Dr. Emmanuel OjameruayeTuesday, June 3, 2014
[email protected]
Phoenix, Arizona, USA




he first part of this open letter focused on the issues of form of government and political restructuring. In this second part, I will focus on the issues of fiscal federalism, revenue allocation and resource control.

1. Fiscal Federalism

One of the most contentious issues that the conference is grappling with is fiscal federalism - the assignment of revenue collection/taxing and spending powers between the federal and state governments. This includes include the revenue allocation formula and the so-called "resource control" question. According to R. A. Musgrave and P.B. Musgrave, "Whereas a unitary government need not have its taxing and spending powers specified in the constitution, a federation by necessity must have them so specified. Indeed, fiscal arrangements - assignment of taxing and spending powers - are at the very core o the contract between the constituent governments which combine to form the federation. While the central government necessarily must fiscal powers, the comprising units retain a sovereign right to conduct fiscal transactions of their own".

Ideally, under a federation, each tier of government (federal, provincial/state, and district/local) should have assigned taxing powers to raise enough revenue to conduct its operations - administration and provision of public services - and no government should rely on another government for a significant portion of its revenue. The problem with Nigeria's federalism is that most states governments (SGs) and local governments (LGs) rely heavily on revenue allocated from the federation account, i.e. revenue collected by the federal government (FG) on behalf of the federation. To cure this anomaly, the taxing or revenue collecting power of the FG must be "devolved" in a way that reduces dependency of the sub-national units on the revenue collected by the federal government. The devolution of the fiscal power will ensure that the state/provincial and local/district government will be able to collect enough revenue on their own to perform their constitutional responsibilities. The challenge is to determine which taxing powers of the FG should be devolved to the state and local governments. Ultimately, the "federation account" should be abolished so that each tier of government can rely on the revenue it collects, but this is not possible in the short to medium terms because it may lead to instability and could cripple many states/provinces and LGs/districts. Therefore, as a first step, the federation account should be reduced by transferring some of the revenue currently collected by the federal government to the state and local governments. As a second step, the revenue allocation formula should be amended in a way that better reflects the "spirit" of federalism and ultimately leads to the demise of the federation account in the long-term as the state and LGs become more financially self-reliant.

In order to transfer some of the revenue-collecting power of the FG to the SGs and LGs, we must take a critical look at the key components of the federation account and determine which of the components the FG should collect and which ones should be devolved to the sub-national units in a "completely developed federation" based on best practices from other federations. The table below shows some of the key components of the current federation account revenue (i.e., federally collected revenue) and my proposed allocation of taxing or revenue collecting powers between the FG and the SGs/LGs in the "new Nigeria".

The "devolution" of revenue collecting power as proposed above will result in the transfer of substantial revenues to the SGs and reduce their dependency on the federally collected revenue. However, it will require companies to keep accurate record of the income they generate in each state and file tax returns in each of the state where they operate, in addition to a federal tax return. While the SGs may have the right to establish their own tax rates, it is important for the federal government to impose a "uniformity rule" for certain rates or bands (lower and upper limits) to allow for competition among the states to attract companies.

In addition to the above, I would like to suggest as follows:

  • Although the SGs are currently empowered to collect individual (personal) income tax from residents of their states (with the FG collecting income tax of residents of the FCT as part of independent revenue source), the FG should also collect personal income tax from all the citizens of the country as in the United States. This will foster a greater sense of "ownership" of the federal government by the citizens of the country and greater accountability and transparency by the federal government to the people. In this regards, the FG personal income tax rate (FITR) could range progressively from 1% to 10% of the taxable incomes of citizens while the SG personal income tax rate (SITR) can range from 1% to 20%. All employers of labour should collect payroll withholding taxes for both the FG and SGs (where the employees reside) and remit same to the FG and SGs on a monthly basis. Not later than the end of April in each year, each citizen - whether they are employed, self-employed or unemployed- must file both federal and state tax returns for the preceding year and be issued tax clearance certificate.

