Why does the federal government struggle to meet its revenue targets?

Budgeting may look simple—what you earn is what you spend. But it becomes even more crucial and takes on a multidimensional approach when we look at it from a country’s view. For instance, Nigeria’s budget determines how the lives of over 200 million people will fare for at least 365 days. It also shows how much money the government hopes to make from different sectors—usually oil and non-oil—and where the money will go.
 

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One place the federal government’s money is going is towards debt servicing. Last week, the federal government said it spent more than its revenue between January and April to service debt. This has put the country’s finance minister, Zainab Ahmed in the spotlight. Her role as the Minister of Finance, Budget & National Planning means she is in charge of drawing up and administering items in the budget. At the beginning of 2022, she told us that the total debt service for the year would cost ₦3.6 trillion—just 34% of total revenues. But the 2022 fiscal performance report for January through April showed the federal government spent ₦300 billion (or 20% more) than its revenue on debt servicing.

Debt service for the year could still be about ₦3.6 trillion—total debt servicing cost just ₦1.94 trillion in the first four months of 2022. It’s also too early to tell if federal government revenue will be lower or higher than debt at the end of the year—the federal government’s revenue has on average, been between ₦4 trillion to ₦5 trillion in the last five years.

But debt servicing is now more than the federal government’s revenue—at least as of April 2022. So, it is worth analysing how the government makes revenue projections. From the chart below, these projections are hardly met.
 

Diagnosing the problem

So, why the constant miscalculations? Let's start with how the ministry prepares the budget in the first place.

In preparing the budget, Mrs Ahmed’s office makes certain assumptions. The problem is that these assumptions tend to be unrealistic.

Remember that a country’s budget has two major sections—revenue and expenses. Let’s start with the revenue assumptions, which usually follow a review of events in the country and worldwide. For instance, this year, the finance ministry expected to make nearly ₦11 trillion from oil and non-oil sources. Oil is expected to rake in ₦3.4 trillion, while non-oil revenue will bring in the rest. However, the amended budget shows that the budgeted revenue is ₦9.9 trillion, and oil revenue is expected to be about ₦2.2 trillion. 

The initial assumption for ₦3.4 trillion in oil revenues was based on oil prices being $57 per barrel, an exchange rate of ₦410.15/$, and the country producing 1.88 million barrels of oil daily (revised to 1.6 mmbpd in July 2022).

However, when the national assembly reviewed the budget, the lawmakers increased the benchmark oil price to $62, based on the World Bank’s forecast that crude oil prices will average $74 in 2022. At the time, oil demand had begun to strengthen and reach pre-pandemic levels.

Fortunately, oil prices are now at $104 per barrel, surpassing both price projections. This means we should be smiling at the bank and meeting obligations. But oil prices are just one of the ingredients that make oil revenue projections achievable.

As explained earlier, other items like oil production and exchange rate matter too. The ministry expected oil production to hit 1.9 million barrels per day (mmbpd). This was quite ambitious because the last time Nigeria printed such a performance was years ago. As of June 2022, oil production was 1.16 mmbpd.

This brings us to the third assumption for oil revenue—the exchange rate, which determines how much naira the federal government will earn from selling crude oil.

If the finance ministry expects the official rate of $1 to be ₦410.15, which was higher than 2021’s  ₦379/$, this means crude oil sales, usually quoted in US dollars ($), will be higher after converting it to naira. This is because the currency (₦) is now weaker. Remember, lower or weaker currency means you need more naira notes for the same $1 bill. So converting dollars to naira (when the naira is weaker) translates into more naira bills for the federal government. 

But on the other hand, when you need dollars to pay for things, this weaker currency is not favourable, as it adversely affects the expenditure side of the budget. Think of Nigeria’s Eurobonds and dollar debt obligations, importing refined petrol equipment for manufacturing and infrastructure. At the end of the day, it’s like robbing Peter and Paul only to pay back Paul and Peter.  

So, it is clear that revenue, especially oil revenue projections, can be better. I’ll admit that estimating exchange rates and oil prices can be tricky, and they (the government) have never been in control of price. For instance, it was hard to know at the beginning of the year if there would be a war in Ukraine, leading to an increase in oil prices.

Still, budget items like oil production are more local and arguably easier to predict. Raising the oil production target from 1.86 to 1.88 million barrels per day when oil companies like Shell and Total were divesting, when crude oil theft was at its peak, or when you haven’t met such a target in the last forty years, is like building castles in the air.
 

Yet, the government believes it makes realistic projections. In the 2022 budget, the finance ministry’s office insists that its assumptions are based on the federal government’s potential to grow its revenue.

Frankly, there are no arguments here. That Nigeria has revenue potential will hardly be contested, but overly optimistic projections do not help. Still, the ministry’s point on realistic projections holds when we look at non-oil revenues, but not in all cases.
 

Nigeria’s non-oil revenue

When it comes to the income the federal government earns from non-oil revenues, they are in two parts—tax revenue and other revenue.

Tax revenues include value added tax (VAT), company income tax (CIT), and customs collection. Other revenues represent income the federal government independently generates from Government Owned Enterprises (GOEs). Some examples of these enterprises are profitable companies that earn income from their thriving industries, such as the National Pension Commission (Pencom), Federal Inland Revenue Service, and the Nigerian Communication Commissions.

