Direct Taxation And Income Inequality In Nigeriadocx

=== Direct taxation and income inequality in Nigeria ===

Direct Taxation and Income Inequality in Nigeria

Timothy OBOH

MGS0708031

A project written and submitted to the Department of Accounting, Faculty of Management Sciences,

University of Benin in partial fulfilment of the requirement for degree of Bachelor of Science in Accounting of the University of Benin,

Benin City.

February, 2014

Declaration

I Timothy OBOH do hereby declare that this project is entirely my own work and composition. All references made to works of other person have dully acknowledged.

__________________________ _____________________

Timothy OBOH Date

[anonimizat] certify that this work was carried out by Mr. Timothy OBOH in Department of Accounting, University of Benin, Benin City.

_______________ _____________

DR. O. J. ILABOYA DATE (PROJECT SUPPERVISOR)

________________________ ____________________

DR. O. J. ILABOYA DATE

(PROJECT CO-ORDINATOR)

_____________________ ____________________

DR. ENOFE E.A. DATE

(HEAD OF DEPARTMENT)

Dedication

I dedicate this project work to my parents Mr. Oboh Paul Akhazemhior (Itema) of blessed memory and Madam Egbesimea mabel Oboh and to my late elder brother Godwin Egbona Oboh.

Acknowledgements

I thank God Almighty especially for giving me the knowledge, grace and strength for the successful completion of this project work. I wish to express my sincere appreciation to my supervisor, Dr. O. J. Ilaboya for his mentoring and useful suggestions that inspired me in completion of this project. I also wish to express my gratitude to Prof. Eric Kelly Inanemo Omogbai for his fatherly role and support for my study. Special thanks to Prof Izedonmi F.O.I who is always there for me.

I am grateful to Dr. Ibadin P. O. for his mentoring, which encourages me greatly as a Class Rep. and to Dr. Ibrahim IBN Shaibu thanks for your support. Thanks to Dr. Dabor E. L. for encouraging me when the study was difficult. Special thanks go to my great friend Efionayi Dickson Osamudiamem and others that have contributed one way or the other in completion of this project.

I truly wish to appreciate my Dad, Late Mr. Oboh Paul Akhazemhior, he will always tell me “Am equal to the task” Daddy, I love you wherever you are now. I wish you are alive to see the end of the study you encourage me to start years back. I am grateful to my mum, Madam Mabel Egbesimea Oboh, I love you mum. Thanks to my brothers and sister for their support.

