DO FISCAL INCENTIVES PROMOTE INVESTMENT?

EMPIRICAL EVIDENCE FROM NIGERIA

Author(s): Babajide Fowowe
Source: The Journal of Developing Areas , Fall 2013, Vol. 47, No. 2 (Fall 2013), pp. 17-35
Published by: College of Business, Tennessee State University

Stable URL: https://www.jstor.org/stable/23612281

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 The Journal of Developing Areas
Volume 47 No. 2 Fall 2013

DO FISCAL INCENTIVES PROMOTE

INVESTMENT? EMPIRICAL EVIDENCE FROM
NIGERIA

Babajide Fowowe
University of Ibadan, Nigeria

ABSTRACT

This study conducts an empirical investigation of the effects of fiscal incentives on

Nigeria. We constructed two indexes of fiscal incentives which track the different t
of incentives embarked upon since the 1970s and these indexes are then included in
investment and foreign direct investment equations. The empirical results show
negative effect of fiscal incentives on both private investment and foreign direct
Nigeria. Rather than focusing on fiscal incentives, the country should concentrate o
factors that discourage investors such as infrastructural bottlenecks, poor institutions
framework.

JEL Classification: C32, E22, H25, 055

Keywords: fiscal incentives, private investment, foreign direct investment
Corresponding Author's Email Address: babafowowe@hotmail.com

INTRODUCTION

Fiscal incentives have been in existence in Nigeria since the Colonial era in
they are still very much on the agenda of the government. There have been rec
at introducing more fiscal incentives and this is evident from the fact that b
and 2010, three different technical committees have been constituted by the
Finance to review the existing system of incentives and recommend addition
to attract investment. Thus, it can be deduced that fiscal incentives will still fe
Nigerian investment climate for years to come.
This is interesting because among other things, there is no agreement
efficacy of incentives. Indeed there have been doubts about whether incentiv
effect on the economy since the 1950s. Studies such as Barlow and We
showed that companies in the U.S. did not consider fiscal incentives as a maj
to be considered prior to investing in foreign countries. Barlow and Wend
study found that companies ranked fiscal incentives fourth among pre-re
foreign investment. This view is corroborated by Wells and Allen (2001) wh
foreign investment did not experience any significant decline following the
tax holidays in Indonesia in 1984. This has made some economists wo
incentives are so popular despite the fact that their effects are either slight
(Shah and Toye, 1978).
Such studies have buttressed the argument that fiscal incentives do no
investment and are in fact detrimental to government revenue and investme
of incentives have been highlighted in the literature and these include: loss of g
revenue, cumbersome and costly tax administration, distortions in econom

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 18

leading to low productivity, leakages in government revenue because of tax avoidance

and evasion, increased tax burden on other sectors, increased lobbying, rent-seeking and
corruption, and difficulty in discontinuing incentives.
Despite the aforementioned, fiscal incentives are still popular in many countries.
Incentives have been cited as a contributory factor to increased investment in countries
such as Ireland, Singapore, and Mauritius. It has been argued that incentives are
necessary if a country's tax system is to remain competitive with respect to its neighbors.
Fiscal incentives have also been rationalized because they help in alleviating market
failures where investment is not being allocated to the most optimal uses. Proponents also
claim that incentives generate positive externalities on the economy such as R & D
investments or development of public goods. Empirical studies such as Young (1988) for
the U.S. and Shah and Slemrod (1995) for Mexico have found that incentives are
important determinants of investment.
It can be seen that there is no consensus about the benefits or otherwise, of fiscal
incentives. While Nigeria has enacted over 15 different legislations and implemented
over 20 different fiscal incentives since 1949, studies that have examined the effects of
such incentives have been purely descriptive and not much empirical work has been
done. Empirical studies of the effects of fiscal incentives in developing countries are very
limited (Klemm, 2009). In addition to this, many existing studies estimate how incentives
have affected the cost of capital or the METR, while neglecting their effects on the
ultimate goal of such policies, namely investment (Klemm, 2009, p.22). Also, it has been
stated that there is a significant vacuum in the literature on econometric studies which
assess the effects of incentives in developing countries (James, 2009, p.6); and Wells and
Allen (2001) observed that many studies which focused on the marginal tax rate have not
directly answered the question of what impact have incentives had on investment flows
(p. 18). Thus, drawing from the above, this study seeks to address some of the deficiencies
of existing research on incentives and investment.
This study aims to fill a gap in the existing literature by conducting an empirical
investigation of the effects of fiscal incentives on investment in Nigeria. We construct
two indexes of fiscal incentives which track the different types and stages of incentives
embarked upon since the 1970s. These indexes are then included in both private
investment and foreign direct investment (FDI) equations.
The rest of the paper is organized as follows: the next section provides a review
of literature on incentives in Nigeria while section three contains an overview of various
fiscal incentives in Nigeria. In section four there is a description of the variables and
methodology of analysis and in section five we have the results of the empirical analysis.
The sixth section provides further analysis of the results and policy implications and the
seventh section concludes.

