CHAPTER TWO

A REVIEW OF RELATED LITERATURE

2.1 Introduction

This chapter entails the conceptual issues relating to tax volatility and investment in Nigeria, a

review of related literature, and a summary and the gap in the literature. In this chapter, a myriad

of literature was explored to establish previous findings, related terms, concepts, and issues. n

2.2 Conceptual Issues

2.2.1 Taxation

Both advanced and developing countries rely heavily on taxation as a source of revenue. Tax is

described as a mandatory levy imposed by the government on the citizens of a country to

produce income for the general administration (Clement & Taiwo, 2019). Tax-generated

revenues are used to finance public utilities, perform social responsibilities and grease the

administrative wheel of the government. The Chartered Institute of Taxation of Nigeria (2002)

defines tax as an enforced contribution of money to the government according to defined

authorized legislation. The amount of income earned for the development of infrastructure in a

country determines its political, economic, and social growth. A well-structured tax system,

however, is one way of producing the necessary income for investment and infrastructural

development. Tax, according to Azubike (2009), plays a key role in every civilization in the

world. A tax system is one of the most effective ways of mobilizing a country's internal

resources, and it lends itself to the creation of an environment favourable to economic growth.
Also, Nzontta (2007) claims that taxes are important sources of revenue for the federation

account, which is shared by the federal, state, and local governments.

There are various taxes collected by the government such as company income tax, personal

income tax, capital gain tax, petroleum profit tax, value-added tax, custom and excise duties,

education tax well as other levies, below is a brief description of some of the different types of

tax in Nigeria.

Company Income Tax (CIT): Company Income Tax is regulated by the Companies Income Act

2004. All income accruing to a company chargeable to CITA is taxed on a preceding year basis,

not on an actual year basis. Therefore, company income tax is a tax imposed on the profit of

companies (excluding profit from companies engaged in petroleum operations) accruing in,

derived from, brought into or received in Nigeria in respect of any trade or business, rent,

premium, dividends, interest, loyalties and any other source of annual profit.

Petroleum Profit Tax (PPT): Petroleum profit tax involves the charging of tax on the income

accruing from petroleum operations. It is a tax applicable to upstream operations in the oil

industry Odusola (2006). The importance of petroleum to the Nigerian economy gives rise to the

enactment of the different laws regulating the taxation of incomes from petroleum operations.

This means that companies engaging in petroleum operations will not be subjected to tax on the

CIT, but rather on the Petroleum Profit Tax Act. For this reason, the Petroleum Profits Tax Act,

cap. P13 LFN 2004 imposes a tax on the profit of companies engaged in petroleum operations.

A petroleum operation is defined as the winning or obtaining and transportation of petroleum or

chargeable oil in Nigeria by or on behalf of a company for its accounts by any drilling, mining,
extracting, or other like operations or process of a business earned on by the company incidental

thereto and any sale of or any disposal of, chargeable oil or on behalf of the company.

Personal Income Tax (PIT): This is a type of tax charged on the income of an individual. The

chargeable income of an individual is the aggregate amount from all sources (whether from

employment, investment, profit from trade, profession, or vocation, etc) after deducting all non-

taxable incomes and relief granted.

Value Added Tax (VAT): Value added tax is a tax on consumption that is collected at each

point of sales of goods and services from production to consumption but eventually borne by the

final consumer. Each person is required to charge and collect VAT at a flat rate of 7.5% on all

invoiced amounts. VAT was introduced by the Federal government of Nigeria in January 1993

Ochei (2010). Analyst says that the tax was intended to be a super tax to eradicate many other

taxes related to goods and services especially sales tax. Under the Value Added Tax Act 1993 as

amended, every person whether resident in Nigeria or nonresident in Nigeria who sells goods or

renders services in Nigeria under the VAT Act is obligated to register for VAT within six months

of its commencement of business in Nigeria. Registration is done with the Federal Board of

Inland Revenue (FBIR).