TABLE OF CONTENTS

Pages

Title page – – – – – – i

Declaration – – – – – – ii

Certification – – – – – – iii

Dedication – – – – – – iv

Acknowledgments – – – – – – v

Table of contents – – – – – – vi

List of Tables – – – – – – x

Abstract – – – – – – xi

CHAPTER ONE: INTRODUCTION

Background to the study – – – – – – 1

Statement of the research problem – – – – – 3

-Research Questions – – – – – 3

Objective of the study – – – – – 4

Research Hypotheses – – – – – 5

Scope of the study – – – – – 7

Significance of the study – – – – 8

Limitation of the study – – – – 9

CHAPTER TWO: LITERATURE REVIEW

2.1 Introduction – – – – 10

2.2 Direct Taxation and Income Inequality – – – 12

2.3 Company Income Tax and Income Inequality – – 19

2.4 Personal Income Tax and Income Inequality – – 24

2.5 Petroleum Profits Tax and Income Inequality – – 28

CHAPTER THREE

METHODOLOGY

3.1 Introduction – – – – – – 30

3.2 Research Design – – – – – – 30

3.3 The population and sampling – – – – 31

3.4 Sources of Data – – – – 31

3.5 Model Specification – – – – 31

3.6 Data Estimation Techniques – – – 36

CHAPTER FOUR: DATA ANALYSES AND PRESENTATION

4.1 Introduction – – – – – 37

4.2 Presentation of Empirical Result – – – – 37

4.2.1 Econometric Analysis – – – – – 39

4.3 Text for Co-Integration – – – – – 42

4.4 Error Correction Model Analysis – – – – 44

4.5 Diagnostic Test – – – – – 48

4.5.1 Serial Correlation test – – – – – 48

4.5.2 Heteroskedasticity Test – – – – – 49

4..5.3 Ramsey Test – – – – – 49

4.6 Discussion of Findings – – – – – 50

CHAPTER FIVE

SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATION

5.1 Summary of Findings – – – – 52

5.2 Conclusion – – – – 53

5.3 Contribution to knowledge – – – – 54

5.3 Recommendation – – – – 54

Bibliography – – – – 56

Appendices – – – – 60

List of Tables

Table 1: Descriptive Statistics – – – – – – 37

Table 2: Phillip-Perrons (PP) Test at Levels (See Appendix) – 40

Table 3: Results of PP Unit Root Tests at First Difference – 41

Table 4: Augmented Dickey-Fuller test statistic – – – 42

Table5: Parsimonious Error Correction Model (ECM) – – 44

Table 6: Breusch-Godfrey Serial Correlation LM Test – – 48

Table 7: Heteroskedasticity Test: Breusch-Pagan-Godfrey – 49

Table 8: Omitted Variables: Squares of fitted values – – 49

ABSTRACT

This study examined the effect of direct taxation and income inequality in Nigeria. Data are gathered from the Nigeria journal of economics and statistics, National centre for economic management and Administration (NCEMA), Federal Office of Statistics (FOS), economic and social bulletin publications, Central Bank of Nigeria Publications and Federal Inland Revenue Service.

The findings show negative and significant relationship between Ratio of petroleum profits tax to total direct tax (PPT/TDT), Ratio of private credit to GDP (PC/GDP) and income inequality in Nigeria with t-value of (-2.705240) and (-2.902908) and negative coefficients of (-1.821040) and (-0.623358) respectively. We found a negative but insignificant relationship between Ratio of company income tax to total direct tax (CIT/TDT), Ratio of personal income tax to total direct tax (PIT/TDT) while Labour force participation (LFP) and Ratio of total direct tax to total tax revenue (TDT/TTR) had positive but insignificant relationship with income inequality with the coefficient of (0.440672) and (0.327264) and t-value of (1.120217) and (1.592402) respectively, for Nigeria’s income inequality between 1980 and 2011.

xi

CHAPTER ONE

INTRODUCTION

Background to the study

Income distribution in developing countries in recent decades is less unequal than in developed countries on average before-tax income. Hence, unlike developed countries, developing countries generally have not been able to utilize tax and transfer policies properly to reduce income inequality (Chu, Davoodi & Gupta, 2000). Direct taxes improve the distribution role of taxation, due to its progressivity in order to reduce income inequality (Seaz, 2004).

This study was motivated by the results of past studies on direct taxation and income inequality that developing countries have not been able to utilize tax and transfer policies properly to reduce income inequality and the effect of some sub-components of direct taxes on income inequality in Nigeria as a developing country. The study made various contributions to knowledge. Mainly, there are few studies that focus on the impact of direct taxes and its sub-component effect on income inequality, in-addition, the study provide indepth understanding of the effect direct taxation has on income distribution in Nigeria as a country specific other than cross-country analysis.

The major findings show negative and significant relationship between Ratio of petroleum profits tax to total direct tax (PPT/TDT), Ratio of private credit to GDP (PC/GDP) and income inequality in Nigeria with t-value of (-2.705240) and (-2.902908) and negative coefficients of (-1.821040) and (-0.623358) respectively. We found a negative but insignificant relationship between Ratio of company income tax to total direct tax (CIT/TDT), Ratio of personal income tax to total direct tax (PIT/TDT) while Labour force participation (LFP) and Ratio of total direct tax to total tax revenue (TDT/TTR) had positive but insignificant relationship with income inequality with the coefficient of (0.440672) and (0.327264) and t-value of (1.120217) and (1.592402) respectively, for Nigeria income inequality between 1980 and 2011.

Statement of the Research problem

For large number of developing countries, widespread poverty and small income available to the poor have been worrisome issues across the countries. Also there have been question raised about the effectiveness of taxation as a redistributive tool (Chu, Davoodi & Gupta, 2000). The above issues are epitome of problems in Nigeria as a developing country and the fundamental question remain, what is the redistributive effect of direct taxation in Nigeria to address the widening gap between the poor and the rich which have made the rich getting richer and the poor getting poorer.

-Research Questions

The following research question shall be answered;

1. What is the relationship between total direct tax to total tax revenue and income inequality?

2. How does petroleum profit tax to total direct tax ratio affect income inequality?

3. Does company income tax to total direct tax ratio influence the level of income inequality?

4. What role personal income tax to total direct tax ratio play in reducing income inequality?

5. Does private credit to GDP change income inequality?

6. What is the relationship between labour force participation and income inequality?

7. What is the impact of education tax on income inequality?

OBJECTIVES OF THE STUDY

The broad objective of the study was to examine the relationship between direct taxation and income inequality in Nigeria.