REVIEW OF LITERATURE

This section provides a review of studies which have assessed the effects
incentives in Nigeria. FMF (2008) conducted a study to review to review the s
incentives in Nigeria. The study found that the complex system of incentives
administered by over 7 different agencies have made it difficult for potential inv

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 19

identify and select the incentives which are applicable to them. The study further noted
that the rapid de-industrialization in Nigeria indicates that incentives do not seem to be
attracting investment. The study recommended introducing a low corporate tax rate,
abolition of tax holidays and discretionary incentives, and merging of business promotion
agencies.
The study by Mousley et al. (2009) examined the impact of fiscal incentives in
Nigeria. The authors found that the efficacy of tax holidays is limited because tax
holidays are only awarded after substantial capital has been committed by the investor.
Because of this, it is difficult to ascertain if tax holidays function in attracting investment
because it is only awarded ex post after the investor has committed capital. The authors
criticized the system of fiscal incentives in Nigeria as too complex and inefficient, which
counteracts the very essence of incentives - which is to provide a supportive environment
for business.
Stapper's (2010) study examined the relationship between tax policy and FDI in
8 Sub-Saharan African countries (Botswana, Zambia, Mozambique, Kenya, Tanzania,
Uganda, Nigeria, and Ghana). Examining Nigerian data over the period 1995 to 2008, the
study found that corporate taxes have been stable at 30 per cent since 1996. FDI also
experienced relative stability from 1995 until 2002 during which time its values ranged
between a low of US$500 million in 1995 and a high of US$1.2 billion in 2002.
However, from 2003, FDI surged and was US$2.17 billion in 2003 and it continued
rising and by 2008 it had reached US$20.28 billion. The author attributed this increase in
FDI to high oil prices. Correlation coefficients showed a negative correlation between
FDI and (a) export processing zones (EPZs) and (b) special policy on fixed assets. The
correlations also showed a positive correlation between FDI and (a) different tax rates
and (b) double taxation treaties (DTTs). The results showed no correlation between FDI
and (a) special policy on employees and research and development and (b) corporate tax
rates. The author concluded that a tax regime designed for attracting FDI should not have
EPZs and a special policy on fixed assets. Such tax regimes should rather have many
DTTs and different tax rates per sector.
Iarossi et al. (2009) used data from a survey of 2,387 firms in Nigeria for the
investment climate assessment. The study found that fiscal incentives do not rank high on
the wish list of businesses in Nigeria. The 3 most important constraints to doing business
were identified as electricity, finance, and transportation. It was found that these 3 factors
were common across all firms irrespective of whether they are small, medium or large.
Tax rates and tax administration were respectively ranked as the 7th and 11th most
important constraints to doing business. This is in contrast to some countries such as
Brazil and Kenya were tax rates were respectively identified as major constraints to doing
business by 82 per cent and 56 per cent of the firms. The authors concluded that since the
overall tax rate paid by firms in Nigeria is the lowest among comparator countries, then
taxes are not a major bottleneck to investment. This has the implication that fiscal
incentives are not considered by firms as a crucial variable prior to investment.
UNCTAD (2009) compared Nigeria's system of fiscal incentives with those of
other countries. The study found that the outcome of Nigeria's pioneer scheme is similar
to that of Malaysia but not as favorable as what obtains in China. The authors classified
Nigeria's tax regime as following the Asian dual approach of combining high general

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 20

taxation with generous incentives for selected activities (p. 49). However, this system can
lead to discrimination among industries and between small and large firms because it is
possible for the gap between the dual regimes to widen and in addition to this, incentive
schemes can also increase. The authors recommended a flat corporate income tax rate of
15 or 20 per cent to co-exist with capital allowances already in use. In addition to this, the
authors recommended that tax holidays should be removed and also caps on utilization of
capital allowances should also be discontinued.