2.2.2 Volatility of Tax

The frequency and intensity with which the market price of an investment swing is referred to as

volatility (Seegert, 2012). In a broad sense, volatility refers to the pace at which the price or rate

rises or falls in response to a particular set of returns. The standard deviation of annualized

returns over a certain period is used to calculate volatility. It can be defined as the range within
which the price of an economic phenomenon can rise or fall, as described by (Balding and

Dauchy, 2013). In other terms, volatility is a statistical measure of a market index's return

dispersion. The standard deviation or variance between returns from the same market index can

be used to calculate volatility. The greater the volatility of corporate revenue, the riskier the

firm's investment, as well as that of individuals. Volatility is frequently connected with large

swings in either direction in markets. The resources of nations and the degree of volatility were

crucial to Shambaugh's (2012) discussion of taxation and volatility, as well as Schaufele's (2016)

discussion of European crises. A 'volatile' tax economy is defined as one in which the tax rate

rises and falls by more than one percent (1%) over a long period. Tax volatility, simply

expressed, is the level of uncertainty or risk associated with the magnitude of changes in the

value of tax. A tax value can potentially be spread out over a greater range of values if its

volatility is higher. This means that the tax rate can swing drastically in either way in a short

period. Lower volatility indicates that the value of an asset does not vary substantially and is

more stable.

Volatility is a measure of a security’s stability. It is an important measure in quantifying risk.

Tax volatility which is the reflection of fluctuations of the tax system, tax legislation,

inconsistency of the general income of taxpayers, and the unfortunate harsh economic climate of

doing business which affect the productivity of companies operating in Nigeria and investment

operations. The term indicates how much and how quickly the value of investment, market, or

market sector changes.

2.2.3 Investment and Investment Decision

Investment is the value of fixed capital assets (plus stocks) produced in an economy over a

period of time. It refers to an increase in capital assets, and typically includes investment by

business, investment in property and investment by governments in ‘social capital’.

Firms invest for two primary reasons: Firstly, investment may be required to replace worn out, or

failing machinery, equipment, or buildings. This is known as capital consumption, and arises

from the continuous depreciation of fixed capital assets.

Secondly, investment may be undertaken to purchase new machinery, equipment, or buildings in

order to increase productive capacity. This will reduce long term costs, increase competitiveness,

and raise profits.

The company's decision to spend its current cash most efficiently in long-term assets in

anticipation of an expected flow of benefits over several years is known as an investment

decision. With finance, an investment is the acquisition of an asset or object in the hopes of

earning money or appreciating it so that it can be sold at a greater price in the future. Deposits in

a bank or other comparable institution are normally excluded. When referring to a long-term

outlook, the phrase investment is commonly employed. Trading and speculation, on the other

hand, are short-term activities with a far higher level of risk. Financial assets come in a variety of

shapes and sizes, ranging from ultra-safe, low-return government bonds to highly riskier, higher-

reward multinational stocks (Verdugo, 2005). An effective investing strategy will diversify the

portfolio based on the needs that have been identified. The most well-known and successful

investor in history is (Warren, 2013).

2.2.4 Tax and Investment

The tax has a particular influence that has been widely established in the literature. The supply-

siders, led by Arthur Laffer, express the disincentive effect of a higher tax rate above the optimal

rate on savings, investment, and labour supply (Rosen, 2009). Taxation has a big influence on

investment because it affects the investment climate. The tax system of a nation has a significant

impact on other macroeconomic variables, implying that it has a systematic, predictable, and

consistent link with economic growth and development. Measures to attract investment through

tax reduction command widespread support. Tax incentives for investment fall into three

categories: reductions in the effective price of new capital goods via the investment tax credit or

accelerated depreciation, reductions in the corporate tax rate, and reductions in the return on

investment at the personal level (Chigbu, Eze & Appah, 2012).

States rely on several revenue sources to fund provision of public goods, and each is driven by

unique dynamics. Of out sized importance are personal income taxes, sales taxes, and the

corporate income tax, and two factors determine the tax revenues from these sources: tax rates

and the size of the tax base. The size of the tax base depends on legal rules set by the state and

economic conditions, which in turn depend on individual behavior and tax rates. For example,

the sales tax base includes the sales of only those goods and services that the state has

determined to be taxable. A state can choose to exclude certain items from the tax base, such as

food or legal services, and individuals can shift consumption from taxed to untaxed goods and

services. Tax revenue volatility therefore depends on three factors: First, a state’s tax portfolio

(the revenue sources it relies on). Second, the volatility of economic conditions. Finally, all other

potential changes to the tax base.

2.3 Theoretical Review

2.3.1 Fiscal Exchange: This theory assumes that the government's supply of public goods and

services will influence taxpayer compliance behaviour (Moore 2004). This indicates that when

the government fulfils its conventional tasks and obligations to citizens, it has an impact on

citizens' tax payment compliance since the major concern of taxpayers is what they get in return

for the taxes they pay. This approach is viewed as a contractual connection between taxpayers

and the government, with the taxpayer trading market purchasing power in exchange for

government services.