The specific objective of the study was to:

Ascertain the relationship between petroleum profit tax to total direct tax ratio and income inequality in Nigeria;

Examine the relationship between company income tax to total direct tax ratio and income inequality in Nigeria;

Investigate the relationship between personal income tax to total direct tax ratio and income inequality in Nigeria;

Determine the relationship between private credit to GDP and income inequality in Nigeria;

Establish the relationship between labour force participation and income inequality in Nigeria; and

Verify the relationship between education tax and income inequality in Nigeria.

Research Hypotheses

H0: Total direct tax to total tax revenue does not have significant impact on income inequality.

H1: Total direct taxes to total tax revenue have significant impact on income inequality.

H0: Petroleum profit tax to total direct tax ratio does not affect income inequality.

H1: Petroleum profit tax to total direct tax ratio affect income inequality.

H0: Company income tax to total direct tax ratio does not influence income inequality.

H1: Company income tax to total direct tax ratio influence income inequality.

H0: Personal income tax to total direct tax ratio does not reduce income inequality.

H1: Personal income tax to total direct tax ratio reduce income inequality.

H0: Private credit to GDP does not change income inequality.

H1: Private credit to GDP changes income inequality.

H0: There is no relationship between labour force participation and income inequality.

H1: There is relationship between labour force participation and income inequality.

HO: Education tax has no impact on income inequality.

H1: Education tax has impact on income inequality.

1.5 Scope of the study

The scope of this study will be defined on temporal basis, which will cover Nigeria data for the period of thirty two (32) years from 1980 to 2011.

1.6 Significance of the study

This study hopefully will extend our understanding regarding distribution of income which becomes inequitable distributed, that has worst off in the past years. In addition, the findings from this study may be helpful in clarifying the results of some literatures that direct taxes had failed to mitigate widening income inequality. Meanwhile, this study will be useful to the following:

Society: the widening gap of income disparity across the Nigeria society can be address through this study.

Researchers: researchers will find the result of this study very useful in forming the bases for further studies.

1.7 LIMITATION OF THE STUDY

Inadequate Time: The duration of time for the study would not be enough to source for sufficient information for perfection of the research.

Lack of Funds: An all embracing research work, involves enormous funds to carryout and due to the present economic situation, such funds are not available as required for a large scale study. Incomplete Data: on wide topics like direct taxation and income inequality, well establish data are not easily available.

CHAPTER TWO

LITERATURE REVIEW

2.1 Introduction

The current chapter presents each of the several studies on direct taxation and income inequality in general and specifically examines types of direct taxes impact on income inequality in order to identify the gap of the studies and also to provide further scope for prospective academic advancement in the area. Hence, on the basis of the objectives the present study classifies the related literature into the following four categories:

2.2 Direct taxation and Income Inequality

2.3 Company Income Tax and Income Inequality

2.4 Personal Income Tax and Income Inequality

2.5 Petroleum Profit Tax and Income Inequality

Income inequality has experienced considerable change throughout the world. The Gini Coefficient has been the most popular method for measuring income inequality in literatures. Gini Coefficient ranges from 0 (perfect equality) to 1 (perfect inequality). Income inequality denotes distribution of income or wealth measurement among households. It is a way of comparison of the gap in household income in a given region, country or world (Bradley, 2013).

Corbett, Zitikus, Williams, Greselin and Pasquazzi (2012) examined useful tools that can effectively measure changes in income distribution with a comparison between the Gini and the Zenga. They use 20% sample of household income from Canada’s Census. Their weight sample represents approximately 13.45 million household incomes from ten provinces in the study, Gini and Zenga score were computed for each province using different household income computations. The household income differs according to family structures and tax adjustment combination. They found that most of the ranking agreed among income measurement groups. In little instances the Gini and Zenga ranking disagreed within income measurements. They concluded their findings by suggesting the Zenga to be reliable measure of income inequality.

2.2 Direct Taxation and Income Inequality

Saez (2004) found out that redistribution of income should be obtained only through direct taxation while indirect taxation is sub-optional in income inequality. They looked at the effectiveness of direct and indirect tax instruments for redistribution of income in the short run and long-run. Their conclusion was that long-run direct taxation should be preferred to indirect taxation instruments to achieve income redistribution and raising revenue. In contrast, Engal, Galetovic and Raddates (1999) examined the impact of taxation on income inequality at the level of household in Chile and approximate the distribution effect of different changes in the tax structures. They found that income inequalities before and after taxation are very similar with Gini Coefficients of 0.488 before tax and 0.496 after tax. Some arithmetic show was presented to describe the scope for direct income redistribution through progressivity of the tax system was limited. Their results suggested that to reduce income inequality, discussion should be focus on the amount to be redistributed, the target at public spending and efficacy of alternative tax and should not be based on the progressivity of the tax structures.