OVERVIEW OF FISCAL INCENTIVES IN NIGERIA

Nigeria's systems of fiscal incentives have evolved over the years and t
phases can be recognized. Firstly, form the late 1940s until the early 1
took the form of investment tax credits, tax holidays and accelerated
Following this period, incentives in the late 1980s were in the fo
development incentives while more recently from the early 1990s, incen
for export processing zones. We provide an overview of fiscal incentives
Nigerian government below.

Investment Tax Credits and Accelerated Depreciation

The first fiscal incentive provided by the Nigerian government dates ba

the Income Tax Ordinance of 1949 and this ordinance granted tax
companies. This was amended in 1952 with the Income Tax Amendment
1952 which granted special initial allowances and annual depreciation rate
Tax relief is granted to companies based on different criteria and these
rates of taxes that companies pay1. Such rates vary from 0 per cent (f
operating in the free trade zones) to 20 per cent for companies involved in
of solid minerals. The operation of accelerated depreciation involves allow
depreciation which are given at different rates depending on the type o
and sector of the economy. For example, in the solid minerals sector, d
capital allowance granted is 75 per cent of the certified true capital expen
in the year of investment and 50 per cent in subsequent years.

Tax Holidays

A major incentive was also introduced in 1952 which is the Aid to Pion
Ordinance which introduced the terminology "pioneer companies". The
Industries Ordinance of 1952 exempted such pioneer companies from pa
income tax for up to five years, and is therefore a tax holiday to such pio
The Pioneer Industries Ordinance was amended in 1971 and the hig
amendment was the granting of tax holidays on company income for f
pioneer private and public limited liability companies. The Pioneer Indust
been amended by various legislations over the years and at present, the ta
7 years for those industries located in an economically disadvantaged loca
area of Nigeria.

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 21

Other Tax Incentives

1979 saw the introduction of a variety of fiscal incentives particularly targeting taxes
some of these include the Tax Relief on Research and Development; Tax Free Divide
and Double Taxation (Income Tax) Act. The Tax Relief on Research and Developmen
Act featured two prominent incentives concerning research and development (R&D)
these are: (i) research and development (R&D) expenses were made tax deductible u
a maximum rate of 120 per cent, as long as the R&D activities are conducted in Nig
(ii) a maximum rate of 140 per cent of R&D expenses were made tax deducti
provided that such R&D activities are for the development of local raw materials.
Double Taxation (Income Tax) Act of 1979 eliminated double taxation on investmen
income.

Export Promotion Incentives

A new era in incentives provided by the government to encourage investment started with
the establishment of the Nigerian Export Promotion Council (NEPC) in 1976 and
commencement of the Structural Adjustment Program (SAP) in 1986. Starting from 1986
and with the promulgation of the Export Incentives and Miscellaneous Provision Decree
no. 18 of 1986, incentives were targeted at promoting exports and this effectively signaled
the end of the previous policy of the government of import substitution. The various
incentives introduced include the following: Export Development Fund (EDF), Export
Price Adjustment Scheme (EPAS), Export Expansion Grant (EEG), Refinancing and
Rediscounting Facility (RRF), Duty Draw-back Scheme (DDS), Currency Retention
Scheme (CRS), and the Export Credit Guarantee and Insurance Scheme (ECGIS). These
schemes are discussed below.

Export Processing Zones

The Export Processing Zone (EPZ) was introduced in 1991 to strategically provide an
environment where companies can be motivated to focus on export oriented productio
The incentives attached to the EPZ include: exemption from taxes, levies and duties at a
tiers of government, duty free imports for all inputs used in the production process. T
Export Processing Factory (EPF) was introduced in 1992 relates specifically to factories
located in the EPZ. Incentives under the EPF include all those under the EPZ and in
addition to these include the following: reduction in taxes for small companies producin
primarily for exports; zero-restrictions on capital allowance for manufacturin
companies; accelerated allowance of 100 per cent on the qualifying building and plan
expenditure of companies; tax holidays for 3 consecutive years for all new companies.

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 22

DESCRIPTION OF THE VARIABLES, DATA AND METHODOLOGY

Dependent Variables

While considerable research has focused on the effects of fiscal incentives on FDI, th
is still a paucity of studies on how incentives affect private investment. Klemm and V
Parys (2009) provide a departure to this by conducting an empirical analysis of how
incentives affect both FDI and private investment. Following from Klemm and Van
Parys' (2009) study, our study also conducts an empirical investigation into the effect
incentives on both private investment and FDI in Nigeria. Private investment is measu
as the ratio of gross domestic investment by the private sector to GDP (PRIVINV) wh
FDI is measured as the ratio of FDI to GDP (FDI).

