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THE IMPACT OF FISCAL POLICY ON ECONOMIC PERFORMANCE IN NIGERIA (1981-2016)

ABSTRACT

The study examines the impact of fiscal policy on economic performance in Nigeria between 1981 and 2016. Fiscal policy is represented by government total expenditure, government total revenue and direct tax. A model was developed in which economic growth (proxy as economic performance) is expressed as a function of government total expenditure, government total revenue, direct tax, capital (represented as gross capital formation) and labour (represented as employment rate). The study covered a 36-year period ranging from 1981 to 2016. The econometric techniques of Augmented Dickey Fuller test, Cointegration test and Error Correction model estimation.  Three theories were reviewed namely the classical, neo-classical and the endogenous growth model. The study concludes that fiscal policy was partially effective on economic growth (surrogate of economic performance) in Nigeria between 1981 and 2016. The study suggest that; Government should enhance investment in productive expenditure including expenditure on education, health, manufacturing, mining and agriculture and also ensure that funds meant for development of these sectors are properly utilized; Government should strive to reduce expenditure on recreational, cultural and religious affairs and other functions like political administrative expenses in order to stabilize the economy; Appropriate mix of fiscal and monetary policies that would effectively stabilize the economy should be pursued; Government should consider restructuring its expenditure pattern by allocating more funds towards productive expenditure such as capital projects; Government should consider harnessing its revenue potentials by expanding its revenue base via effective and efficient taxation system and diversification of Nigeria’s revenue base by tapping into solid minerals and agricultural potentials.

CHAPTER ONE

INTRODUCTION

1.1    Background to the Study

Fiscal policy has traditionally been related to the use of taxation and public expenditure to influence economic activities of a country. The implementation of fiscal policy is basically rooted in the budget of the government. The most vital aspect of a public budget is its use as an instrument to manage an economy (Omitogun & Ayinla, 2007). Fiscal policy is a deliberate action of government which entails the use of government spending, taxation and borrowing to control the pattern of economic activities, level of output growth, employment, inflation and employment (Ugwanta, 2014).  Over the last decade, the growth impact of fiscal policy has generated large volume of theoretical and empirical literature. Economic growth is considered is a key macroeconomic objective of a country and that increase in government expenditure on socio-economic and physical infrastructure encourage economic growth as well as expenditure in health and education stimulates the rate of growth of national output (Barro, 1990). Expenditure on infrastructures such as road, power, communication, railway, etc, reduces production costs, raises private sector investment and profitability of firms thus enhancing economic growth. Barro (1990) supported this assertion that increase in government expenditure fosters economic growth. Conversely, another school of thought argued that increasing government expenditure inhibits economic growth. This school of thought maintained that higher levels of government expenditure tend to reduce the aggregate performance of an economy. Furthermore, in an attempt to finance increasing expenditure, government tends to increase taxes and/or borrowing which might affect her spending behavior. Higher income tax de-motivates individuals from working for long hours or even searching for jobs, which in turn reduces income and aggregate demand (Maku, 2015). Similarly, higher profit tax tends to increase cost of production and reduces investment expenditure and profitability of firms. If government increases borrowings, especially from banks, in order to finance expenditure, it will crowd out the private sector, thus reducing private investment.

The debate on the effectiveness of fiscal policy as a tool for stimulating growth and development remains unanswered given conflicting results of past studies. Oshinowo (2015) observed that there are two sides of literature regarding the role of fiscal policy in stimulating economic growth. The first view is that government’s support for knowledge, research and development, productive investment, maintenance of law and order and provision of public services can stimulate growth in short-run and long-run. Conversely, the second view is that governments, especially in developed economies, are bureaucratic and less efficient and as a result they tend to impede growth if they get involved in the productive sectors of the economy. Fiscal policy is perceived to destabilize economic growth by distorting the effect of tax and inefficient government spending. In addition, propositions exist on the effect of fiscal policy on economic performance outcomes. Khosravi and Karami (2010) stated that supporters of the classical school of thought believed that the effect of government spending is temporary and not effective particularly in the long-run when prices adjust and output is at optimal level. In similar vein, endogenous theorists proposed that government expenditure and taxation have temporary and permanent effect on economic growth.  To this end, the study contributed to the argument by examining the effect on fiscal policy on economic performance in Nigeria.