Ilaboya and Ohonba (2013) examined direct and indirect tax impact on income inequality, their approach was country-specific using tax and macroeconomics data from 1980 to 2011. They employed multivariable econometric analysis approach to find the effect taxation has on income inequality in Nigeria. Their study found a negative and strong relationship between total tax revenue to GDP and income inequality in Nigeria, as a result of t-value of (-2.748706) and (-2.287270) and negative coefficients of (-0.007869) and (-0.512235) accordingly. They also found negative but insignificant effect between GDPPC, PCREDIT/GDP, TDT/TIT *TTR. While LFP and TDT/TIT had positive but insignificant impact on income inequality in Nigeria as a result of coefficients (0.421) and (1.243794) and t-value of (1.732565) and (1.717362) accordingly.

In the same vein, Chu, Davoodi, and Gupta (2000) in their paper review on income distribution in developing countries, found that on the average before-tax is less unequal in developing countries than the developed countries. They determined that developing countries generally have not been able to utilize tax and transfer policies properly to reduce income inequality unlike the developed countries. During the period of 1980s and 1990s, many transition countries encounter an increase in income inequality. They gave the following reason why the developing countries are lacking behind in using tax and transfer policies, which are unique to transition countries, generally developing countries have a number of weak fiscal features, such as a low ratio of tax-to-GDP this reflect poor governance, weak tax administration and wide spread tax evasion, transition countries are dominated by indirect taxes and limited social protection policies.

OECD (2012) found in their study that on the average, three quarters of the reduction in income inequality is due to transfers, the rest to direct household taxation. They investigate income inequality and growth: The role of taxes and transfer system, reduce overall income inequality in all countries. Income distribution before taxes and transfer is mainly influence by the dispersion of labour income and the prevalence of part-time employment. Cash transfers are not large in size but highly targeted on those in need in some countries and in others, large transfer redistribution income particularly over the life-cycle rather than across individuals. The personal income tax seems to be progressive, while consumption taxes and real estate taxes often take over a larger share of the current income of the less well-off. Setting reforms of tax and transfer systems deals with a double dividend in respects of reducing inequality and raising GDP per capita. Specifically, reducing tax expenditures, which mostly benefit the well-off, contributes to equity objectives while also giving chance for a growth-friendly cut in marginal tax rates. Finally that other reform may involve trade-off among these two policy objectives. To shift the tax mix to less-distorting-specifically away from labour towards consumption would increase incentives to work and save but increase inequality at least a given point in time. On the average across the OECD, three quarters of the reduction in inequality is due to transfers, the rest to direct household taxation.

Bastagli, Coady and Gupta (2012) review how fiscal policy can address income distribution in both developing and developed economics. They assembles a detail data-base on post tax and transfer income inequality for 128 developing and 22 developed economies they found that fiscal policy can influence income inequality both indirectly through its impact on the future earning capacities on market income of individual and direct through it impact on current disposable incomes. The role of fiscal policy may vary among economies, showing difference in available fiscal instruments and in social preferences regarding equity and government role. They note that recognition of redistributive tax systems benefit may introduce economic inefficiencies, since firms and individuals change their behaviour to avoid paying taxes or to maximize the transfers they receive, reducing the overall size of the income pie being redistributed. They concluded that in developed economies fiscal policy has played a significant role in redistribution, particularly on the expenditure side, also through income taxation progressivity. However, the developing economies need to improve their distributive influence of fiscal policy by improving their capacity to raise tax revenue and to spend those resources more equitable and efficiently.

Park (2011) examined Taxes, social transfers, and income inequality, they found out that taxes and social transfers can have immediate effect on income inequality and using tax instruments to reduce income inequality possible impact should be consider on growth and employment: limit distortions on the incentives to work, invest and create wealth. They concluded that inequality can be addressed by taxation, social transfer and social expenditure, yet whether and to what extent taxation should be used for active redistribution under debates.

Sacchi and Salotti (2011) investigate the interactions among fiscal decentralization and regional disparities using a sample of 23 OECD countries for the period 1971-2000. They explore the impact of fiscal decentralization on income inequality. They there by test whether regional economic disparities have effect on the fiscal decentralization process. Their results show the importance of both the nature of fiscal decentralization- expenditure versus taxation and of the extent to which responsibility and decision powers are really left to sub-central government.