Description of Fiscal Incentives Variable

Measuring fiscal incentives has proved to be a tenuous task in applied empirical resear
This has been so because fiscal incentives do not by themselves have quantitative valu
but are actually a series of policies put in place by various governments over the cou
of time. Many studies resort to using dummy variables to signal the start or end, of fisc
incentives (Beyer, 2002; Banga, 2003; Cleeve, 2008). Other studies have used t
corporate tax rate as a measure of incentives. Recently, Klemm and Van Parys (200
tried to depart from previous research by using a variable which measured the longe
available tax holidays and another variable which measured the ratio of investment
allowance to total investment.
In this study we depart from previous research and develop indexes of fisca
incentives which are all-encompassing and provide a summary measure of incentive
provided in Nigeria. This type of index has been used in the literature to meas
financial liberalization (Bandiera et al., 2000; Laeven, 2000; Abiad and Mody, 20
Abiad, Detragiache and Tressel, 2008; Fowowe, 2008). These indexes are then include
in the investment equations and the results obtained will provide a more comprehens
idea of how fiscal incentives have affected investment in Nigeria.
In developing the index, following Zee et al. (2002) we have identified four
fiscal incentives measures: CIT rate incentives, investment cost-recovery incentives
export oriented incentives, and export processing zones. We then allocate to each of th
measures a value of 0 before the specific fiscal incentive starts. Each measure then tak
on higher values starting from 1 and this increases with subsequent additional incentiv
This produces a matrix of four variables corresponding to each fiscal incentive measu
The appendix contains information concerning each specific fiscal incentive measure a
this was used to arrive at the matrix of four variables contained in Table 1.
Some interesting features of fiscal incentives in Nigeria can be observed by
looking at Table 1. Firstly, it is seen that incentives did not feature prominently in t
Nigerian economy from the early 1970s until the mid-1980s. This is evident from the f
that only one incentive was introduced for all four incentive measures during this per
and this has the implication that the Nigerian government was not particularly interes
in stimulating either domestic or foreign investment in the country. This can possibly

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 23

explained by the fact that the government was deriving substantial foreign exchange
earnings from oil exports and there was no motivation to seek for new investment. In
fact, oil exports had risen from 420,000 barrels per day recorded in 1966 to 2.05 million
barrels per day in 1973. Exports of crude oil remained above 2 million barrels per day
throughout the 1970s but this dropped in the early 1980s and oil exports were 1.24
million barrels per day in 1983. This could have been a contributory factor for the surge
in incentives which can be noticed from 1987. It can also be seen from Table 1 that
investment cost-recovery incentives were the most popular form of incentives because it
had a score of 10 by 2006 as opposed to scores of 6 for CIT rate incentives and export
incentives.
A number of methods have been proposed in the literature which can be used for
combining the various measures of incentives into a summary index of fiscal incentives.
Principal components analysis have been used by some studies (Bandiera et al, 2000;
Shrestha and Chowdury, 2006) while some others have added up all incentives in a given
year (Laeven, 2000). In this study we make use of the two different types of methods and
develop our index of incentives by using both principal components analysis and
summation of measures for each year. Thus, we arrive at two different indexes which we
have called INCENT1 and INCENT2. INCENT1 is the index derived from principal
components while INCENT2 is the index derived by adding up all incentive measures.
These indexes are included separately in our investment equations and thus serve as
robustness checks on the empirical results.
Figure 1 graphs both fiscal incentives indexes and the dependent variables and it
can be seen that the fiscal incentives indexes were flat between 1970 and 1987 thus
showing that incentives did not feature prominently on the agenda of the government in
this period. It is also observed that private investment fell substantially from 14.6 per cent
in 1973 to a low of 2.3 per cent in 1985, while FDI was generally low in this period and
had its highest rate of 2.6 per cent in 1974. From 1987 when the government started
introducing a range of incentives, it is observed from the figure that the 2 incentives
indexes surged, with the second index (INCENT2) showing a particular steep increase.
FDI experienced a sharp rise in 1989 and 1993 but apart from this, remained relatively
stable between 3 and 4.5 per cent. Private investment has a steep and particularly
consistent rise from 1990 and reached a peak of 16 per cent in 1994 and subsequently
fell. However, unlike FDI, private investment was more volatile but generally hovered
between 9 per cent and 15 per cent.
This cursory examination of the data shows a modest relationship between fiscal
incentives and investment in Nigeria. It is seen that both private investment and FDI
appear to be volatile and their changes do not seem to be instigated by incentives
measures. Apart from the period between 1988 and 1993 when increased incentives were
matched by increases in private investment and FDI, these 2 variables appear not to have
been substantially affected by fiscal incentives.

