Nigeria is a federal state in which high reliance on volatile oil revenue has complicated intergovernmental fiscal relations. The conflicting demands for control of the oil revenues generated in specific parts of the country, and for their distribution to all governments, have marked intergovernmental relations in Nigeria for several decades. In an attempt to attenuate regional and ethnic rivalries, the four regions existing at independence have been transformed into the present 36 states.1
Control over oil revenue is a contentious issue that has been tackled through substantial revenue-sharing arrangements. The financial relations among the federal, state, and local governments are currently governed by the 1999 constitution, which set broad revenue and expenditure assignments. The sharing of oil revenue is guided by provisions in the constitution. Currently, 13 percent of oil revenue (net of federation charges) is distributed to oil-producing states and—after deducting the initial 13 percent derivation—26.7 percent and 20.6 percent of the remaining oil revenue is distributed to all states and local governments, respectively. Following the large increases in oil revenue in recent years, state and local governments (SLGs) have come to account for about 55 percent of consolidated government non-oil primary spending.
The high share of spending by SLGs presents a challenge for the execution of macroeconomic policy. SLGs account for about half of general government spending (Table 13.2). As a result, coordinating policies across a very large number of SLGs is difficult, especially in the context of large and volatile oil revenue. In addition, establishing a vast network of strong institutions and processes to minimize duplication and ensure effective service delivery is complex in a country with a large population (more than 140 million people) with substantial needs (nearly 55 percent of the population lives in poverty). The key macrofiscal challenges facing the federal government are to maintain macroeconomic stability and foster greater consensus with states on the management of oil revenues.
Nigeria: Indicators of Fiscal Decentralization
Nigeria: Indicators of Fiscal Decentralization
| Type of government | Federal | |
| Population (million, 2007) | 136.3 | |
| Area (million km2) | 0.9 | |
| Levels of government | 3 | |
| States | 36 | |
| Municipalities | 774 | |
| Average municipality size (population) | 176,037 | |
| Minimum municipality size (population) | 19,710 | |
| IMF technical assistance mission on | 2001 | |
| fiscal decentralization | ||
Nigeria: Indicators of Fiscal Decentralization
| Type of government | Federal | |
| Population (million, 2007) | 136.3 | |
| Area (million km2) | 0.9 | |
| Levels of government | 3 | |
| States | 36 | |
| Municipalities | 774 | |
| Average municipality size (population) | 176,037 | |
| Minimum municipality size (population) | 19,710 | |
| IMF technical assistance mission on | 2001 | |
| fiscal decentralization | ||
Nigeria: Summary of Subnational Governments’ Finances, 2006
State and local governments coparticipate in 54 percent of budgeted oil revenue, 85 percent of value-added taxes, and 47 percent of the corporate income tax and import duties. Personal income taxes are directly assigned as own-source revenue.
Nigeria: Summary of Subnational Governments’ Finances, 2006
| Percentage of general government | Percentage of GDP | Percentage of non-oil GDP | ||
|---|---|---|---|---|
| Total subnational revenue | 37.5 | 12.7 | 20.5 | |
| Own-source revenue1 | 2.3 | 0.8 | 1.3 | |
| Transfers from the federal government1 | 35.2 | 11.9 | 19.2 | |
| Total subnational expenditure | 48.7 | 13.1 | 21.2 | |
| Overall balance (before transfers) | n.a. | -12.4 | -20.0 | |
| Overall balance | n.a. | -0.4 | -0.7 | |
State and local governments coparticipate in 54 percent of budgeted oil revenue, 85 percent of value-added taxes, and 47 percent of the corporate income tax and import duties. Personal income taxes are directly assigned as own-source revenue.
Nigeria: Summary of Subnational Governments’ Finances, 2006
| Percentage of general government | Percentage of GDP | Percentage of non-oil GDP | ||
|---|---|---|---|---|
| Total subnational revenue | 37.5 | 12.7 | 20.5 | |
| Own-source revenue1 | 2.3 | 0.8 | 1.3 | |
| Transfers from the federal government1 | 35.2 | 11.9 | 19.2 | |
| Total subnational expenditure | 48.7 | 13.1 | 21.2 | |
| Overall balance (before transfers) | n.a. | -12.4 | -20.0 | |
| Overall balance | n.a. | -0.4 | -0.7 | |
State and local governments coparticipate in 54 percent of budgeted oil revenue, 85 percent of value-added taxes, and 47 percent of the corporate income tax and import duties. Personal income taxes are directly assigned as own-source revenue.
IMF Advice on Fiscal Decentralization
A staff mission in early 2001 provided comprehensive technical assistance on decentralization issues. The mission included participation by World Bank staff and was aimed at examining options for improving the intergovernmental fiscal system in Nigeria. The mission reviewed the institutional framework for decentralization, its macroeconomic implications, expenditure and revenue assignments, and administrative arrangements to improve tax collection and management of public funds.