  • The local governments (LG) should be better empowered to collect property taxes based on the fair property values in their areas. On their part, the LGs should be required to adopt a structured and accountable approach in place of the arbitrariness that characterizes the collection of "tenement rates" in many parts of the country.

  • SGs should be empowered to collect estate and gift taxes on property inheritance and donations in a structured, transparent and accountable manner.

  • SGs should be empowered to expand the value added tax (VAT) or introduce sales tax on some commodities that are not currently subject to VAT provided it is done in a transparent and accountable manner.

2. Revenue Allocation

With regards to a new Revenue Allocation Formula (from the Federation Account), I will suggest as follows:

  • In addition to collecting revenue on behalf of the federation into the federation account (FA) based on the items in table 6 above, the FG should continue to collect its "independent revenue" (IR).

  • The FG should explore alterative and more efficient ways of funding its JV operations rather than the current approach of using NNPC to collect its share of crude oil, selling it and using part of the proceeds to pay its "cash call" and fund other petroleum-related activities such as "frontier exploration services", gas development, and payment of fuel subsidy, which deplete the "distributable revenue" - the funds available for sharing or allocation to the FG, SG and LG for the discharge of their constitutional responsibilities.

  • The NNPC should be dismantled or structured in a fundamental way to make it more transparent, accountable, efficient and effective. Most of its current subsidiaries or holding companies such as NPDC, NGC, Duke Oil, PPMC, KPRC, WRPC, PHRC and IDSL should be extricated from the Group to form independent public companies with the FG having a maximum of 20% and each SG having between 0 and of 10% and the private sector owning the rest.

  • The Excess Crude Oil Fund and Nigerian Sovereign Wealth Fund (Investment Authority) should either be abolished or re-structured as a FG entity and funded from the FG's share of the federation account and its independent revenue. Each state should be empowered to establish its own sovereign wealth fund like the Alaska Permanent Fund, the Texas Permanent School Fund, North Dakota Legacy Fund and Alabama Trust Fund, all in the United States and Alberta's Heritage Fund in Canada.

  • Local Governments should not directly participate in the allocation of revenue from the federation account. However, the SG should be required by law to allocate a fixed portion of their federal allocation (and internally generated/independent revenue) to their LGs.

  • Based on the proposed "devolution" of the FA in table 6, a differential-incremental derivation revenue allocation model should be adopted based on the following equations:

Where GOR = gross oil revenue, COS - total government crude oil sales, COSN = govt oil sales (onshore oil), COSS = govt oil sales (shallow offshore oil), COSF = govt oil sales (deep offshore oil), GS = total gas sales, GSN = gas sales (onshore gas), GSS = gas sales (shallow offshore gas), GSF = gas sales (deep offshore gas), PPT = total petroleum profits tax, PPTN = total petroleum profits tax (from onshore oil), PPTS = petroleum profits tax (from shallow offshore oil), PPTF = petroleum profits tax (from deep offshore oil), GT = total gas tax, GTN = gas tax (from onshore gas), GTS = gas tax (from shallow offshore gas), GTF = gas tax (from deep offshore gas), SB = total signature bonus, SBN= signature bonus (from onshore oil blocks), SBS= signature bonus (from shallow offshore oil blocks) SBF= signature bonus (from onshore oil blocks), GNOR = gross non-oil revenue, MD = import duties, NESS = Nigerian export supervision scheme (and/or export duties), LEV = various levies such as levy on rice import and levy on imported vehicles, CNOR = cost of collection of non-oil revenue, FAR = federation account revenue (gross), CGOR = "first line" charges on gross oil revenue such as JV cash calls, frontier exploration services and fuel subsidy, NOR = net oil revenue, DON = derivation fund for onshore oil and gas production; DOS =derivation fund for shallow offshore oil and gas production; DR = Distributable Revenue, FGSDR = federal government share in the distributable revenue, SGSDR = state governments' share in the distributable revenue, SGSDR(i) = "i" state government share in the DR (i.e. amount allocated to state i), Pi = population of state i, n = number of states, FGR = federal government revenue, FGIR = federal government independent revenue, and a, b, c, d, e, f, g and h are parameters that can be determined and changed over time by the National Assembly.