1.2    Statement of Problem

Over the years, Nigeria’s potential for sustainable economic growth and development has remained unattained. This is quite disheartening that despite the enormous mineral and human resources the country owns coupled with increasing trend of public spending year in-year out, the economy has been performing below expectation. Policy analysts, economists and other professionals have attributed the poor performance of the Nigerian economy to corruption, bureaucracy, political instability, lack of accountability and transparency, poor governance and lack of visionary leaders that will direct the economy to the path of growth. Asaju, Adagba and Kajang (2014) added that the misapplication of monetary and fiscal policies and complications in the adoptions of non-market friendly tools constituted major challenges to realizing Nigeria’s fiscal objectives. The public has remained inefficient in terms of service delivery, infrastructural decay, high rate of corrupt practices and lack of accountability and probity in the management of public policies and resources shows the depth of the ineptitude of the public sector in Nigeria that is supposed to lead the economy through fiscal policies. These have resulted to high rate of unemployment, rising inflation, fall in growth, decreasing real incomes and high rate of poverty.  It can be unequivocally stated that fiscal policy has not been effectual in the accomplishment of macroeconomic objectives of full employment, price stability, balance of payment equilibrium, efficient resource allocation, uneven redistribution of income and wealth, exchange rate stability and economic growth.

Moreover, there has been serious contention in literature as to which policy is more appropriate for the pursuit of macroeconomic stabilization in developing countries. Supporters of the monetarist school of thought reported that monetary policy exerts greater influence on economic performance and it should be embraced by developing economies. On the other hand, the Keynesians school of thought posited that fiscal policy has greater influence on economic performance and should be adopted by developing economies. However, both monetary and fiscal policies have not been appropriately used to spur improved performance of the Nigerian economy (Ugwanta, 2014).

1.3   Research Questions

The questions central to this study are:

To what extent has government total expenditure influenced the economic performance of Nigeria?

What is the magnitude of government total revenue on the economic performance of Nigeria?

To what extent has direct taxes influenced on the economic performance of Nigeria?

1.4     Objectives of the Study

The broad objective of the study is to examine the effect of fiscal policy on the economic performance of Nigeria. The specific objectives are:

To determine the extent to which government total expenditure has contributed to economic performance of Nigeria.

To explore the extent to which government total revenue has contributed to economic performance of Nigeria.

To assess the extent to which direct taxes has contributed to economic performance of Nigeria.

1.5       Significance of the Study

A number of studies have been conducted to examine the impact of fiscal policy on economic performance (economic growth) in Nigeria. There is consensus from empirical past findings that fiscal policy has positive impact on economic growth in Nigeria. However, the magnitude of the impact has been contentious. Scholars such as Audu (2012) and Agu, Idike and Okuwo (2014) stated that fiscal policy has robust impact on the Nigerian economy. On the contrary, scholars such as Onwe (2014) and Abdulrauf (2015) contended that fiscal policy has negligible impact on the economy of Nigeria. This however has created a gap in literature. The study therefore examine the magnitude of the impact of fiscal policy on economic growth in Nigeria by extending the scope of past studies in recent years, because the periods 2014, 2015 and 2016 has not been covered in literature.

1.6        Scope of the Study

The study examines the impact of fiscal policy on economic performance in Nigeria between 1981 and 2016. The fiscal policy instruments considered are government total expenditure, government total revenue and direct taxes. Similarly, economic performance is streamlined to economic growth (proxy as real gross domestic product).

1.7     Definition of Key Terms

Fiscal Policy

This refers to the discretionary power of the government to control and regulate an economy through government spending and taxation.

Economic Performance

This refers to the extent to which an economy has accomplished its macroeconomic objectives. Economic performance can be ascertained through price stability, full employment, economic growth and soundness of foreign account. However, the study used economic growth as an index of economic performance.

Government Total Expenditure

This refers to the total spending of government over a period of time. Government total expenditure is the summation of recurrent and capital expenditure over a period of time.

Government Total Revenue

This refers to the total amount of funds realized by the government of a country. Government total revenue in Nigeria can be broadly sub-divided into revenue from oil and non-oil sources.

Direct Taxes

This refers to a compulsory levy imposed by the government on the personal income of individuals and profits of companies and industries.

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