The mission stressed the deficiencies of the transfer system current at the time. This system—based on sharing of oil revenue and including the 13 percent allocation for oil-producing states on a derivation basis—was viewed as not sustainable given increasing tensions between the demand for additional derivation and the claims for redistribution among different states. The mission found significant horizontal imbalances at the state level, a low correlation between transfers and states’ relative needs, a derivation formulation that benefited mostly middle- and high-income states, and no definition of minimum public services to be provided by SLGs in return for the transfers. Furthermore, the arrangement makes most subnational budgets highly sensitive to volatile oil revenue, and complicates macroeconomic management by fostering increases in spending as oil prices rise, leading to significant deficits or arrears at subnational levels when oil prices decline.
Greater clarification and understanding at all government levels with regard to the execution of their expenditure assignments was recommended. The formal assignment of expenditure responsibilities among the different tiers of government is similar to that found in large federal systems. However, the mission found lack of clarity and duplication of effort in certain areas (responsibilities were either overlapping or not assigned, especially in relation to education and health care). The mission also noted problems in the coordination of intergovernmental expenditure policies, a lack of accountability in service delivery by SLGs, and the potential proliferation of deductions-at-source practices by higher levels of government to undertake some spending responsibilities originally assigned to lower government levels (this was the case for basic education, for example, because the lower levels could not ensure payments to teachers). In this regard, the main recommendations included the following:
define through national legislation the detailed distribution of functions relating to individual public services, such as education and health; and
ensure that the availability of financial resources for each level of government is broadly commensurate with that level’s assigned expenditure responsibilities.
The transfer system should be reformed accordingly. At a minimum, special-purpose transfers should replace direct investment by the federal government in areas of subnational jurisdiction.
A more radical approach would also include
a new general transfer system based on the costing of minimum essential functions and on estimates of overall expenditure needs and own-revenue capacities;
a floor for transfers to ensure the continued provision of essential services, to be financed by savings from periods of high oil prices; and
capital transfers to promote a more even distribution of infrastructure.
The mission also called for a strengthening of SLGs’ non-oil revenue collection and administration, and a revision of the revenue-sharing arrangements. Tax policy and administration in SLGs were found to be fraught with weaknesses, including limited non-oil revenue collections with largely unexploited tax bases, lack of control by SLGs over the rates of most of the taxes they levy, widespread tax evasion and noncompliance, and pervasive corruption in tax administration. Despite the fact that transfers are likely to remain large in relation to SLGs’ expenditures, the mission believed that it was essential for accountability that SLGs finance their expenditures at the margin from own-revenue sources. In that context, specific recommendations included
centralizing the collection of personal income tax in the federal revenue agency while allowing subnational governments to set marginal rates;
transforming the 13 percent derivation rule into a royalty share and an explicit environmental excise; and
providing SLGs with additional sources of revenue, with some control over rates, including excises and business taxes, surcharges on utility bills, and improved property taxes.
Public financial management in SLGs should be strengthened. At the time of the mission, there was no common macroeconomic framework for all government levels, and reporting of fiscal operations by SLGs was lacking, partly as a result of the absence of a harmonized system of budget classification and accounting for all levels of government. To tackle these problems, the budgets of all three levels of government should be consistent, having the same basic underlying macroeconomic assumptions; and a uniform set of guidelines should be introduced for budget preparation and accounting to be followed by all tiers of government. A consolidated account for the states at the central bank would help coordinate treasury functions at the state level.
Setting limits on borrowing by different government levels is crucial to maintaining macroeconomic balance. The mission recommended a set of rules, including limiting domestic borrowing to a certain percentage of SLG revenue, maintaining the practice of not allowing external borrowing by SLGs, creating professional capacity for debt management in the states’ ministries of finance, and establishing a system to provide the federal government Debt Management Office with information on all aspects of debt.
Recent Progress
Limited progress has been made to date in implementing the recommendations on decentralization issues, and the challenges may have increased since 2005 in the context of unusually volatile oil prices. Following the return to democratic rule after a long period of dictatorship, building trust in the relationships between the different government levels remains a challenging task. At the same time, intergovernmental dialogue has improved, leading to the implementation of several initiatives to strengthen the decentralization framework.
Since 2004, informal agreements have been reached by all government levels to follow an oil-price-based fiscal rule.2 Windfall oil revenue, determined on the basis of a conservative oil price, has been set aside in a dedicated account (excess crude account) at the central bank.3 This fund facilitated the conduct of macroeconomic policy during a time of very high oil prices, and should help to smooth spending in the current downturn. In 2008–09, however, some states have challenged the constitutionality of this arrangement.
The Nigerian authorities started working on the implementation of service-delivery benchmarks for poverty-related spending by SLGs. With support from the World Bank and U.K. Department for International Development, the federal government coordinated the design of benchmarks for service delivery to be followed by most state governments in the context of each state’s own reform agenda—State Economic Empowerment and Development Strategy (SEEDS). A first SEEDS benchmarking report was published in 2007; however, the program was suspended in 2008.
