Exploring PPP options for subnational IGR expansion
Martin Ike-Muonso, a professor of economics with interest in subnational government IGR growth strategies, is managing director/CEO, ValueFronteira Ltd. He can be reached via email at email@example.com
May 22, 2023144 views0 comments
Many subnational governments in Nigeria cannot generate enough money to meet their demands for more taxable assets. Yet it is wholesome that they continuously create tax bases at a matching pace to sustain independent revenue growth at levels consistent with population growth and modern public goods demands. But delivering on this expected goal is fraught with enormous challenges. First, in many cases, the accumulated consequences of the misaligned priorities of previous governments wiped away virtually all possible levers to properly launch their revenue growth expansion. When not outrightly embezzled, most subnational governments’ earnings primarily funded over-inflated, bogus, barren and later abandoned projects. Second, this piling of failures to build robust revenue-generating bases orchestrated a mismatch with the strongly growing population they should support. For instance, any well-meaning government should ensure matching rates of expansions in public goods such as water supply with its rates of population growth at least to minimize pressure on existing infrastructure. Unfortunately, for decades serial administrations at most subnational government levels consistently failed in proactively planning for rural-urban migration, population expansion, the turn-out rates of tertiary school graduates, growth in vehicular traffic on our roads, and so on. Third, many areas of good governance require immediate attention, mainly because the arguments adduced already outweigh the declining revenue amount. Modern living has a longer list of requirements for meeting citizens’ good governance expectations than their contemporaries a few decades ago.
Many state and local governments have responded to this challenge through increased borrowing, more aggressive revenue collection activities, the introduction of new tax types, and the upward reviews of tax and tariff rates. In almost all instances, they have also faced corresponding resistance from taxpayers who feel that such upward changes in the rates paid are not fair and justifiable. Many citizens also condemn the penchant for seemingly unbridled public sector borrowing and the exposure of future generations to unnecessary burdens. In many instances, the subnational government’s debt exposure is far more extensive than the actual costs of public goods and the infrastructure they supposedly funded. However, a hugely unexplored option is strengthening revenue collection institutions to tap into the informal sector more effectively, high net worth individuals HNIs, and very important personalities [VIPs]. Most revenue collection agencies have yet to work out feasible approaches to harvesting the abundant tax-yield opportunities within the informal sector. Likewise, high-net-worth individuals and other very important personalities hardly pay their fair share of tax liabilities to state governments. In many instances, some of them that have rich political connections do not pay at all. Most importantly, subnational governments must complement the strengthening of the revenue collection institutions by building the right calibre of trust from the citizens through good governance, which invariably enhances compliance rates.
Another option is public-private partnerships [PPPs]. Public-private partnerships are popular but poorly utilised financing models that state and local governments can leverage to create substantial taxable wealth and satisfy the citizens’ good governance aspirations. PPPs are usually collaborative efforts between the government and the private sector to provide public assets and services, with the latter bearing significant financing and management responsibilities and risks. One of the essential benefits is that it often makes it easier to complete projects in good time and at the right quality. On the government’s side are usually contributions of tax waivers and other fiscal incentives, land and other natural resources, protection from liability, and so on. Some of the mostly adopted models of PPPs include Build-Operate-Transfer (BOT), Build-Own-Operate (BOO), Build-Operate-Lease-Transfer (BOLT), Design-Build-Operate-Transfer (DBFOT), Lease-Develop-Operate (LDO), Operate-Maintain-Transfer (OMT), etc.
Unfortunately, because most subnational governments find it challenging to meet some of the conditions set by partnering private sector investors, they also lose the benefits of such financing models. For instance, many cities will certainly have a regular water supply if the government concessions water provision to private investors. Under such an arrangement, the private sector builds the water infrastructure, distributes and reticulates it across the city accordingly, and then returns to recover its water infrastructure investment. This example is just one of the tens of types of PPP models deployed worldwide to complement governments’ efforts in providing public goods and other essential infrastructure in collaboration with the private sector. With the devolution of power on the national electricity system, it is only natural that progressive subnational governments may invoke appropriate PPP approaches to take full advantage of the opportunity. As long as a mutually beneficial arrangement is possible between the government and potential private sector investors, it is possible to attract significant private sector efforts in creating revenue-generating assets for subnational governments.