Joumard, Pisu and Bloch (2012) in their paper tackling income inequality: the role of taxes and transfers reduce income inequality in disposable income relative to market income and the redistributive impact of taxes and transfers depends on the size, mix and the progressivity of each component. Also that some countries with a relatively small tax and welfare system achieve the same redistribution effect as countries characterized by much higher taxes and transfers, because they rely more on income taxes, which are more progressive than other taxes, and on means-tested cash transfer.

2.3 Company Income Tax and Income Inequality

Harberger (1962) investigate the effect of the corporate income taxes and also show inferences about the likely incidence of corporate income tax in limited states. The major characteristic of the study was presented in general equilibrium nature, that in a closed economy of two perfectly competitive sectors and absolute mobile factors of production, imposition of tax in one sector capital would lead to movement of capital from the taxed to the untaxed sector, causing redistribution of labour across two sectors and charges in output prices and factors of production.

Martinez-Vazquez, Moreno-Dodson and Volovic (2012) interact company income tax variable with globalization index to account for dimension of company income tax and their results was in support of Harberger’s (1962) findings of close and open economy where capital flow freely. They found in a close economy one percentage point increase in ratio of company income tax to GDP reduces income inequality by 0.7 percent point. Thus, the more open an economy is, the lower this negative effect on income inequality. 10 point rise in the globalization index, decreases negative effect of company income tax on income inequality by 0.1 percentage point. In general, their study show the potential role that taxes and public expenditure policies play in affecting income distribution, that progressive personal income taxes and corporate income taxes decrease income inequality. The effect of corporate income taxes tends to be eroded away in open or globalised economies. While they also argue that general consumption taxes, excise taxes and customs duties have a negative impact on income distribution. Their study was concluded that there is significant effect of both taxes and public spending on income distribution when they are considered jointly. When considered separately, progressive income taxes have a positive impact on income distribution, contributing to reduce inequality, and this effect is more pronounced, the higher the degree of progressivity and the higher the share of GDP that is collected with individual income tax. Corporate income taxes also have a positive effect on income distribution but this effect seems to be misplaced in economies that are very open or globalized.

Ramot and Ichihashi (2012) examined the effects of tax structure on economic growth and income inequality. They use a panel data set of cross national data of 65 countries with the period 1970-2006. Top statutory corporate and personal income tax rate. The study found that statutory corporate income tax rate is strongly negatively associated with economic growth and income distribution by controlling for various other variables of growth and income inequality. They however, state that personal income tax rates have no effect on economic growth and on income inequality. In addition to their findings, they classify the countries into tax group’s base on their average top statutory corporate income tax rates and found that, high to company income tax rates, above 40% corresponded with lower income inequality also on the other hand; lower company income tax rates below 40% are not significant in reducing income inequality.

Duncan and Peter (2008) investigate whether income distribution is affected by structural progressivity of national income tax systems. They use large panel of countries, detailed income tax schedules to develop and estimate full measures of structural progressivity of income tax system. For a period of 1981-2005, They found that tax progressivity reduce observed inequality in accounted gross and net income with a little significant effect on true inequality, this was approximated by consumption-based measures of Gini. Their study shows that, under précised condition, progressivity of tax may increase actual income distribution. Specifically in countries with weak statute and a large informal sector that is not taxable. However Duncan and Peter (2008) did not put into consideration the effect of progressivity on income inequality also depend on importance in GDP of income tax revenue, higher progressive tax on income but with relatively little collections is likely to have less effect on income inequality (Martinez-Vazquez, Moreno-Dodson & Volovic, 2012).

Gentry and College (2007) had made an empirical study of the impact of corporate income tax. Their paper reviews the evidence on the incidence of corporate income tax, mainly in the light of recent empirical studies that base on the relationship between corporate income tax and wages. While more research was necessary to draw definitive conclusion, their studies suggest that labour may bear a substantial burden from the corporate income tax. These result were consistent with computable general equilibrium models base on an open economy in which a single country sets its tax policy independently of other countries; in their models assumptions that capitals is mobile and consumers are willing to substitute tradable goods produced in different countries imply that labour can bear more of the incidence of the corporate tax than capital bears. They assumes in their theory that capital is mobile between countries and that capital investment varies with tax policy. These arguments about capital mobility and investment focus on the main channel for the corporate tax affecting labour income is through changes in the capital stock.

