inland Revenue Service (FIRS) – Nigeria‘s apex tax authority, implementation of which commenced in 2004. Therefore, the specific objectives of the study are to ascertain the:

1.  Effect of FDI on the growth of Nigeria economy (1990 -2017)

2.  Relationship between taxation and FDI

3.  Impact of tax reforms (1990 – 2017) on Nigeria‘s FDI (Net-Inflow)

1.4       RESEARCH QUESTIONS

1.   To what extent does the inflow of foreign direct investment affect economic growth in

Nigeria (1990 – 2017)?

2.   What is the extent of the relationship between taxation and FDI  in Nigeria during the period (1990 – 2017)

3.   What is the impact of recent tax reforms on Nigeria‘s FDI (Net-Inflow)?

1.5   RESEARCH HYPOTHESIS

1.   FDI has no significant effect on  the growth of Nigerian economy

2.   There is negative correlation between taxation and FDI (Net Inflow) in Nigeria.

3.   Tax Reforms do not have a significant positive effect on Nigeria‘s FDI (Net inflow).

1.6   SCOPE OF THE STUDY

The study covers the period 1990 to 2017.   The choice of the period is due to the following reasons:

–   This is a period that Nigeria economy experienced the most radical tax reforms ever.

–    The present democratic dispensation with its attendant political and social stability and economic reforms began in 1999.

–    Successive governments have embarked on a number of reforms and specific policies directed at improving the investment climate in the country since 1999.

–    The choice of the period will also permit a comparison between FDI inflow in Nigeria pre 2005 (1990 – 2004) and post 2004 (2004 – 2017).  This will serve to measure the nominal and real revenue-effects of the ongoing tax and other investment climate reforms on FDI inflow in Nigeria

Moreso, the study concentrates on the effect of taxation on FDI inflow in Nigeria due to potential difficulty in sourcing reliable data for a panel study.

1.7       SIGNIFICANCE OF THE STUDY

–    Nigeria government, tax authorities and other fiscal regulatory, as well as investment promotional agencies (such as NIPC) will benefit from the study as it aims to review Nigeria‘s present tax regime and the ongoing tax reforms in order to point out its deterrents/loopholes and proffer suggestions on the way forward .

–    It  will  also  specifically  proffer  solution  to  Nigeria‘s  government  on  some  policy guidelines  and  checklist  for optimal  fiscal  incentive that  will  not  only optimize tax revenue from MNEs but make our economy very FDI/Investment-Friendly.

–    The study will go to contribute to growing body of literature on the Taxation-FDI nexus and particularly as it relates to Nigeria, on which much have not been written.

Again, its attempt to measure the effects so far, of the current major Nigeria tax reforms on FDI is unprecedented.   This is particularly important what with the general believe that most sub- Sahara Africa countries (Nigeria inclusive) economic reforms hardly achieve the set economic goals or impact significantly on economic growth, (World Bank 2005 & 2010).

As expected, it is going to be significantly beneficial to policy makers, academia, tax administrators, foreign companies and the Nigeria economy in general.

1.8       LIMITATIONS OF THE STUDY

1.   The study has to rely on a number of proxy representations of some of the variables for non-availability or difficulty in deriving or managing the large volume of data that doing otherwise would entail.

2.   It is also limited to the use of secondary data by the envisaged difficulty in assessing and collecting primary data. MORESO, Time frame within which to carry out the study, given work and other socio-economic disruptions, was a limiting factor too.

3.   As it is typical for this kind of research question, our data are of limited extent and of limited quality. Therefore we have to make some assumptions (using proxies) on which we  base  our  confidence  that  we  can  use  these  limited  data  to  answer  our  research question.

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