Nigeria’s revenue sharing formula needs a facelift

BY MUHAMMAD SAGAGI

Nigeria’s revenue allocation formula, which dictates the statutory sharing of revenues from the Federation Account (drawn from section 162(1) of the Constitution of the Federal Republic] among the three tiers of government, negates all known principles of fairness, and equity. The system does not promote fiscal efficiency or allow effective fiscal coordination. Revenues are distributed to and spent by states and local governments with no consideration whatsoever for fiscal or monetary stability. It doesn’t engender the even development of the federating units.

In the allocation of revenue from the Federation Account, the Federal Government is unduly favoured at the expense of the states and local governments. Out of every Naira in the Federation Account, the FG is entitled to 48.5 kobo, the states, 24 kobo and the local councils 20 kobo. The balance of 7.5 kobo is shared between four other ‘special accounts’ – namely ecology, FCT, stabilization and natural resources’- which are being managed by FGN! So technically, FGN controls 56K of every Naira or 56% of all revenues in the Federation Account.

Not only does it take too much at the expense of other beneficiaries, but the Federal Government also wields too much power over and behaves as if it owns the Federation Account. The states and local governments are often dismissed as irritants and parasites and their legitimate shares of revenue are regarded as grants. There were attempts in the past to fiddle with the formula without recourse to due process, such as when Olusegun Obasanjo, created the Excess Crude Account, or when he unilaterally caused the suspension of Federation Account transfers to states and local governments.

The state governors exercise excessive influence on the management and utilisation of revenues meant for the local governments in their domain. They are emboldened by Sections 162(5) and 162 (6) of the Constitution, which provide for a ‘state joint local government account’ into which shall be paid all allocations to the local government councils of the state from the Federation Account and from the government of the state.

The sharing formula is based on several contentious principles. Section 162 (2) of 1999 Constitution provides that “……in determining the formula, the National Assembly shall take into account, the allocation principles especially those of population, equality of states, internal revenue generation, landmass, terrain as well as population density….provided that the principle of derivation shall be constantly reflected in any approved formula as being not less thirteen percent of the revenue accruing to the Federation Account directly from any natural resource”

The derivation principle has been the most controversial of all. The award of 13% of the Federation Account to the oil producing states is seen as compensation for the pain associated with oil exploration. The oil producing states are not, however, impressed by the ‘gesture’. They advance the argument that all “resources belong to the federating units (where they are located). In particular, royalties derived from oil and gas production should properly accrue to the host communities and landowners in line with international practice’ (David Dafinone, The Nation Friday August 15, 2008).

On the other hand, the application of the derivation principle is viewed, by others, as conferring undue advantage on the oil producing states. It enhances their status while penalising non-oil-producing states and is capable of exacerbating the uneven development of the federating units. The oil producing states, in addition to the 13% derivation fund, partake in the regular sharing of revenue amongst the states and local governments; also, the NDDC — an intervention fund dedicated to the development of the Niger Delta as well as the Niger Delta Ministry are generously funded from the Federation Account.

No less contentious are revenue-sharing principles or ‘accounts’ that are either prone to corrupt practices or actually tainted by several corruption allegations. These include two special accounts managed by the Federal Government, namely, ecology and natural resource development; and two revenue sharing principles, namely, Social Development and Internal Revenue Efforts.

There is a general consensus that the sharing formula should therefore be reviewed to overcome these challenges and for the satisfaction of five key objectives as listed in the following paragraphs.

The first objective of the review is to enlarge the fiscal space of the sub-nationals. State and local governments’ revenues are too small relative to the daunting challenges of development. Significant resources are required for achieving the Social Development Goals (SDGs), viz: relieving poverty, improving accessibility, affordability and quality of health and education facilities etc. Very few states have made significant breakthroughs in internal revenue generation efforts. The most important internally generated revenue (IGR) source for the states is personal income tax, the receipts from which are low and stagnant. Local governments also have independent revenue, from local taxes, which are difficult to administer and easy to evade due to weak structures and high levels of illiteracy and poverty.

The second objective of the review is to decongest the Federal Government and make it leaner and more efficient in the delivery of service. The Federal Government has succeeded in appropriating too many responsibilities – and along with those, too many resources. Many federal MDAs are involved in micro direct production and operational activities, instead of focusing more on policy development and strategies. This may have been partly responsible for excessive recurrent expenditure and ineffectiveness.

Many of the FGN’s current responsibilities need to be transferred to the states and local governments. For example, the responsibilities for the delivery of education, health and other social services, housing, agriculture, water resources and rural development, should rest on the shoulders of the states and local governments, while the Federal Government retains responsibilities for policy development, strategy, standardization, and quality control.

This new arrangement is expected to increase the efficiency of government and improve the quality of policy outcomes. The dispersal of power will decrease red tape and delays and improve efficiency in service delivery.