In the above model, in order to address the vexed issue of onshore/offshore dichotomy, I have divided oil and gas operations into three categories - onshore, shallow offshore (which I will define as less than 10 nautical miles from the shore of the littoral states) and deep offshore (more than 10 nautical miles from the shoreline). Although the above equations are self-explanatory, I would like to shed more light on some of them. Equation x states that the first line charge on the gross oil revenue should be fixed as a fraction of gross oil revenue and allocated to the FG (see equation xvii) to cover the related costs. Based on recent data, the first line charge hovers around 20%, so we can assume that a= 0.2 but this should be made to decline over time with the elimination of subsidies and restructuring of oil and gas operations. In equations xii, the derivation fund for onshore oil and gas is taken as a proportion (b) of the gross crude oil and gas sale as well as signature bonus from onshore oil blocks. This proportion is fixed at "not less than 13%" in section 162 (2) of the 1999 Constitution. However, the 2005 National Political Reform Conference recommended "an increase in the level of derivation from the present 13% to 17%, in the interim pending the report of the expert commission…Having regard to national unity, peace and stability, they (the South-South delegates) agreed to accept, in the interim, 25% derivation with a gradual increase to attain 50% over a period of five years". I will therefore suggest that the proportion be fixed at 15% (b = 0.15) and should be increased gradually by 2% point every until it reaches 50% - the percentage in the 1963 Constitution.

In equation xviii the derivation fund for shallow offshore oil and gas is also taken as a proportion (c) of gross crude oil and gas sale as well as signature bonus from shallow offshore oil blocks. Given the fact that the impact of oil and gas production in the shallow offshore oil blocks on littoral communities is less than in the onshore oil blocks, it can be argued that a smaller proportion of oil and gas revenue from shallow offshore blocks should accrue to littoral states, i.e., c should be less than b. I will therefore suggest that c should be fixed at 10% which is less than the 13% stipulated in the offshore/onshore dichotomy abolition act of 2004 which provides among other things that "The 200 metre water depth isobath contiguous to a state of the federation shall be deemed to a part of that state for the purposes of computing the revenue accruing to the federation account from the state, pursuant to the provisions of the Constitution of the Federal Republic of Nigeria (1999) or any other enactment" . In the model, oil and gas revenue from deep offshore operations (i.e. COSF + GSF + PPTF + SBF) - i.e., from beyond "200 metre water depth isobath" - is not to be subjected to derivation and should be paid in full to the distributable revenue (equation xv). The rationale for this is based on President Obasanjo's letter of 5 February 2004 to the National Assembly on his proposed Offshore/Onshore Dichotomy Bill in which he stated that "all existing producing oil fields are located within 200 metre water depth isobath…virtually all deep offshore commercial oil discoveries are located in less than 1,000 metre of water depth beyond which the quest for derivation cannot be justified…the impact of environmental pollution to coastline is at this distance considerably reduced…this contour also marks the limit of routine fishing activities". There are however several practical challenges in distinguishing or drawing the contour dividing the shallow offshore (less than 200 metre water depth isobath) from deep offshore. Based on the assumption that on average the depth of the ocean increases by about 1.3m over 100 m distance, I have estimated that the average depth of 200m will be reached at about 10 nautical miles (about 16.7 km). Therefore rather than using the 200m water depth isobath, I am suggesting that a distance of 10 nautical miles from shoreline should be used to demarcate shallow offshore from deep offshore for the purpose of applying the above model. I believe that excluding deep offshore from derivation (i.e. making the derivation coefficient = 0), reducing the derivation coefficient for shallow offshore (c) below 13% and increasing the derivation coefficient for onshore (b) above 13% is an acceptable compromise between those who are agitating for an increase in the derivation percentage and those advocating for its reduction.