The advantage that the taxpayer is anticipated to get encourages voluntary compliance rather

than compulsion. Tax negotiations are crucial to establishing accountable relationships between

the government and society based on reciprocal rights and obligations rather than patronage and

force (Brautigam 2009; Moore 2004). As a result, fiscal exchange theory is essentially a game of

politics and power played by the government in power to give fundamental public goods and

services to the populace in order to influence tax payment behaviour. By the motivation of the

citizen through the provision of social and economic goods needed by the citizen, taxation will

be accepted as a normative act hence there is the tendency that increase tax revenue will be

generated due to tax compliance.

2.3.2 Neoclassical Theory of Investment: Neoclassical financial theorists have attempted

acrobatic theoretical maneuvers to defang the principal-agent dilemma, allowing the Pareto

efficiency qualities of markets to elude it. Unfortunately, the assumptions that must be made in

order to complete this work have no empirical or institutional support. The neoclassical

principal-agent literature has been appropriately described by Stiglitz as "the victory of dogma

over theory and evidence." Neoclassical investment theory, on the other hand, refuses to even

accept the problem exists. Almost all neoclassical models of enterprise investment decisions start
with the unsupported claim that the firm's goal is to maximize market value to meet the owners'

goals. There are three aspects worth mentioning concerning the value maximization assumption.

To begin with, there is a lot of empirical and institutional evidence that this assumption is false,

and almost no direct empirical evidence that it is true. 3 Second, even if this dubious assumption

is discarded, it is unclear if a separate neoclassical approach to firm theory can be defined.

Neoclassical theorists lack a widely accepted approach for selecting an enterprise objective

function, describing the constraint set, or even determining the cost of financial capital in its

absence.

2.3.3 Keynesian Theory of Investment: Gordon gives a formal model of what he refers to as

the Keynesian investment theory. We'll try to sketch out the broad characteristics of an investing

theory based on the substitute core assumptions stated in the previous sections. The premise that

the firm is a semi-autonomous actor with its preference function should be included in any

realistic investment theory. We'd expect the company to strive for expansion in terms of size,

market share, and earnings (its growth aim) while avoiding challenges to its decision-making

autonomy or financial security (its safety objective). The existence of this safety goal causes the

company to be risk-averse. Capital accumulation is the only way to achieve growth, but capital

accumulation must be financed. Debt finance establishes legally enforceable cash flow promises

to creditors. Internal financing and stock floatation, on the other hand, imply cash flow

commitments to shareholders. If commitments to stockholders cannot be satisfied out of the

future operational profits created by invested capital, management may feel a threat to its

decision-making autonomy; if commitments to creditors are not honored, the firm might go

bankrupt.

2.3 Empirical Review

 Edam and Okoi (2014) used the ordinary least square method of multiple regression

analysis to examine the impact of taxation on investment and economic growth in Nigeria from

1980-2010. The annual data were sourced from the central bank of Nigeria's statistical bulletin

and NBS. The result of the analysis showed that there is an inverse relationship between taxation

and investment. The economic implication of the result is that a one percent (1%) increase in

CIT will result in a decrease in the level of investment in Nigeria. Consequently, an increase in

PIT will result in a decrease in the level of investment. The result, therefore, showed that

taxation is negatively related to the level of investment and the output of goods and services

(GDP) and is positively related to government expenditure in Nigeria.

Kipngetich (2012) carried out a study on the relationship between tax paid and the level

of investment for the quoted companies in Kenya. The population of the study was all companies

listed in the NSE from the year 2006 to the year 2010. Data were analysed using descriptive

statistics. The study established that a relatively strong relationship exists between tax paid and

investment made especially in the financial sector and agricultural sector.

Lodhi (2015), utilizing the ARDL, dissected the effect of tax incentives on investment in

Pakistan from 1990 to 2014. FDI and domestic investment were the reliable factors while

corporate tax rates and levy costs were the unbiased variables. The discoveries uncovered that

the corporate tax rate is altogether adversely connected with domestic investment and FDI

inflows in Pakistan in both the short and long term. It was therefore suggested the public

authority of Pakistan reduce the corporate tax rates and duties to drive investment to Pakistan.