Fiscal responsibility legislation is being prepared as a means to improve intergovernmental fiscal relations. In 2007, the Fiscal Responsibility Act was approved by the National Assembly and signed by the president. The act sets out transparency requirements, sanctions for noncompliance, guidelines for budgetary practices, debt limits, and a fiscal framework centered on an oil-price-based rule. However, this act only applies to the federal government, although it encourages states to follow similar practices. Political agreement has been reached for each state to draw up its own fiscal responsibility legislation, which is meant to be supportive of the objectives of the federal law. Drafting of state-level laws commenced in 2008; a few have been enacted, and the federal government and donors are providing support. A key measure aimed at enhancing the transparency and accountability already in place is the publication of the transfers from the Federation Account (the account into which all federally collected revenues are paid on a monthly basis) to the federal government and each SLG.
Borrowing by SLGs appears to have been limited, partly explained by the sharp increase in resources available for SLGs during the period of booming oil prices. In addition, however, a high provisioning requirement was introduced to discourage lending by commercial banks to SLGs, and the federal government is making it difficult for SLGs to use monthly oil revenue distributions as collateral for borrowing. The effectiveness of these measures will be tested as SLGs seek to increase borrowing in response to the sharp decline in oil revenue in 2009. A National Debt Management Framework setting the policy guidelines for debt management in Nigeria has been prepared and includes a number of restrictive provisions and guidelines regarding subnational borrowing. It also offers guidelines for sustainable subnational debt management within Medium-Term Public Debt Strategies (2008–12). The Subnational Debt Management Strategy is to facilitate the development of institutional capacity for public debt management at the subnational level through the provision of support for the establishment and operation of Debt Management Departments in state governments.
Remaining Challenges
Comprehensive reform of intergovernmental relationships remains critical to ensuring macroeconomic stability and safeguarding Nigeria’s oil wealth. SLGs are reasserting their constitutional right to use accumulated oil savings and current oil revenues. As a consequence, the informal budget price rule is being reconsidered, some tiers of government are assessing whether to establish a sovereign wealth fund, and there is a risk that the rules for accumulation into, and withdrawal from, the excess crude account might be adjusted. Another source of fiscal risk is linked to the new policy to discontinue withholding states’ external debt service obligations from their allocations from the excess crude account. The 2007 Fiscal Responsibility Act enshrines the oil-price-based fiscal rule, but it cannot bind subnational governments.
Expenditure assignments across government levels need to be clarified further. National legislation should specify the detailed distribution of functions relating to individual public services, such as education and health. At the same time, the availability of financial resources for each level of government must be ensured to broadly match that level’s expenditure responsibilities.
An overhaul of the revenue-sharing system would be needed to reduce horizontal imbalances, increase the correlation between revenues and states’ relative needs, and establish explicit links between revenues and service delivery. Although changes along the lines of staff recommendations are politically difficult, some of the recent measures—the current oil-price-based fiscal rule and the medium-term expenditure framework by the federal government—are steps in the direction of setting spending levels irrespective of current oil prices and more closely linking spending units’ objectives with costed projects and programs. A further stimulus to the discussion of revenue allocations could come from proposals in mid-2009 to make the non-oil revenue system more business friendly.4 SLGs currently receive 85 percent of value-added tax revenue. Proposals for changes to the non-oil tax regime would increase indirect taxes at the expense of direct taxes, and likely also involve a reconsideration of the value-added tax sharing agreement. Hence, grounds on which to discuss proposals to change the current revenue-sharing system already exist. Even though revenue-sharing will continue to be the dominant source of funds, financing SLGs’ expenditures at the margin from own-revenue sources should increase their accountability.
Judicious borrowing constraints on SLGs need to remain in place. Borrowing by SLGs is limited to the domestic market; it is also constrained by high capital-provisioning requirements on banks (50 percent) and the difficulty most states have in accessing domestic capital markets at nonprohibitive rates (only a small number of states have obtained financial ratings). Furthermore, the Fiscal Responsibility Act requires that all tiers of government present cost-benefit analyses of their borrowing. These constraints must be fully enforced, especially at times of lower oil prices when the sharp reduction in monthly oil allocations is likely to prompt states to borrow more to partly of set the required expenditure adjustment. Details on borrowing strategies and existing debt levels are not yet known, further underlining the need for increased transparency of fiscal operations at the subnational level.
The Nigerian federation includes 36 state authorities and the Federal Capital Territory of Abuja.
The rule works as follows: Following parliamentary discussion, a budget reference price is set for an assumed production target. Revenues greater than budgeted are saved in an account at the central bank. In the event of revenue shortfalls, disbursements are made from this account. In addition, the excess crude account has been used to repay Paris Club debt, finance large-scale infrastructure projects jointly agreed to by all levels of government, and finance the explicit fuel subsidy.
About US$12 billion was used in 2005–06 to cancel the debt with the Paris Club. The budget oil price was US$35 per barrel in 2006, compared with an actual price of US$60 per barrel.
These issues were discussed by an IMF tax policy mission in December 2007.