Under the hood: A look into taxation in Nigeria’s informal sector

A recurring theme in many reports about Nigeria’s tax base or compliance is that a huge part of the country’s working population do not pay taxes. In this report, using data from a recent survey, we challenge that assumption. Instead, we show that Nigerians do indeed pay taxes, however, in an informal way and many times to non-state recognised actors. We also show that in many cases, these taxes are extracted before and irrespective of whether the payer makes any money. In most cases, the payers get little benefit from these non-state collectors and are only constrained to comply with the threat of force or loss.

The decline in oil prices has had a tremendous impact on Nigeria’s revenue and the country’s ability to finance its obligations. In confronting this reality, the Federal Government has indicated its desire to maximise its tax potentials. Expanding Nigeria’s tax base and encouraging tax compliance has proven to be a rather herculean task, as the country has a large shadow/informal economy. Thus, it becomes difficult to measure the unreported economy – possible tax evasion – and the “unrecorded and non-observed” economy, which indicates the income excluded from national income data following the inability to adequately account for them.

Traditionally, the informal sector or shadow economy describes business activities that operate outside of government regulation and are largely unregistered. Wholesale adoption of this definition suggests that the sector is untaxed, unregulated and largely operates underground. While this explains the informal economy of developed nations, developing countries do not have these clear distinctions. Informality in developing countries is characterised by relics of traditional trading patterns such as open-air markets, quirky transportation modes like okada (motorcycle taxis) and businesses that emerged in response to unplanned urbanisation like stall trading, hawking, vulcanising (patching tyres) and the likes.

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Unlike the underground economy of the developed world where the informal economy operates parallel to the formal economy, the informal economy in Nigeria provides some basic services that are absent in the formal economy. For instance, grocery shopping in formal supermarkets, almost absent prior to 2001, is taking a retreat and is becoming more limited where it is available. The growing gap is being reclaimed by informal grocers. Vulcanising services are another entirely informal activity that are typically done by organised garages in the developed world.

Against this background, this research was aimed at assessing the percentage of income that informal businesses spend on taxes, the frequency and types of taxes paid and its effect on their businesses. For a balanced view, tax enforcers and collectors were interviewed to get an understanding of the authority backing their tax collection and their system of remission.

This research explored the following questions:

• Total daily revenue of some informal businesses and percentage of this income spent on taxes
• Number of taxes paid daily, weekly or monthly and consequences for non-compliance
• Perceived effect on businesses and general perception of these tax arrangements
• Legitimacy of these tax networks, remittance networks and their stalks

The findings of this study clearly showed that the tax base of Nigeria is much larger than thought, but much of it is in the informal sector. These taxes, to a great extent, are not captured in any official records at state or federal level, reflecting the inability of the state to properly project itself, leaving the door open for other actors to come in and secure relevance. When Nigerians are asked why they do not pay taxes, they say it is because they get no services from the government. However, the entities that collect various levies from bus drivers, okada riders, hairdressers and vulcanisers, do not deliver much in terms of benefits either. It should, therefore, prompt a rethink of what really ensures higher tax compliance in a state, namely the credible threat of sanctions, up to and including violence.

This means that the capacity of state and federal governments to enforce tax collection is directly proportional to their ability to enforce penalties for tax default. We are also already seeing this emerge in some parts of the North-West and North-East, where armed groups can enforce tax compliance.

Our findings also bring into sharp relief the unease of doing business in Nigeria’s major cities. The arbitrary and multiple nature of taxes and levies affect all classes of economic actors, including those at the bottom of the pyramid. In their case, it only serves to impoverish these people who do not have the means to secure a better deal from those who collect these taxes.

These multiple and arbitrary taxes also have the effect of slowing down their financial gains and reducing their disposable income, which might have benefited other sectors of the economy.

To successfully incorporate the informal sector into the tax base of the country, it is our view that incidents of multiple taxation need to be addressed urgently. The process of administering tax Identification Numbers needs to be streamlined and tied to something that every Nigerian needs, such as a mobile phone number or National Identification Number and a Bank Verification Number. To this end, the concerted efforts around NIN registration will go a long way to achieve the objective of giving a foundational ID to Nigerians, upon which other services can be built.

We believe that the tax administration regime should be simplified and unions and non-state actors that place a tax burden on citizens should be checked. Also, the government needs to do a lot to surmount the distrust that citizens have for it, by showing people the benefits of tax compliance, which include better infrastructure and service delivery.

Download the complete report (38 pages)