Equations xv and xvi represent the "vertical allocation" formula. Equation xv is used to compute FG's share in the distributable revenue, with coefficient d representing that share. Equation xvi gives the state governments' share in the distributable revenue with the coefficient e representing that share. Since the local governments will not participate in the sharing, d + e = 1. For the "sharing coefficients", I will recommend d = 0.4 and e = 0.6. That is, 40% of the distributable revenue should accrue to the FG (which is slightly less than the current 48.5%) and 60% of the distributable revenue should accrue to all the state governments combined (which is significantly more that the combined 44.4% that currently accrues to the SGs (24%) and LGs (20%)). However in order to avoid a situation where some state governments may starve their LGs of funds or show preferential treatment to some LGs, the federal constitution should require each SG to allocate 60% of the revenue it receives from the DR to its LGs and keep only 40%. Notice that current Special Funds account (7.5%) has been excluded because I believe that the items funded under the "special funds" should be the responsibility of FG and should funded from its revenue (FGR).

Equation xvii represents the horizontal allocation formula. It states that the allocation to a particular state "i" from the state governments' share in the distributable revenue (SGSDR) should be based on only two factors - population and "equality" with population assigned a coefficient or weight of g and equality assigned a coefficient of h, such that g + h = 1. What this means is that SGSDR will be divided into two components - a "population component" (gSGSDR) and an "equality" component (hSGSDR) - using the coefficients g and h. The allocation to a state "i" from "population component" is proportional to the share of the state's population (Pi) in the total population of the country (P), i.e. Pi/P. However, the equality component will be divided by n, the number of states (federating units) and each state will get an equal portion, i.e. hSGSDR/n. I would suggest that g be fixed at 0.6 and h at 0.4, i.e., population should be given a weight of 60% and equality a weight of 40%. Notice that under this recommendation, we limited the factors for horizontal allocation to the first two stated in section 162(2) of the 1999 constitution and have excluded the other factors - internal revenue generation, land mass and terrain- which are contentious and not unnecessary in my judgment.

I would also suggest that the computation and allocation of funds from the federation account should be conducted quarterly rather than the current monthly ritual. In between the quarterly allocation, the Central Bank can advance funds to both the federal and state governments if required and the loaned funds can be deducted "at source" during the next allocation.

To illustrate the above vertical and horizontal allocations, if the DR in a quarter is N1,000 billion and there are 10 states (federating units or provinces), and the population of Nigeria is 150 million as per the last census while the population of state "A" is 10 million and that of another state B is 25million, then:

  • The FG share of DR, i.e. FGSDR = dDR = 0.4x1,000 = 400 billion

  • All the SGs share in the DR, SGSDR = eDR = 0.6x1,000 = 600 billion

  • The population component of SGSDR will be gSGSDR = 0.6x600 = 360 billion while the equality component will be hSGSDR = 0.4x600 = N240 billion

  • State A's share in SGSDR will be SGSDR(A) = 10/150 x360 + 1/10x240 = N48 billion

  • State B' s share in SGSDR will be SGSDR(B) = 25/150 x360 + 1/10x240 = N84 billion

  • State A will keep 40% of its allocation (i.e. 0.4 x 48 =N19.2 billion) and allocate the other 60% (i.e., N28.8 billion) to all its LGs using population(60%) and equality (40%) as the factor for sharing the N28.8 billion among the LGs.

I strongly believe the above suggested revenue allocation formula is smarter and more "federation-friendly" than the current formula.