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 24

TABLE 1. FISCAL INCENTIVES IN NIGERIA

Year CIT rate Investment cost Export oriented Export

incentives recovery incentives
incentives
1970 0 0 0 0
1971 1 1 0 0
1972 1 I 0 0
1973 1 1 0 0
1974 1 1 0 0
1975 1 1 0 0
1976 1 1 1 0
1977 1 1 1 0
1978 1 1 1 0
1979 1 1 1 0
1980 1 1 1 0
1981 1 1 1 0
1982 1 1 1 0
1983 1 1 1 0
1984 1 1 1 0
1985 1 1 1 0
1986 1 1 2 0
1987 2 2 2 0
1988 3 3 3 0
1989 3 4 3 0
1990 3 5 3 0
1991 3 6 4 1
1992 4 7 5 2
1993 4 7 5 2
1994 4 7 5 2
1995 5 7 5 3
1996 6 8 5 3
1997 6 8 5 3
1998 6 9 6 3
1999 6 10 6 3
2000 6 10 7 3
2001 6 10 7 3
2002 6 10 8 3
2003 6 10 8 3
2004 6 10 8 3
2005 6 10 8 3
2006 6 10 8 3
Sources: various, see appendix.

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 25

FIGURE 1. INVESTMENT AND FISCAL INCENTIVES IN NIGERIA

30

25

15

10

%-»! w is fj; w U V
lOHlNffi^i^lflhCOOlO'
cocawtcoioitnoiaiCTioioimoiooooooo
oioioioioiaioiCTitnoioitnoioioicnoicioioioioioicnoiCTiijitJioioiooooooo
t—I *—I *—I *—I *—t *—I t—I t-H t—I t—I t-H t-H t-H t-H t-H t-H t-H t-H tH t-H t—I *—I t—I *—I rH t-H rH t-H t-H *—I (NJ CsJ (M fsj C^J r\] r**J

FDI -X—INCENT1 —•— INCENT2

Description of Additional Explanatory Variables

Many variables have been proposed in the literature as determinants of both private
investment and FDI. While it is not possible to include all available variables in our
model, we have selected some variables based on their strength from previous empirical
studies and Nigeria's peculiar characteristics.
For our private investment models, we have included variables to account for
macroeconomic uncertainty, accelerator theory, and institutions. The relationship
between macroeconomic uncertainty and investment has received considerable attention
in the literature (Serven, 1997, 1998). Our chosen measure of macroeconomic uncertainty
is the volatility of inflation (INFLVOL). Volatile and unpredictable inflation rates can be
portrayed by investors as a sign that the government is losing control of the economy and
this could discourage investor confidence. Following other studies (Bo, 2006; Veiga and
Aisen, 2006), we measure inflation volatility in each year with a 3-year rolling standard
deviation of the CPI inflation rate. Output growth has been the most consistent and
significant determinant of investment found by other studies (Khan and Reinhart, 1990;
Khan and Kumar, 1997). The accelerator theory makes investment a function of changes
in output. In this theory, planned investment is seen as brought about by changes in
demand, and so changes in aggregate demand for consumer goods will cause changes in

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 26

demand for capital goods. Following other studies (Oshikoya, 1994; Dailami and Walton,
1992; Moshi and Kilindo, 1999), in the private investment model, output growth is
measured by the growth rate of real GDP (GDPGRO). In the FDI model, we follow other
studies (Cleeve, 2008; Klemm and Van Parys, 2009) in including per capita GDP
(PCGDP) as the preferred output variable. North (1991) defines institutions as humanly
devised constraints that structure political, economic and social interaction and they
consist of formal rules such as constitutions and rules, and informal constraints such as
taboos, customs, and codes of conduct (p.l). Institutions have been identified as
important in stimulating investment and consequently promoting economic growth
(Frances, 2004). This is achieved by the ability of good institutions to enforce property
rights and reduce rent-seeking behavior. We have used data on political rights and civil
liberties from Freedom House to measure the quality of institutions in this study. Political
rights and civil liberties are measured on a one-to-seven scale, with one representing the
highest degree of freedom and seven the lowest. We constructed an average of these two
indexes to arrive at our measure of institutions (INST) and a negative coefficient would
imply that institutions have exerted a positive effect on investment.
Following from the above discussion we arrive at 4 equations for estimating the
effects of fiscal incentives on investment. These equations have specified below:

PR1VINV, = a0 +allNCENTi, +a2VOLINFli +aiGDPGRO, +a4INST,+u, (1)

PRIVINV, =/?0+ ftlNCENn, + /32VOLINFL, + GDPGRO, + faINST, + s, (2)
FDI, = y/Q + y/JNCENTi, +y/2 VOLINFI, + y/,PCGDP, + y/JNST, + u, (3)
FDI, = <j>0 + 0JNCENT2, + <f>2VOLINFIi + faPCGDP, + </>4INST, + v, (4)

Data Description

This study utilizes annual data over the period 1973 to 2006. Data sources are the World
Development Indicators CD-ROM 2008 for macroeconomic variables, Freedom House
for data on institutions, African Development Bank for data on private investment, and
various sources as indicated in the appendix for data on fiscal incentives.

Econometric Methodology

This study utilizes annual time series data and the econometric methodology adopted
draws from the literature on applied time series research (Luintel and Khan, 1999; Ang
and McKibbin, 2007). The main objective of this study is to conduct an empirical
investigation of the effect of fiscal incentives on investment in Nigeria. Consequently,
our testing procedure involves three steps (Arestis and Demetriades, 1996; Ang and
McKibbin, 2007). The first step involves testing for the properties of the variables by
conducting unit root tests and we have adopted the Phillips-Perron (PP) test. The second
step involves testing for the existence of a stable long-run relationship between the
variables using cointegration tests and we have adopted the Johansen cointegration test. If

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 27

the variables are cointegrated, the third step involves estimating the long-run parameters
and associated loading factors.

EMPIRICAL RESULTS

Unit root tests are presented in Table 2 and all variables are stationary in first d
that is they are integrated of order 1. Thus, we can proceed to conduct the
cointegration test. The results of the Johansen cointegration tests are presented

TABLE 2. PHILLIPS-PERRON UNIT ROOT TESTS

Variable
Variable Levels
LevelsFirst Differences
First Differences
PRIVINV
PRIVINV -1.761
-1.761 -8.329*
-8.329*
FDIFDI -2.007
-2.007 -4.460* -4.460*
GDPGRO -1.854
GDPGRO -1.854 -4.894*
-4.894*
VOLINFL
VOLINFL -1.800
-1.800 -3.661**
-3.661**
INCENT1 -1.644
INCENT1 -1.644 -4.063**
-4.063**
INCENT2
INCENT2 -1.643
-1.643 -3.983**
-3.983**
INST
INST -2.247
-2.247 -4.607*-4.607*
PCGDP
PCGDP -1.649
-1.649 -5.996*
-5.996*
Notes: The critical values ar
respectively for the variables in
The critical values are -4.316,
variables in differences.

Table 3 reports the results

the trace test and maximum
cointegration tests for the p
and 4 show the cointegration
For both private investm
cointegrating relationships w
cointegrating relationship
conflicting results, the max
alternative hypothesis (En
eigenvalue cointegration tes
equations 1 and 2. For equati
and maximum eigenvalue test
The results in Table 3 in
between the variables in equ
procedure and concluded tha
can then proceed to the 3rd s

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 28

TABLE 3: JOHANSEN COINTEGRATION TESTS

Trace statistic Maximal eigenvalue statistic

r=0 r<l r<2 r<3 r=0 r<l r<2 r<3

Eq.l 78.52 47.14** 25.09 8.69 30.38** 23.05 16.41 7.43

Eq.2 83.56 51.87* 24.95** 8.45 31.69** 26.93 16.49 7.43

Eq.3 57.16** 33.45 15.57 6.38 23.71** 17.87 9.19 4.87

Eq.4 59.82** 34.27 16.61 7.35 25.54** 17.67 9.25 4.87

Notes: * indicates statistical significance at the lfo level and ** in
the 5% level.
The optimal lag length is 2 for all models.