2.5 Personal Income Tax and Income Inequality

Paulus, Figori and Sutherland (2009) made a study of the effect of tax and benefits on income distribution, they show the major ways in which governments can influence income distribution through the system of cash benefits and personal incomes taxes. They point out that taxes tend to be progressive, in the sense that people with higher incomes pay a higher proportion of their income in tax. Benefits may be focus at the poor or, even if flat rate, they will bring down the proportional difference between the incomes of the rich and the poor. Also when benefits are paid to people in particular instances, these tend to be related with low income or greater needs or are benefits that are specifically intended to replace income from work. They found that in order to reduce incomes inequality of main income, tax and benefit play major roles. When combined redistributive effect is not strictly related with inequality in main income due to re-ranking of countries, when they consider the distribution of disposable income. The total redistribution of taxes and benefits in absolute terms was larger in Hungary (with an absolute change in Gini equal to 0.27) and Belgium (0.24), and smaller in the Netherland (0.14) and Portugal, Italy and Ireland (0.15 in each). Considering disposable income, inequality is then lower in the Nordic and the continental countries (led by Austria, Denmark and Sweden with a Gini of 0.23 in each). Inequality is high, on the other hand, in the southern European (Greece, Italy, Portugal and Spain) and the Anglo-Saxon countries (the UK and Ireland) with Portugal (0.36) and Italy (0.35) having the most unequal distribution of disposable income. The four Eastern European countries that they examined do not form a distinct group of their own in terms of disposable income inequality.

Okner (1975) determine empirically individual taxes and the distribution of income. Their paper was concerned only with the distributional impact of personal income and employment taxes. In addition to the overall distribution of after and before tax income they also examine and compare the incidence of individual taxes for particular subgroups of the population. In their study individual taxes was interpreted widely to include transfer payments receive from the government as well as taxes paid, they assess the extent to which both individual taxed and transfers affect the distribution of income in their analysis. The study was concluded that the net impact of direct Federal taxes and transfer has an important effect on distribution of individual income, and transfers play very important role in redistribution of income among families than taxes. They discover a significant increase in social security benefit (addition to payroll tax increases) during the period which would tend to affect some of the tax reduction impacts. Concluding that taxes now account for a little bit more of redistribution, while transfer account for a slightly smaller degree of redistribution. Thus, if income redistribution is an important national objective, we must either adopt changes that will increase the progressivity of existing taxes or expend transfer payments to individuals using financial arrangements which are not regressive.

Attinasi, Checherita-Westphal and Rieth (2011) examine personal income tax progressivity and output volatility; evidence from OECD countries over the period 1982-2009. Their measure of tax progressivity was based on the difference between the marginal and average production worker. They found significant empirical evidence for the hypothesis that higher personal income tax progressivity leads to lower output volatility. All other factors remain constant, countries with more progressivity personal income tax system seems to benefits from stronger automatic stabilizers.

OECD (2012) examines the role of taxes and transfer. They discover that tax and transfers system reduces total income inequality in all countries. Income distribution before taxes and transfer is mainly influence by the dispersion of labour and part-time employment. They found that a personal income tax seems to be progressive, while consumption taxes and real estate of current income of the less well off. Setting reforms of tax and transfer systems deals with a double dividend in respects to reducing inequality and raising GDP per capita. Specifically reduce tax expenditure, which mostly benefit the well-off contributes to equity objectives while also giving chance for a growth friendly cut in marginal tax rates.

Finally, that other reform may involve trade-off among these two policy objectives. To shift the tax mix to less-distorting specifically away from labour towards consumption would increase incentives to work and save.

Martinez-Vazquez, Moreno-Dodson and Volovic (2012) found that progressive personal income taxes and corporate income taxes decrease income inequality. The impact of corporate income taxes tends to be eroded away in open or globalised economics.

2.5 Petroleum income Tax and Income Inequality

Ogbonna and Appah (2012) investigate the effects of petroleum income on the Nigerian economy for the period 2000 to 2009 using the gross domestic product (GDP), per capita income (PCI), and inflation (INF) as the explained variables, and oil revenue, petroleum profit tax/royalties (PPTIR) and licensing fees (LF) explanatory variables. Their sample covers all the sector of the economic, including the oil sector and the non oil sector. Their study shows the result that oil revenue has a positive and significant relationship with GDP and PCI but a positive and insignificant relationship with INF. Also PPT/R has a positive significant relationship with GDP and PCI, but a negative and insignificant relationship with inflation. It was also discover that LF has a positive but insignificant relationship between GDP, PCI and INF, respectively. Their study concluded that petroleum income (oil revenue and PPT/R) has positive and significantly impact on the Nigeria economy when measured by GDP and PCI for the period 2000 to 2009.

