One sound subnational PFM practice is regularly reviewing tax rates, tariffs, and fees. Apart from the government, sellers and business people also periodically review and revise the prices of their goods and services. Tenants are equally very conversant with their landlords’ periodic reviews of tenancy rates to adjust for changes in the economy and for such other reasons as covering possible repairs and upgrades on the property. This thinking is no different at the subnational government level, as such reviews serve several vital purposes for effective fiscal management and economic development. Tax rates, fees, and tariffs constitute crucial sources of independent revenue for subnational governments, collectively accounting for between 15 percent and 40 percent of their total earnings. Until recently, statutory earnings from the Federation Accounts numbed many states and local governments’ willingness to pay adequate attention to making desired changes in tax rates, fees, and tariffs to enhance revenue receipts. Yet, fiscal federalism imbues them with fiscal autonomy, allowing them to set their tax rates and tariffs and tailor their revenue-raising policies to local needs. Regularly updating tax rates, fees, and tariffs will ensure adequate revenue, effective response to changing economic conditions, and proper identification of areas to improve tax collection. For instance, broadening tax bases helps reduce compliance costs while promoting economic growth. There are a host of other benefits.
As discussed, the first advantage is undoubtedly revenue generation. Regular tax rates and tariff updates help the government collect the requisite revenue amounts. Over time, inflation, changes in the economy, and shifts in consumer behaviour can erode the purchasing power of existing tax amounts charged. Hypothetically speaking, a 50 percent inflation rate would have cut the actual value of the collected amount by half. Authorities can adjust for this loss by updating tax rates and maintaining a stable revenue stream. Secondly, outdated tax rates can create confusion and encourage tax evasion. Updating tax rates and effectively communicating the basis for adjustment to the public can lead to taxpayers perceiving them as fair and reasonable when reflecting current economic realities. This perception may reduce the likelihood of tax evasion and encourage voluntary compliance. Generally, regular updates to tax rates and tariffs demonstrate the government’s commitment to maintaining a responsive system while also helping to build taxpayer confidence and trust in the tax system. And because income and wealth distribution change over time, tax rates require adjustments to ensure that the tax system remains fair. Regular updates help maintain this fairness and prevent tax policies from becoming regressive or overly burdensome on specific groups.
Thirdly, tax rates, fees, and tariffs impact the competitiveness of businesses within the state and local governments. Regularly assessing and adjusting tax rates, fees charged, and other tariffs helps ensure that firms operating within them remain attractive to investors, which is critical for economic growth and job creation. High tax rates can disincentivize investment inflows, while overly generous tax incentives can erode the government’s revenue base. Therefore, finding a middle ground is very critical to ensuring that the states and local governments do not lose much-needed investment on the one hand and government revenue on the other. This thinking is consistent with the economic growth advantage of regularly reviewing and updating tax rates, fees, and tariffs. Subnational governments must carefully choose not only the level of tax rates but also the tax base, carefully aligning tax policies with changing economic conditions and ensuring that they remain competitive globally.
The fourth justification for regular reviews and updates of taxes, fees and tariffs charged by the subnational government is to make adjustments for the effects of inflation. Inflation erodes the actual value of money. Neglecting adjusted tax rates and tariffs for inflation means that taxpayers are effectively paying lower taxes in real terms. This inflation-induced loss reduces government revenue, making it challenging to meet its financial obligations. Regular updates help prevent this and maintain the actual value of tax revenues. Fifth, regularly updated tax rates provide more accurate revenue forecasts, enabling better budgetary planning and execution. Accurate revenue forecasts, in turn, give the government a clearer understanding of available resources, allowing them to allocate funds efficiently for essential public services, infrastructure projects, and social programs. Consequently, budgetary planning becomes more reliable, preventing budget deficits and fiscal crises while promoting responsible financial management and economic stability.
Despite these numerous advantages, many subnational governments in Nigeria still fail to implement regular reviews. However, because these processes can be resource-intensive and time-consuming, resource constraints, political considerations, bureaucratic challenges, and the broader economic and political contexts often influence this behaviour. Most local governments face challenges of limited staffing, inadequate financial resources, and technical expertise, which always stand in the way of conducting regular reviews and updating tax policies. Again, tax policy changes can be politically sensitive, potentially impacting voter sentiment and political support. Some governments, particularly those seeking reelection or guarding the party’s prospects, may avoid frequent reviews to maintain political stability, especially if they fear a backlash from taxpayers or interest groups affected by tax adjustments. In addition, governments prioritizing short-term fiscal objectives over long-term planning may avoid frequent tax rate reviews to maintain a stable revenue stream, even if it means missing out on potential revenue gains or failing to adapt to changing economic conditions.