Table 4 contains the cointegrating vectors and associat

private investment equations. For the primary variable o
negative relationship between fiscal incentives and private
long-run. This result is statistically significant and robust acr
fiscal incentives. This implies that the various incentives in
adverse effect on private investment. Specifically, the resu
index (INCENT1) suggests that incentives have reduced priv
about 3 percentage points while the second incentive inde
muted effect of half of a percentage point.
For the other variables in the model, as expected ma
proxied by inflation volatility has a significant negati
investment. This is similar to the results of other stud
Ndikumana (2000), and Asante (2000) who found a sign
inflation on investment. As expected the growth rate of re
statistically significant in equation 2. The variable to measure
positive coefficient but is insignificant.
a shows the loading factors and this is the error corre
the speed of adjustment. The loading factors for both equ
(negative) and are both statistically significant. This further
cointegration tests and confirms the presence of a long-r
variables in our model. For equation 1 the loading factor
implies a medium adjustment towards the long-run equili
implies that within 1 year, private investment will adjust
equilibrium value.
Table 5 contains the results of the estimated cointegra
the results broadly corroborate the findings on private in
presence of a negative relationship between fiscal incentive
Nigeria. This implies that the various fiscal incentives emb
government over the years have discouraged both foreign and

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 29

TABLE 4. COINTEGRATED EQUATIONS FOR PRIVATE INVESTMENT

Variable Equation 1 Equation 2

INCENT1 -3.035*
INCENT2 -0.587*
VOLINFL -0.413* -0.430*
GDPGRO 0.101 0.170**
INST 0.234 0.061
A -0.481*** -0.475***
Notes: * indicates statistical s
the 5% level.

TABLE 5. COINTEGRATED EQUATIONS FOR FDI

Variable Equation 3 Equation 4

INCENT1 -3.927*
INCENT2 -0.572*
VOLINFL -0.027* -0.023*
PCGDP 30.889* 19.487*
INST 1.528* 0.780*
a -0.454* -0.612*
Notes: * indicates stat
the 5% level.

Our findings are

study used 3 variab
The only variable t
models and the auth
in attracting inves
investment incenti
this variable was fo
for 16 Sub-Sahara
negative relationsh
investment in Sub-
Parys (2009) found
investment.
The finding that
private and foreign
confirms the thin
implemented, and
diverse array of act
crops, and proces
consequently been c
(NEMT, 2009). Such
investors are not gi
ambiguity and bur
prospective investor

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 30

This is demonstrated by the fact that in 2000 decisions about incentives that investors
could benefit from were not made until substantial commitments had been made to the
project by the investor (Wells and Allen, 2001, p.62).
Our results also corroborate the findings of other studies that Nigerian runs an
overly complex system of incentives (FMF, 2008). The multitude of incentives are
administered by diverse agencies such as the Ministry of Finance, Central Bank of
Nigeria, Federal Inland Revenue Service, Export Promotion Council, Ministry of
Commerce and Industry, and this poses enormous problems for potential investors in
identifying and ascertaining which of the incentives he might benefit from (FMF, 2008).
With over 15 different enactments that provide incentives for investors, there is no
comprehensive enactment setting out the principal incentives available to an investor
wishing to invest in Nigeria (FMF, 2008).

CONCLUSIONS AND POLICY IMPLICATIONS

This study conducted an empirical analysis of the effects of fisc

investment in Nigeria. Fiscal incentives did not feature prominently o
climate in Nigeria until the late 1980s after which many incentives we
stimulate investment. In order to adequately quantify the effect of i
developed 2 indexes of fiscal incentives which capture the various stage
of the introduction of various fiscal incentives in Nigeria. The study em
the period 1973 to 2006 and used 2 measures of investment as depend
private investment and FDI.
The results of cointegration tests showed the existence of a long-ru
between investment and fiscal incentives and the other explanatory var
estimation of long-run parameters showed that fiscal incentives have h
negative relationship with both private investment and FDI in Nigeri
corroborates what other studies have advocated - that rather than incen
countries should focus on correcting deficiencies in the investment cli
infrastructure and macroeconomic instability.
A number of policy implications for fiscal incentives in Nigeria a
study. Firstly, the consensus view and our results suggest that Nigeria s
using fiscal incentives but should rather improve the investment climat
observed to function better in improving investments. In the few cases
are to be used, there is a need to properly articulate strategies for the i
such incentives. Such implementation strategies should focus on three
are: identification of proper procedural considerations for fiscal incent
fiscal incentive policy; and an effective way of administration of fiscal
2010).
On proper procedural considerations, the government needs to consider or re
consider some practices in the implementation of fiscal incentives before enacting laws
accordingly. Firstly, the government needs to decide on the use of either automatic or
discretionary incentives. It is widely accepted that automatic incentives are better in
achieving the objectives of stimulating investment. Automatic incentives help in reducing
the time needed for planning investments, reduce administration costs of incentives, and