3. Resource Control

With regards to the vexed issue of (oil) resource control, I would like to make the following points. Firstly, the proponents are not quite clear about what they want. While some are pressing for an increase in the oil derivation percentage from its current level of 13% to 50% over the long-term, others are calling for a total control of "oil resources", including oil and gas revenue by the oil-bearing state and/or local governments or ethnic nationalities. For instance, the authors of the 1990 Ogoni Bills of Right called for the right of the Ogoni people - a minority ethnic group of less than 1 million people in an area of about 1,000 square miles- in Rivers State, to "the control and use of a fair proportion of Ogoni economic resources for Ogoni development…the right to protect the Ogoni environment and ecology from further degradation" (by oil exploration and production) . The unanswered question is what is a fair proportion? On the other hand, the authors of the 1998 Kaiama Declaration stated that "all land and natural resources within Ijaw territory as belong to the Ijaw communities …because they are our basis of survival… (Ijaw) peoples and communities (have) right to ownership and control of our lives and resources". Again, the unanswered question is what does ownership and control of oil resources mean in practice? Does it mean that the "people" (individuals) or communities should be responsible for issuing permits and licenses for oil exploration or become shareholders or JV partners, collect and sell crude and receive payments of rents and taxes directly from oil companies? To add to the confusion, at their 2001 meeting in Benin City on the Resource Control issue, the Governors of the South-South Political Zone defined resource control as "The practice of true federalism and natural law in which the federating units express their rights to primarily control the natural resources within their borders and make agreed contribution towards maintenance of common services of sovereign nation state; the federating units are the 36 states and the Sovereign nation is the Federal Republic of Nigeria". Obviously, the governors want to control the oil business in their state which would include issuing licenses and permits, and collecting all forms of oil and gas revenue and then paying an "agreed" amount or tax to the federal government. However, contrary to their statement, this is applicable to a confederation, not a federation as I have described under the forms of government in section 1 of this paper. In other words, the governors were unwittingly calling for the transformation of Nigeria into a confederation which is untenable.

Secondly, the opponents of resource control believe that if the FG is denied the bulk of oil revenue by the oil-producing states, the FG and non-oil producing states, especially those in the North will not survive and there will be increased inequality in the country. Therefore they want the past and current addiction to oil revenue by all the levels of government in the country to continue. However, the fact is that the profile of oil and gas will decline in Nigeria in the long-term as the oil and gas wells dry up and the various governments are able to exploit other sources of revenue. Therefore, it is important to have a revenue collection and allocation system that reduces dependency on a natural resource that is found and produced only in a few parts of the country. Furthermore, the federating units in all federations usually enjoy a "comparative advantage" from the natural resources found in their territories.

Thirdly, the concept of resource control must not be restricted to oil and gas only; it must cover all mineral resources. Thus, while the rate of taxation and method of control may vary from mineral to mineral, the principle of control should remain virtually the same. For instance, if we all agree that the FG should control oil and gas, the FG should also control all other mineral including tin, gold, coal, marble, bitumen, etc. For instance, the revenue allocation formula proposed above should be applicable to all minerals, including oil and gas. You cannot have a local Igbeti Marble formula in the South West states which favors the communities while oil producing communities do not enjoy similar benefits as provided under the Igbeti Marble formula.

Fourthly, given the current state of the Nigerian federation and the need to ensure some degree of uniformity in the "control" of mineral resources, I think such control should rest with the federal government. However, the federating units as well as local governments (which represent the communities) where minerals are found and produced should enjoy a greater share of the benefits, especially revenue, arising from such mineral resources. If this is done, the demand for resource control will abate. I strongly believe that the revenue allocation formula I have proposed above will ensure that the federal government continues to control mineral resources while the mineral-bearing and producing states enjoy an increasing share of the benefits from such minerals.

10. Conclusion

I will conclude by reiterating that the National Conference offers a unique opportunity to create a new Nigeria for the 21st Century. We cannot continue business as usual otherwise we may either not survive this century as one country or we may continue to be a country marred in constant tensions and crisis that will continue to prevent us from being "one nation bound in freedom, peace and unity" and from attaining the "great lofty heights" envisaged in our national anthem. In this letter, I have offered far-reaching and ground-breaking proposals that will propel Nigeria forward as a "completely developed federation" for the 21st Century. I urge the conference to seriously consider the proposals.

Thank you.