The fourth objective will be to foster the even development of the federating units. The Nigeria of today is an unbalanced federation. Ensuring spatially balanced resource-flows across different communities, states, and regions will provide more opportunities in the poorer and less endowed federating units. No federating unit should be left behind on account of its being inherently poor or less endowed than other units.

The final objective is to ensure the independence of the FAAC and the neutrality of the FGN and states in revenue sharing.

To reflect the above stated objectives, the revenue sharing formula shall contain the following provisions:

• There shall be two charges on the main pool before distribution of funds to the tiers of governments. These charges are for the satisfaction of the Derivation Principle and a Stabilization and Investment Fund to be created by an Act of the National Assembly. This requires the amendment of Section 162 (2) of 1999 Constitution.
• The derivation principle, currently with a weight of 13%, shall be maintained and enhanced to at least 25% of the main pool. Under the new arrangement, the NDDC shall continue to exist as a Development Agency jointly funded and operated by the oil-producing states but shall cease to benefit from FAAC.
• The Stabilization and Investment Fund deserves special attention. It is an international best practice to maintain such accounts to protect the planned budget against unpredictable shortfall due to volatility. Countries like Nigeria with a single export commodity whose price is subject to market fluctuations will find such funds especially appealing; for the rehabilitation and development of critical infrastructure.

The Federal Government’s budgetary spending of approximately $30 billion per annum falls short of the required spending to bridge the country’s huge infrastructure deficit which is estimated at approximately $100 billion per annum. The stabilization account currently receives only 0.5% of FAAC – which is not sufficient for it to play the envisaged role of an intervention fund. Funding for critical infrastructure will now become the responsibility of all tiers of government.

• Review the vertical sharing formula (section 162(3)) as follows:
• Provide 37% of revenue in the main pool for the Federal Government, 35% for the 36 states, 22% for the 774 Local Governments, 1% for the Federal Capital Territory and 5% for a Special Account, to be known as the Fund for Human Capital Development.
• Discontinue the current practice of funding four special accounts, namely, Ecology, Natural Resources Development, FCT and Stabilization. However, FCT and Stabilization Accounts will be funded under separate arrangements (see paragraph 1.2 and 2.1).
• Create a Special Account (The Fund for Human Capital Development) to cater for the funding of Federal Universities, Federal Polytechnics, Federal Colleges of Education, Federal Research Institutes and Federal Teaching Hospitals and Medical Centres. The creation of the special fund recognizes that the funding of these federal institutions remains a national rather than federal responsibility, following the devolution of responsibilities for the delivery of education and healthcare services to the lower levels of government. The Fund shall operate for a period of 10 years after which it will be reviewed.
• For the horizontal distribution of revenue (amongst states and local governments), only three principles shall apply henceforth: The Principles of Equality of States with a weight of 45% (currently 40%); Population with a weight of 45%, (currently 30%) and Terrain/Land mass 10%. The Principles of Social Development (currently 10%) and Internal Revenue Effort (currently 10%) shall be discarded.
• Review Sections 162 (5) and 162 (6) of the Constitution to enable local governments directly receive their statutory share of revenues from FAAC. The operation of state-local government joint account should be discontinued.
• To ensure the ‘independence’ of FAAC and the neutrality of the FGN in matters of revenue allocations,
• The Revenue and Fiscal Commission (RFC) shall be the custodian of FAAC. The Chair of RFC shall chair all meetings of FAAC.
• There shall be an accountant general of the federation with responsibilities for FAAC and one for the federal government with responsibilities for federal government accounts.

We conclude with three cautionary notes. First, enlarging the sub-nationals’ fiscal space will undoubtedly relax their fiscal constraint but does not guarantee economic growth or reduced poverty for their citizens. For impact, sub-national governments must commit to a growth and diversification agenda, by prioritising spending on economic infrastructure and on social services, notably education, health, and social investment programmes. Resources must be judiciously and responsibly deployed for development.

Second, putting more money into the purse of state governments doesn’t necessarily provide a solution to their rent-seeking and unproductive culture of over-dependence on government transfers. States and local government authorities must therefore be supported in strengthening internal revenue mobilisation measures.

Third, devolution of powers and responsibilities to lower levels of government will not automatically induce efficiency in service delivery. Indeed, given what we know about the public sector – with inefficient institutions, inappropriate infrastructure, insufficient capacities, etc.… There are strong reasons to worry about the readiness of the sub-nationals to shoulder new and additional responsibilities. States and local governments may simply be overwhelmed by the sheer volume of new and added responsibilities. For impact therefore, considerable time and resources must be expended to overhaul delivery structures and build new frameworks for coordination, human capacity development and strategies for change.

Sagagi, a professor of economics can be reached via [email protected].