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 31

also limit uncertainty related to incentives. Another procedural consideration the

government needs to consider is whether incentives are temporary or permanent. Some
incentives may be deemed appropriate to operate for a limited period while it is decided
that others should operate permanently. The government needs to be clear in their policy
statements about which incentives are temporary and which are permanent. An important
issue though, is that whether permanent or temporary, incentives should be included as
part of the tax code. This enhances administration and implementation and helps in
mitigating confusion and stems the problem of tax evasion and avoidance.
For proper implementation of fiscal incentives there is the need to reform
incentive policy to reduce volatility in government revenue and limit uncertainty and risk
related to investment decisions. This involves a reform of tax policy where the ultimate
aim will be to drive for a low tax rate on a broad tax base (James, 2010). The path for
reform of the tax policy consists of a gradual move from a system of granting generous
tax holidays to partial tax holidays and through a stage of indirect tax incentives to finally
reaching the stage of a reasonable low tax rate on a broad tax base.
The administration of fiscal incentives needs to be reformed if both the country
and investors are to benefit from the incentives. In view of this the administration of
incentives needs to be reformed to eschew good practice. There is the need to move from
discretionary to automatic incentives and increase transparency in the process of granting
incentives. The government needs to make sure no company or sector is accorded
preferential treatment to the detriment of other companies or sectors (James, 2010).
Incentives should be able to generate positive externalities and such incentives should be
warehoused within tax laws so as to limit conflicts between different agencies and tax
evasion.

APPENDIX

(A) CIT rate incentives

1971: tax holidays
1987: CIT reduced from 45% to 40%
1988: a lower rate of company tax of 20% introduced for small and medium scale enterprises
engaged in agriculture, manufacturing and mining
1992: CIT reduced from 40% to 35%; tax exemption status extended to companies in rural
areas and incentives granted on the basis of locally available infrastructure
1995: tax incentives to small-scale manufacturers extended from 3 to 5 years
1996: CIT reduced from 35% to 30%
(B) Investment cost-recovery incentives
1979: elimination of double taxation; R&D investments made tax deductible
1987: companies or individuals that earn dividends from at least 10% equity ownership in
another company are entitled to enjoy tax free dividends for 3 years
1988: an additional 5% capital tax allowance introduced for eligible expenditures for plants,
construction and agriculture production
1989: companies allowed a maximum 10% tax-free allowance on their annual gross profits to
promote R&D
1990: a 10% investment allowance introduced on expenditures incurred on production
machinery
1991: excess profits tax eliminated

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 32

1992: R&D expenditures to become deductible from companies gross earnings

1996: capital transfers tax cancelled
1998: capital gains tax on stocks and dividends cancelled
1999: production sharing contracts members allowed to claim investment tax credit
allowance such as tax offsets
(C) Export-oriented incentives
1976: establishment of Nigerian Export Promotion Council
1986: Export Incentives and Miscellaneous Provision Decree; establishment of Export
Expansion Grant, Duty Drawback Scheme and Export Expansion Scheme
1988: introduction of advalorem customs and excise duties for manufactured goods
1991: amount earmarked for the Duty Drawback Scheme increased from NIOmillion to
N50Million
1992: introduction of Bonafide Manufacturer/Assembler Scheme
1998: excise duties abolished for domestic manufacturers
2000: 10% administrative charge paid to NEPC abolished
2002: Bonafide Manufacturer Scheme extended to other sectors
(D) Export processing zones
1991 : establishment of export processing zones
1992: establishment of export processing factory
1995: additional tax incentives introduced to EPZ operations
Sources: Ariyo (1997), Odusola (2006), UNCTAD (2000, 2009).

ENDNOTE

'The current rate of company income tax in Nigeria is 30%. In addition to this, compa
VAT, 2% Education Levy, and other State and Local Government charges which bring
burden on companies not enjoying any fiscal incentives close to 40%.

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