Like oil revenue, the projections for non-oil revenues are also based on assumptions such as expected inflation, domestic consumption and GDP. As with oil revenue projections, the assumptions for non-oil are not all hits. For instance, the finance ministry expects inflation to drop to 13% this year and consumption is projected to increase by about 9.4% from a revised ₦136.6 trillion in 2021 to ₦149.4 trillion in 2022. 

These assumptions usually drive how much the government expects to earn through taxes. The logic here is that lower inflation should encourage higher consumption. And a higher consumption of goods and services will increase VAT and boost company profits.

The assumptions for last year worked. The federal government met and even exceeded the finance ministry projected non-oil revenues. For instance, as of November last year, CIT, VAT and customs collections were 115%, 165%, and 104% above the prorated targets for the period, respectively. This meant that the federal government earned much more than it targeted from these sources.

But a performance review of the first four months of 2022 shows the opposite result. The expected and prorated VAT for January to April was about ₦800 billion, compared to the  ₦770 billion the government earned, representing a 6% shortfall. CIT was 1.4% shy of an expected ₦303 billion, and customs collection was ₦527 billion or 22% short of the expected ₦672 billion.

One explanation from the finance ministry is that there is a seasonality to some of the non-oil taxes. For instance, some companies pay their taxes during the year's first half. So, the country expects to collect significantly more in the year's second half.

It's worth noting that the finance ministry uses the nominal GDP figures to make VAT and CIT revenue projections, while imports determine customs collection. Nigeria’s trade data for 2022 is yet to be published, but a reduction in imports due to a lack of foreign exchange could also explain the shortfall in customs collection. On the other hand, VAT and CIT can be attributed to GDP projections being a little higher than reality. Despite rising global inflation, Nigeria’s GDP forecasts from the International Monetary Fund (IMF) and World Bank are still strong at 3.4%. But higher prices could mean consumers are already tightening consumption.

However, unlike oil revenue, non-oil revenue sources are within the federal government’s control and the projections are usually missed by small margins, if they are missed at all. But it will be remiss to overlook the government's role in ensuring these assumptions, especially non-oil revenue assumptions, hold or are at least realistic.

For instance, expecting inflation to slow down when the budget is expansionary is counterintuitive. At the beginning of the year, the finance ministry expected the government to spend ₦17 trillion in 2022. This was ₦3 trillion or 18% higher than 2021’s budget, suggesting that the government will pump more money into the economy, which should drive consumption and tax revenues. But higher consumption further increases prices.
 

Also, the finance ministry expected ₦13 trillion or 75% of this money to be spent within the country on items such as salaries and capital projects. With such expenditure plans, any economist will tell you to expect more, not less, inflation. This was why the US expected inflation in its economy after pumping in cash grants to its citizens in 2020, during the height of the pandemic.

So even if disruptions like the war did not happen, assuming that the inflation rate would drop to 13% was unrealistic. But the reason for wanting a lower inflation rate is not far-fetched. Inflation shaves off the value of everything, including non-oil revenue.
 

Turning a blind eye

Meeting revenue projections is not a function of well-thought-out assumptions alone. Other factors matter too. For instance, the federal government attributed the success of higher non-oil revenue in 2021 to implementing fiscal reforms such as the introduction of audited accounts for government owned enterprises. This subject of fiscal reforms shows that plugging leakages (a form of fiscal reform) also ensures budget efficiency. Once things like account auditing come into play, it is easier to see where money is coming from and where it is going.

You already know where most of the government’s revenue is going or where the federal government says it went between January and April this year. At the beginning of this article, I discussed how Nigeria’s debt situation has worsened to the extent that the federal government uses all its revenue to service debt.

We’ll probably need to acquire more debt to meet other obligations apart from debt servicing. For instance, The approved 2022 budget was already ₦6 trillion above projected revenues, and the finance ministry expected to borrow the money from domestic, foreign and multilateral sources. 

But, with revenue becoming inadequate to service these borrowings, getting more loans today is worrisome and becomes harder and harder if debt to revenue continues to rise above 100%.

So far, we’ve seen that the finance ministry prefers to make ambitious revenue projections even when past performances show these projections are not obtainable. But this is not surprising considering the government’s rising expenses.

Expecting the finance minister to make more realistic revenue projections means that the government will either slash expenses considerably or present a budget deficit two or three times bigger than overall revenue. The finance minister seems to have settled for the easier route—inflate revenue and hope it meets the basic expenses like debt servicing and recurrent expenses. The problem with this approach is that capital projects that can lead to economic development often suffer.

The government can attempt to borrow more funds to meet these obligations, but now that interest rates are rising globally and locally, it has become more costly to take loans. Many African countries are already facing rising debt repayment costs, which are taking a toll. Between 2015 and 2022, the IMF list of SSA countries in debt distress (or at high risk of it) has grown from eight to 23.

While Nigeria was not listed despite its heavy public debt burden, high debt repayments present an opportunity cost for the government. If the government is too busy repaying its debts, it can’t spend money on key development projects that will directly improve the lives of its citizens, such as investing in education and healthcare. Hopefully, as the year progresses, the federal government can rake in more income, especially from non-oil sources, to reduce revenue shortfalls. If not, its salary payments will tread dangerously close to being in the hands of God or a creditor merciful enough to grant the FG more loans.