The Politics of Revenue Allocation and Derivation
Postscript By Waziri Adio
The heated debate around the proposed change to the formula for sharing the revenues from value added tax (VAT) among states would not have come as a surprise to anyone who has paid more than scant attention to our history. Revenue allocation among and within tiers of government is always contentious and usually politically fraught in a federal system, especially in ours. And of the different revenue allocation principles that we have employed, pre- and post-independence, the derivation principle has always aroused the most passion.
The presidential committee on fiscal and tax reforms veered into revenue allocation space, and therefore into controversial territory, when it proposed a new formula for vertical and horizontal distribution of VAT revenues. To be sure, adjusting the VAT rate and how consumption is attributed falls within the ambience of tax reforms. But venturing into how revenues should be shared, no matter the intention, is a needless encroachment into another territory, and into a historically contested territory at that.
Even when a link can be established between how a pie is shared and the potential size of the future pie, the co-mingling of tax reforms and revenue sharing should have been avoided. Tax reform is largely a technical exercise. However, revenue sharing in a federal system is an intensely political affair, managed through “negotiated compromise” and “political bargain” between and among the centre and the constituent units of the federation. It is not handed down like a tablet from the mountain.
Revenue allocation in a federation with deep fault lines and uneven development/endowment is naturally combustible. It is not a matter to be approached with the levity, the conceit and the paternalistic attitude shown so far by the presidency and its committee. One, the money involved is not a grant from the Federal Government to the states. Rather, the money belongs to the Federation; and in this particular instance, VAT is largely a subnational tax in Nigeria. The FG that receives the least of VAT (some say just as a cost of collection) should not be the one dictating the terms of how the others will share their portion, and without even the simple courtesy of requesting inputs from them.
Two, we have a permanent and constitutional body, the Revenue Mobilisation Allocation and Fiscal Commission (RMAFC), whose principal remit is revenue allocation. So, that revenue sharing bit should have been off-limits to an ad-hoc presidential committee. Three, changing how revenue is shared among and within tiers of government in a federation is first and foremost a conversation between the centre and the constituent units. To be sure, the inter-governmental discussion can be facilitated by experts and other stakeholders are allowed to chime in. But this is principally a negotiation among the federating entities that jointly own the revenues (FG, states and LGAs).
From our history, the necessarily disparate positions of the constituent units of the federation should be documented and submitted, then a middle-ground hashed out. The politically sensitive issue is not what can be subsumed under a heap of hundreds of other issues in two-hour presentations that appear like mere attempts to tick the box. Even if there is a political consensus to drive the proposed changes through tax reforms rather than through changes in overall revenue allocation or even if the states are not in the mood to insist only on one route, it is not unreasonable for the states to expect drafts of the proposed changes in the revenue allocation formula be shared with them before the bills are sent to the legislative arm. There are some missteps around inter-governmental relations, political management and even policy process on these sensitive bits that unfortunately suggest that deliberate guile is at play. It is such perception that feeds the narrative about a hidden agenda.
Nigeria has a rich history on revenue allocation and a verdant literature on federal finance that the presidency has no excuse for making such a hash of things or to be acting surprised about the blowback. We are a federal state, not a unitary one, and the federal government cannot be riding roughshod over the constituent units. Government cannot make, implement and sustain public policies without a sense of history and without paying serious attention to subsisting political bargains in the country. There is no activity more political than revenue sharing in a federal system.
Before RMAFC was established as a permanent revenue allocation body, Nigeria had eight different revenue allocation commissions, starting with the Phillipson Commission of 1946 after the Arthur Richard Constitution of the same year came into being. The other commissions were: the Hicks-Phillipson Commission (1951), the Chick Commission (1953), the Raisman Commission (1958), the Binns Commission (1964), the Dina Commission (1968), the Aboyade Commission (1977), and the Okigbo Commission (1980).
At various times, the different commissions recommended the introduction/application of different criteria/principles for revenue allocation in Nigeria. These criteria included: population, derivation, even progress, need, minimum responsibility/minimum national standards, balanced development/even development, equality of states, absorptive capacity, independent revenue/tax effort, and social development factor. Some of these criteria are still in still in force today in one form or the other.
But as Augustine Ikein and Comfort Briggs-Anigboh pointed out in their book on “Oil and Fiscal Federalism in Nigeria,” revenue allocation has always been a hotly contested endeavour because revenue sharing is necessarily a zero-sum. They wrote: “Which principles to use, in what combinations, and how much weight should be assigned to them, in order to obtain some level of satisfaction from interested stakeholders, had been a ‘most serious and intractable political issue’ in Nigeria.” Of these criteria, the principles of Derivation and Need (in different iterations) have been the most controversial. We will return to this shortly.
There are many authoritative books and essays, written by Nigerians and non-Nigerians, about the history and process of, the rationale for and contestations about revenue allocation in Nigeria. A notable one is the classic by Professor Adebayo Adedeji, “Nigeria Federal Finance: Its Development, Problems and Prospects,” published in 1969 but recently reissued. Some others are: “Nigeria Federal Financial Experience” by Adedotun Phillips (1971); “Recent Trends in Federal Finance” by Prof Sam Aluko (1979); and “Revenue Sharing in the Nigerian Federation,” by Lawrence Rupley (1981). The 1998 book by Ikein and Briggs-Anigboh, quoted above, is also a good reference document.