Arnold et al (2011) submit that high taxes lead to an increase in the cost of capital and

reduce incentives to invest in new business equipment. Similarly, Keho (2010) averts that taxes

provide preferential incentives to specific sectors hence leading to distortions in capital

allocation and reducing the overall investment productivity. Private domestic investment is

usually influenced by the tax policy which directly influences the rate of return on fixed

investment (Overesch and Wamser, 2010).

According to Dackehag and Hansson (2012), Foreign direct investment could be harmed

by higher taxes (FDI). High levels of firm taxes, discourage both domestic and international

fixed investments, stifling economic growth. According to Kaldir (1963), the availability of tax

breaks and incentives influences the placement of FDI. According to McBride (2012), tax

policies have an impact on both domestic and foreign investors' investment decisions, implying

that there may be a link between private fixed domestic investment and FDI. When non-tax

obstacles are removed and national economies converge, taxes are expected to become more

important in deciding where to invest (Dackehag and Hansson, 2012).

Scholes and Wolfson (1992) posited that changes in rates of return on assets will

influence foreign investors' decisions to invest in a country. They claim that raising taxes will

lower rates of return and deter FDI inflows to a country. Hines (1999) discovered that FDI is

sensitive to tax rates and that a 10% drop in tax rates will result in a 10% rise in FDI. According

to Hartman (1984), countries that offer a non-discriminatory regulatory tax framework, access to

markets, and profit prospects, as well as a predictable and stable corporate operating

environment, skilled and responsive labour markets, and well-developed public infrastructure,

attract FDI. According to studies of cross-border flows, a one-percentage-point rise in the FDI

tax rate reduces FDI by 3.7 percent on average (see Hartman, 1984). According to some recent

studies, FDI is becoming more tax-sensitive, suggesting more capital mobility as non-tax

impediments to FDI are reduced (Boskin and Gale, 1987)

 Firms that are not making new fixed investments are unlikely to respond to tiny tax

advantages that simply lessen the amount they intend to disinvest, according to Lyon (1990).

Similarly, tax reform researchers in numerous countries, including the United Kingdom (see

Sumner, 1986, Devereux, 1989; Feldstein, 1982) and France (see Muet and Avouyi-Dovi, 1987),

have found that tax policy has a minor impact on private domestic investment behaviour.

Taxation, according to Santoro and Wei (2012), reduces investment and effectively raises the

cost of investment capital, lowering business productivity.

Tax rates, according to Menjo and Kotut (2012), influence the quantity and allocation of

productive capacity through their effects on net returns to labour, saving, investment, and

aggregate demand. With the passage of time, the rise in aggregate demand has a greater impact

on an economy's allocation of productive capacity through its influence on returns to factors of

production, human capital development, capital spending allocation, and technological

innovation investment (Arnold et al., 2011; Bustos et al., 2004).

According to Engen and Skinner (1996), a distorted tax policy may permanently impede

technical innovation and private domestic investment growth. Similarly, Vartia (2008) finds that

corporate tax rates reduce company profitability and cash flows, diminishing total factor

productivity (TFP). Corporate taxation has a detrimental influence on both firm-level TFP and

investment, according to Arnold and Schwellnus (2008), notably in industries with higher

average profitability, such as manufacturing, and in enterprises that are further behind the

technological frontier (the food industry). The efficiency of public spending and preferences in

the public supply of goods and services should be taken into account when looking at the link

between taxation and private fixed domestic investment through the crowding-out effect (Zwick

and Mahon, 2017). Taxes, according to Auerbach and Hines (2002), cause distortions by
influencing pricing and corporate and consumer decision-making. As a result, taxes distort input

allocation within and between enterprises, reduce the efficiency with which production inputs are

used, and so affect the overall growth of a private fixed domestic investment.

Clark (1979) showed that for the 1954-78 output was clearly the main determinant of

business fixed investments in the United States of America. Given the prime determinant of

corporate capital ending is the demand for its products to the workers, while the government in a

bid to stimulate capital investment manipulate the corporate tax rate as having a strong impact on

capital spending such studies include, Rockley (1863) who found that reductions in the rate of

taxation did not appear to have very powerful impact on corporate investment. He, however,

attributed this to a large number of firms who evaluated investments proposals on a pre-tax basis.

Krausz (1987) using NPI stimulation revealed that for certain assets classification

lowering tax rates from 46 to 33% may actually reduce NPI of projects for companies whose tax

rate is below 35%. As to its influences on foreign investment, the corporate income tax has been

founded by Moore, Swenson & Steece (1982) as having a weak relationship with foreign

manufacturers investments. However, Hall and Jorgenson (1971) estimated a one percent

increase in cost of capital as a result of a cut in corporate tax rate from 52 to 48 persons in 1964.