Furthermore, tax policy changes often require legal and administrative amendments, which can be complex and lengthy, involving legislative approval, public consultations, and regulatory adjustments. These process requirements and the attendant bureaucracy may discourage some state and local governments from regularly reviewing tax rates, fees, and tariffs. Inadequate data collection and analysis of infrastructure prevalent at the subnational level across the country may also intimidate them.
Regularly reviewing tax rates, fees charged, and tariffs by subnational governments also comes with numerous challenges and problems, requiring careful consideration. Firstly, frequent changes in tax rates and tariffs can create an administrative burden for taxpayers and tax authorities. Taxpayers must constantly adjust their financial planning and compliance processes to accommodate the changes, while tax authorities must invest resources to implement and communicate these changes effectively. Secondly, regular tax rate changes can create uncertainty for businesses, making it challenging to make long-term investment decisions. Firms may hesitate to expand or invest in new ventures due to the unpredictability of tax obligations. Thirdly, frequent adjustments in tax rates and tariffs can disrupt economic stability and the investment climate. Businesses need a stable fiscal environment to thrive, and constant changes can deter domestic and foreign investors. Fourthly, rapid changes in tax policies can strain the capacity of tax authorities to implement and enforce new rules effectively. Adjusting administrative processes and systems to accommodate new rates and fees may take time. Fifth, frequent changes can lead to confusion among taxpayers, resulting in increased instances of non-compliance or unintentional errors in tax reporting. This unpleasant feedback can strain tax enforcement efforts and reduce revenue collection. Again, frequent reviews may lead to a short-term focus on revenue generation rather than comprehensive tax reform and long-term fiscal planning.
For effectively reviewing tax rates, fees, and tariffs charged by subnational governments, subnational tax authorities must consider four factors adequately. These include comprehensive research and analysis of the prevailing economic conditions and stakeholder consultations, considering the impact of changes in tax rates on small and medium-sized enterprises (SMEs), and how best to monitor and evaluate the effects of the reviews. First, the review process must evaluate economic indicators, market conditions, and international best practices. It is a no-brainer that subnational tax authorities must consider the potential impacts of rate adjustments on different sectors, businesses of varying sizes, and overall economic competitiveness. Thorough research and analysis would enable the Internal Revenue Service (IRS] to make informed decisions that promote economic growth while maintaining a fair and sustainable tax system. Second, engaging stakeholders in consultations is crucial for securing buy-in and reassuring them that tax rates, fees, and tariff updating processes are transparent and inclusive. Accordingly, subnational tax authorities must seek input from businesses, industry associations, tax experts, and other relevant stakeholders to ensure that updates reflect the needs and concerns of the business community and the rest of the citizens. This collaborative approach fosters trust, encourages compliance, and guarantees that updates align with the realities of the local economy.
Again, when reviewing tax rates and tariffs, subnational tax authorities should carefully consider their prospective impacts on SMEs. SMEs are vital in driving economic growth and employment, underscoring the criticality of considering their peculiar needs in the review process. Therefore, significant efforts are critical to maintaining moderate tax rates for SMEs, as excessive tax burdens can hinder their growth and discourage formalization. Balancing the needs of SMEs with subnational government revenue requirements is crucial for promoting inclusive and sustainable development. Fourth, subnational tax authorities must also regularly monitor and evaluate the impacts of the revision, as discussed in previous paragraphs. Regular monitoring allows the IRS to assess the effectiveness of rate adjustments in achieving economic growth, tax compliance, and revenue collection objectives. Evaluating the impact of updates ensures that tax policies remain responsive to changing economic realities and enables authorities to make necessary refinements in the future.
Finally, regular updates to tax rates and tariffs are essential for subnational governments’ revenue generation, economic stability, equity, competitiveness, compliance, and effective fiscal management. The updates promote economic growth, encourage investment, and ensure tax compliance. Authorities foster trust and confidence in the tax system by maintaining fair and reasonable tax rates. Engaging stakeholders, considering the impact on SMEs, and conducting comprehensive research are crucial steps in the update process. Adopting best practices and monitoring the outcomes of the reviews enable subnational tax authorities to create a tax system that supports sustainable economic development and enhances the overall well-being of societies.