CHAPTER THREE

METHODOLOGY

3.1 Introduction

This chapter gives an insight of the methods, the procedures, the modalities and sequential steps which the research intend to undertake in order to ensure that the results of findings are reliable, accurate and valid. It gives a careful description of the research design, population and sampling of the study, Sources of data for the model and model specification.

3.2 Research Design

The research design use for the purpose of this study includes the exploratory survey and descriptive researches in order to have an in-depth understanding of the impact of direct taxation on income inequality in Nigeria. These design form the full basis upon which the data which shall be analyzed and then be generalized in an attempt to making inferences.

3.3 The population and sampling

The population of the study consists of Nigeria data. The sample of the study entails a segment of the population of interest which covers Nigeria data from the years 1980 to 2011 a period of thirty two (32) years.

3.4 Sources of Data

Secondary sources of data are used in this research. Data are gathered from the Nigeria journal of economics and statistics, National centre for economic management and Administration (NCEMA). Federal Office of Statistics (FOS), economic and social bulletin publication, Central Bank of Nigeria Publications and Federal Inland Revenue Service.

3.5 Model Specification

Based on the research study three (3) models are examined as follows:

Ramat & Ichihashi (2012) in examine the effects of tax structure on economic growth and income inequality estimates the following models. To investigate the impact of tax structure on economic growth, the study estimates, model developed by lee and Gordon (2005) as:

Growthit = o + 1Tit + 2Xit +ə1DGit + ə2DRit +qi + еit

Where I represents the country, t denoted the time period (1970 to 2006), Growth is an annual growth rate of GDP per capital, T is the tax structure which represent top CIT and PIT rates X is a set of control variable consisting of Gini’s index, education, openness, inflation and investigation a1 is unobserved variable in this model. DG is dummy variable for countries classified by regions.

Also to quantify the impact of income tax structures on income inequality, the study estimates the following equation.

Giniit = o + 1Tit + 2Git + 3G3it + 4Xit +עCIT* OPENit + ə1DGit + ə2DRit +ai + еit

The equation shows that income inequality, measured by the Gini coefficient, Giniit for country i in year t, is a function of GDP per capita, Git income tax structures, Tit and a set of control variables Xit which is commonly used in literatures to explain income inequality control variables consist of education, trade-openness, inflation rate and population growth rate. a1 is unobserved variables in the model to indentify region-specific income tax policy effect a dummy variable, DRit, is interested with the explanatory variables. To account for the impact of taxing the capital on inequality, CIT is interacted with openness. Moreover, eit observation- specific errors.

Duncan & Sabirianova (2008) in their study tax progressivity and income inequality; they observed income inequality as a function of structural progressivity and other control variables as:

Iit = ʒt + Pit + UDgit + o Zit + ØWit + Ƹit

Where Iit is observed inequality measured by income- based Gini coefficients (either net or gross income) in country i and year t, ʒt captures year effects Pit is relevant measure of PIT progressivity , Dg, it is a dummy equal one if Gini is based on net income, zit is a vector of control variable, Wit is a vector of auxiliary variable that are included to control for consistency of the Gini coefficients (a dummy for national area coverage and a set of dummies for the type of income adjustment), and Ƹit is the error term.

Martinez-vazquez et al (2012). The impact of taxes and expenditure policies on income distribution. They estimate the following model as:

giniit = αginiit-1 + yfit xit + vi + Ƹit, i=1,…., n, t=1,…,T

gini represents the gini coefficient in country i in year t, i=1, … n, t=1, …. T, while αginiit-1 represents its value in year t-1. Next, Fit stands for a vector of fiscal variables represent tax instruments and public expenditures in country i in year t the variables representing tax instruments are PIT, CIT, SSC and payroll taxes, general sales tax |(GST), exercise and customs duties. The vector Xit represents the set control variables that have been consistly found to play a significant role in explaining income inequality in the previous literature. Vi stands for unobserved country fixed effects.

Against the above background we modified the three models to capture our specific situation. Thus the model estimated as follows;

Ginint = αginint-1 + yknt-i +xnt + vnt + Ƹnt

Where gini represents the observed inequality measured by income-based Gini coefficient (either net or gross income) in Nigeria in year t, t=1, –- T, while ginint-1 represents its value inyear t-1. Next Knt stands for total direct taxes to total tax revenue (TDT/TTR) variable representing tax instruments in Nigeria year t. the variables representing tax instruments are petroleum profit tax to total direct tax ratio (PPT/TDT), company income tax to total direct tax ratio (PIT/TDT), private credit to GDPPC/GDP and labour force participation(LTP). Xnt represents the set of control variable that have been consistly found to play a significant role in explaining income inequality in most literatures. These include population growth, age dependency, the level of globalization, GDP per capital growth, unemployment, the extent of corruption, education level and the size of government.