PPP has numerous advantages to the states, the local governments, and the private partner. The first is the savings on the state’s resources. In a well-structured and implemented PPP arrangement, subnational governments save on their budgets and can still accomplish project targets and programmes. For example, a state government that wants to set up three general hospitals, but faces financial constraints, can consistently achieve the same through partnerships with the private sector, which develops the hospitals, possibly managing them in line with the agreements and delivering an agreed proportion of the earned revenue to the government. The second benefit is that through the PPP channel, some states and local governments can bring into existence and enhance the quality of a range of public goods and services and considerably expand on the citizens’ choices. Thirdly, PPP primarily enhances the deployment of cost-cutting practices and access to cutting-edge technology, mainly when the private sector partners have far-reaching expertise on the technology or from countries that can provide such technology at much cheaper rates. Fourthly, such engagements also improve the stakeholders’ financial material, managerial know-how, and competencies. Public sector officials usually benefit from the managerial expertise of the private sector, where the PPP arrangement has much to do with the private sector management of a publicly-owned facility. In the same vein, it also benefits from the financial structuring knowledge the more exposed they are to public-private partnerships.
Although many countries such as Egypt, Thailand, India, China, and Colombia maximally reap the benefits of PPP, we are yet to tap into it to improve publicly provided assets and services, particularly at the subnational government levels. The reason is an ingrained inability to live up to a good PPP arrangement’s critical success factor expectations. A robust institutional and governance framework is an important critical success factor for excellent PPPs. The private sector must have a conviction of good governance with a clear and comprehensive legal and regulatory framework eliminating grey areas of potential conflicts. This governance clarity is critical because private partners assume most risks in a PPP arrangement. Excellent PPP laws, policies, and operational PPP units at the sub-national level are desirable. The second factor is strong political support for the partnership. Governments’ support confers some measures of hope that the projects may be sustainable over time, particularly with competitive and transparent procurement processes and adequate protection of investors. The third is the availability of a knowledgeable team of experts with a good understanding of the markets, financing technicalities, risk allocation and mitigation, legal drafting, and sundry skills.
Historically, PPP arrangements usually involve huge and financially or managerially demanding projects that the public sector requires the intervention of private investors to either bring into existence or make more efficient and profitable. Such projects’ size and complexity usually mean that micro and small businesses are off the table because they cannot cope with complex prequalification, bidding, and legal contracting requirements. However, while micro and small enterprises may not directly participate as partners, subnational governments can consciously tailor the PPP terms to include them. Such inclusive PPPs have a supercharged power to grow local capacity and expertise, entrepreneurial awareness, competitiveness, and the size of real output. One of the ways that the government can include the small and micro enterprises to tap into the PPP opportunities is by providing them with procurement incentives, capacity building, and subcontracting opportunities in the contract terms. It is important to note that while empowering micro and small businesses within subnational governments’ PPP arrangements is worthwhile, it should not be at the expense of good quality service delivery.
Subnational governments benefit from the revenue opportunities provided by PPP financing or management of their projects in several ways. The first is the investment income opportunities and the possible short-term upsides in the case of trading on the instruments of ownership or debt. Notwithstanding that private investment partners bear the bulk of the risks in such arrangements, the partnering public sector receives corresponding ownership entitlements in the venture. And depending on the terms of the contract, any of the partners can either divest at a higher value or trade on the instruments (equity or debt). Again, subnational governments expanding the deployment of the PPP financing or management model, and the extension of participating opportunities to micro and small enterprises would likely result in the increased formalisation of ventures of such size. A previously unregistered, informal firm must register with the appropriate authorities to qualify for these PPP-embedded service-providing opportunities. Increased formalisation of enterprises correlates positively with the revenue yield to the states. Therefore, PPP increases employment opportunities and the derivable quantum of personal income taxes from employed persons. Other enhanced value-chain opportunities, such as improved vehicle ownership, expanded traffic, and commercial activities, increase the derivable revenue opportunities.
Finally, in addition to the compelling benefits of PPP justifying subnational governments’ expanded utilisation of the model is the escape window that it provides many of them to mitigate the effects of the debt ceiling on their capacity to continue running the government. Many states have already reached their borrowing limits and may find it challenging to rely on debts to fund their operations regardless of the severity of their financial distress. Again, PPPs do not constitute privatisation, as governments still have considerable roles in service delivery regarding the target projects and programmes. In all, this is an auspicious period for subnational governments to jump on this PPP boat to revenue expansion.