THE EFFECT OF TAXATION ON MANUFACTURING FIRMS

CHAPTER ONE

INTRODUCTION

Theoretically, it is believed that tax have a negative correlation with investment and economic growth because taxes causes distortions in the economy. Thus, the believe tax policy discourage new investment and entrepreneurship; by discouraging work effort and acquisition of skills by individuals, cause misallocation or deform resource allocation through their impact on saving and corporate investment. A critical review of the effects of taxation can be most usefully explained through an argument of the diverse channels through which tax policy can affect the economy. For instance, while company income tax is statutorily levied on an incorporated business, the incidence and burden of the tax is generally seen to be distributed in the entire economy among participants in the production value chain. At the one end, the key relationship is that the burden of company income tax is shared between the returns to capital in the form of investor profits and the return to labour in the form of wages paid to employees. If there is a “reduction in company income tax rates, in the form of incentive, companies would accumulate capital, attract inward investment of capital and incentivize innovation” (Engen and Skinner, 2008), thereby expanding output. At the other end, increase company tax rates are detrimental to investment expansion and distortive to productivity and reducing gross domestic product per capital. The two extreme views of the impact of taxation on productivity has attracted several debates in both developed and developing economies. More generally, “there is not all the distortionary taxes that have some adverse effects on economic growth at long-term; the net effect depends on the fact that the considered tax is or not used as an instrument to correct negative externalities or other distortions” (Agenor, 2005). Also, taxation as a fiscal policy instrument is a tool for societal development by those entrusted with the social contact to collect taxes and deploy same for the delivery of security and public goods that enhance the society‟s wellbeing. But how well this has been achieved in the case of Nigeria has remain a subject of daily debate following the fact public infrastructure such as roads, schools, railways, health care facilities, power, among others are either below required international standard or not available at all. The consequence being poor living standard among the populace and high cost of doing business in the country. This positioning is premise on the basis most countries measure their extent of growth, development and standard of living by the proportion of taxes as a percentage of 50.6% and 45.4% in 2003 „while Australia and United States of America collects 31.6% and 25.6% of their national income as taxes respectively”, (OECD, 2008). This similar record for Nigeria is either lacking or relatively below expected standard. Taxes are of different kinds and affect individuals and organizations in diverse manners and, “in addition, different levels of taxation distort market activities to greater or lesser degree”. „Evidence based on a wide number of countries indicates that a 10% reduction in company tax could have anywhere between a 0.6% and 1.8% effect on economic growth rates. In Ireland, the effect of lowering the corporate tax rate in the business and services was shown to have significantly increased GNP in the years following the change” (O‟Connor, 2014). The treatise of taxation and fiscal activities of government is premise on the logic that taxation and government spending lead to higher growth rates. As argued by Dalibor (2002), „government redistribution can stimulate savings and investment by redistributing wealth to individuals with a higher marginal propensity to save (MPS)”. In a general perspective, „higher MPS can be found among people with higher incomes and redistribution stimulating economic growth would thus in reality be a redistribution from the poor to the rich‟. This circle of relationship boost output and other economic activities from various sectors of any economy particularly the manufacturing output.