Everlyne (2013) looked at the impact of corporate taxation on investment decisions made

by companies listed on the Nairobi stock exchange. The study's goal was to determine the links

between corporate taxation and investment decisions made by companies listed on the NSE.

Descriptive The report was based on research, which included the analysis of quantitative data

derived from company financial statements from 2008 to 2012. Regression analysis, ANOVA,

and correlation analysis were used to analyse the data. The findings revealed that corporate taxes

have an impact on business investment decisions. The depreciation tax break had a negative
effect, implying that lowering corporate taxes would boost investment. Investment is influenced

by the interest tax shield, after-tax cash flow, and corporate tax. As a result, the total effect of

these tax incentives was asset-specific, based on the physical asset's qualities and, to a lesser

extent, the industry in which the asset was placed.

Gwartney and Lawson (2006) High marginal tax rate as witnessed in Nigeria has an

enormous effect to GDP. As marginal tax rate rises, individuals get to keep less and less of their

additional earnings. It discourages work effort, as taxes reduce the amount of additional earnings

that one is permitted to keep. It also distorts price signals and encourage individuals to substitute

less desired but tax deductible goods for non-deductible ones that are more desired. High tax rate

will reduce the incentives of people to invest in both physical and human capitals. When tax

rates are high foreign investors will look for other places to put their money and domestic

investment will look for investment projects abroad were taxes are low. This therefore

contributes to reduction in GDP.

Oloidi (2014) investigated the impact of Company Income Tax [CIT] on investment

decisions made by companies in Nigeria that are subject to the CIT Act. A questionnaire was

created to gather information from 180 businesses in the South West Zone, which was then

analyzed using descriptive and regression analytic methods. CIT has an impact on the rate of

return on investment and investment evaluation criteria, according to the findings. Tax incentives

encourage investment, and when compared to other factors influencing investment decisions, the

tax was deemed to be very important. As a result, the study suggests that tax policy should strive

to promote economic growth. Innovative capital investment supports the use of new production

techniques and the development of new products.

 Vergara (2004) examined the relationship between corporation tax reform and private

investment behaviour in Chile from 1975 to 2003, finding that high corporate tax rates harmed

private domestic investment. High marginal tax rates, according to Karabegovic et al (2004),

diminish people's willingness to work to their full ability, take entrepreneurial risks, and start and

expand a new business. Increased marginal taxes have a detrimental impact on economic growth,

labour supply, and private fixed domestic investment (Njuru et al., 2013; Reynolds, 2008).

According to Pereira, the increase in private domestic investment resulting from deficit financing

might be more than offset by financial crowding-out and inter-sectoral efficiency losses.

According to Jorgenson and Yun (1989), indexing the capital tax base and moving the tax burden

from corporate to household capital could yield significant benefits.

In Nigeria, Mary (1965) found that only six out of twenty-six British companies

operating in Nigeria attached much importance to the generous tax incentive offered in Nigeria.

Hakeem (1966), in his survey, discovered that only 16% respondents selected tax incentive as a

factor that influenced their decisions to set up a pioneer industry. In another empirical study

carried out by Philip (1969), it was understood that out of 51 companies studies 33 ranked import

duty reliefs highest amongst tax incentives available to them. It ranked the most important. Also,

Philips (1969) study 60% of the firms studied thought they probably world set in without tax

holiday. 7% were more definite about the unimportance of tax incentives while 35% through

otherwise.

2.4 Lessons Learned and Research Gaps/Summary

Myriads of literature have been explored and it can be deduced that many researchers have

primed their investigations towards tax policy, tax revenue, and investment. This bunch of

research has examined how tax revenue and its fluctuations affect economic growth, how the
government tax policy influences investment decisions, and the relationship between investment,

tax, and economic growth. There is a need to take into account the volatility of tax in Nigeria and

the risks involved and how these influence investments in the country. There is little research

ever made on the influence of tax rate volatility on investment.

Nigeria, just as many underdeveloped countries, does not have a stable tax policy and a

stereotyped with frequent changes in tax policies which in turn makes tax volatile. Taking all

other factors on hold, the tax rate and its stability is a determinant of investment for new and

already existing investors in Nigeria. Thus, the gap in the literature revealed that there is a need

to investigate the effect of tax rate volatility on investment in Nigeria.