What is clear from the foregoing is that federal finance is a distinct field (separate from tax advisory) and that Nigeria has substantial body of knowledge and experience to lean on to handle the matter with the sensitivity that it deserves. This is especially so because the major change proposed to the horizontal formula for sharing VAT is to increase derivation from 20% to 60%. Just a casual reading of the rich texts on revenue allocation would have shown that derivation, which entered our revenue allocation lexicon right at the beginning of federal finance in 1946, has been the most controversial principle. Even thinking of a three-fold increase in the primacy of a contested principle should have set off alarm bells. This is not just because of the sudden challenge to an existing political bargain but also because this could invite request to have a similar hike in derivation proportion in other areas, particularly oil and gas.
Over the time, the contestation about derivation has been between those who consider it as just and those who think it is a drag on even development in a federation. The application of derivation has varied with time: it was allocated a higher percentage when the constituent units (regions) were more dominant than the centre and a lower percentage when the centre gained greater prominence. There have also been disputes over what is included in or excluded from derivation and how such inclusion-exclusion matrix advantages or disadvantages some regions/states.
Accuracy of and changes in data have also been at issue. Prof. Adedeji, who reckoned that derivation principle is better suited for loose federations with little sense of national unity or citizenship, stated that: “unqualified application of the derivation principle in a country like Nigeria, where statistical data are far from reliable, is bound to lead to an unfair distribution of resources.” He wrote this more than 50 years ago.
Additionally, regions/states have switched their positions based on whether they have resources that attract derivation or not. Two examples would suffice. According to Rupley, the governments of Northern and Western regions supported derivation from 1946 to around 1960 when agricultural produce were the mainstay of the country’s economy but as oil was coming into prominence, the two regions “reversed their arguments with respects to the desirability of the principle of derivation” while the Eastern Region protested the plan to change the “rules of the game.” However, during the revenue allocation debates of 1981/1982, only the three oil-producing states of Bendel, Rivers and Cross River led the clamour (Rivers and Cross River were not joined by Imo and Anambra from the old Eastern Region; while Bendel broke ranks with the successor states of the former Western Region which had opposed derivation in the 1960s).
Basically, regions/states support derivation principle when it suits them and oppose it when it doesn’t. Nigeria, however, has struck a political bargain on derivation: it is accommodated, though assigned a low percentage while priority is given to other principles such as equality and need. The negotiated compromise is that derivation, no matter how it is attributed, is what everyone can live with as long as it is not the main principle for sharing centrally-collected revenues. Derivation for minerals was thus 3.5% in 1982 and raised to at least 13% in the 1999 Constitution.
For the VAT due to states, derivation currently attracts 20%, behind equality of states and population, which are assigned 50% and 30% respectfully (and possibly derivation was up to 20% because VAT was not a significant source of revenues in 1994 when it started). The current political bargain (for minerals and VAT) is definitely not perfect and there is adequate evidence to that effect within and across zones and in terms of perverse incentives in some states cheating others by not paying VAT on their contracts while still guaranteed decent payout from the VAT pool. The question is not that there is nothing to address. It is about the need to address such through the appropriate channel and in the proper way.
There is also a small lesson about process and concession from the last time we tried to change revenue allocation formula in a democracy. This was in the Second Republic. On 23 November 1979, President Shehu Shagari set up the Presidential Commission on Revenue Allocation headed by Dr Pius Okigbo. The Federal Government, the then 19 states and the LGAs were invited to submit memoranda to the commission on how centrally-collected revenues should be allocated. In its memo, FG wanted 70% for itself but 20% to states and 10% for LGAs. The states, however, wanted FG to have just between 28% and 50% and more for themselves.
After extensive consultations and deliberations, the commission submitted its report to the government in June 1980, recommending 53% to FG, 30% to states, 10% to LGAs and 7% for a special fund. FG reviewed the report and issued a white paper in August 1980, indicating what it was accepting or changing (increasing its share to 55%), and making a significant concession on derivation, which the commission had rejected (but recommended that part of the special fund be used for remedying the impact of mineral exploration).
It was after the whitepaper that the executive sent a bill to the National Assembly in November 1980. Procedurally, the key stakeholders and the public need to know what a government has accepted and rejected from the expert committee or commission it set up and the reasons for its decisions. Nothing of such happened with the fiscal and tax reform committee. Yet such transparency and adherence to public sector processes are necessary not just for doing everything by the book but also for reducing friction in a low-trust environment.
Also, reasonable concessions have to be made as policymaking in a diverse federal state a sensitive like revenue sharing cannot be driven by dogmatism, absolutism or ego. Revenue sharing is a political enterprise, and politics is about give and take. The first version of the bill that Shagari sent was passed and signed under a cloud of controversy, and when challenged, the Supreme Court declared it null and void. That’s another lesson about the democratic process. A new bill was sent, passed following due process, and signed into law on 22 January 1982. On the proposed VAT formula, it is not late to step back and make course correction, guided by practical politics, process and history.