Lastly, in the error term, Vnt stands for unobserved Nigeria Fixed effects and Ƹnt represents the observation- specific error

Ʊnt = Vnt + Ƹnt

3.6 Data Estimation Techniques

In order to ensure validity and reliability of the results we conducted some diagnostic tests.

– Normality

– Heteroskedasticity test

– Auto/serial correlation

– Model misspecification.

The empirical model specified was analyzed base on stationarity, cointegration and error correction model

CHAPTER FOUR

DATA ANALYSES AND PRESENTATION

4.1 Introduction

This chapter deals with the presentation and analysis of the empirical results obtained from the estimation process. The model specified was tested base on stationarity by employing the Phillip-Peron test. Test for Co-integration and Error Correction model analysis were carried out. Diagnostic Tests: Serial Correction Test, Heteroskedasticity Test and Ramsey Test were analyzed to ensure validity and reliability of the model.

4.2 Presentation of Empirical Results

Table 1: Descriptive Statistics

Source: Researcher’s Computation (2013)

The table above shows the descriptive statistics of the variables used in the analysis. The Table showed that between 1980 – 2011, the average ratio of Petroleum profits tax to total direct tax(PPT/TDT) was about 81.00, the average ratio of total direct tax to total tax revenue(TDT/TTR) was about 64.87, the average ratio of Personal income tax to total direct tax(PIT/TDT) was 1.83, the average Gini Coefficient for the period was about 45.00. The descriptive analysis also revealed that most of the variables used in the study are normally distributed as observed from the Jarque-Bera statistics.

4.2.1 Econometric Analysis

It has been established in the most econometric literatures that most time series variables are not stationary and using non-stationary variables in the model might lead to spurious regression which cannot be used for precise prediction. Hence, our first step is to examine the characteristics of the data in order to determine if the variables are stationary and the order of integration. For this purpose, the Phillip-Perrons (PP) test was used. A variable is stationary if the absolute PP value is higher than any of the absolute critical value for the Phillip-Perrons (PP) statistic at 95% level. The unit root test was carried out on both levels and first difference. The result of the stationary test with intercept and trend is presented in the table below:

Table 2: Phillip-Perrons (PP) Test at Levels (See Appendix)

Source: Researcher’s Computation (2012) see appendix

Note: * one-sided p-values.

The result of the unit root tests at level shows that only TDT_TTR was stationary since the absolute PP test statistics was greater than the absolute critical PP value of 3.56 at 5% significance level of significance. While PPT_TDT, PIT_TDT, TDT_TTR, PC_GDP, GINI and LFP were not stationary at levels since their absolute calculated PP values of -3.09, -2.52, -1.78, -1.89, and -1.67 respectively were less than the absolute critical PP value of 3.56 at 5% significance level of significance. Thus, the table showed clearly that most variables were non-stationary at 5% significance level. Thus, we cannot reject the hypotheses of unit root for each of the variables. This suggests the need to take the first difference of the variables to obtain stationarity.

Table 3: Results of PP Unit Root Tests at First Difference

Source: Researcher’s Computation (2013) see appendix

Note: * one-sided p-values.

The table above shows that at the first difference all the variables are stationary. D(PPT/TDT), D(PIT/TDT), D(CIT/TDT), D(TDT/TTR), D(PC/GDP), D(GINI) and D(LFP) were stationary since the absolute PP test statistics with constant and trend values of -28.94, -36.06, -28.09, -15.38, -12.01, -38.77 and -27.76 respectively were greater than the absolute critical PP value of -3.60 at 5% level of significance. Thus, it has been established that all the variables are integrated of order one I(1).

4.3 Tests for Co-integration

We test for co-integration in both models. The Engle and Granger two stage test was used to carry out the co-integration test. The most commonly used method is to run an OLS regression at level of GINI and the regressors and test its residuals for stationarity, using the PP to test for unit roots. The result of the unit root tests on the OLS residuals is reported in the table below:

From the table, it was observed that the residual is stationary since the absolute PP test statistics with a value of -3.85 is greater than the absolute critical PP value of -2.96 at 5% level of significance. This leads us to conclude that GINI and the regressors are co-integrated. This conclusion arises from the Engle and Granger (1987), postulations that if two or more variables with a unit root, a linear combination of such variables would ensure that the resultant residuals would be integrated of order zero(Stationary).

4.4 Error Correction Model Analysis

The short run adjustment dynamics can be represented by an error correction model. The result from ECM model is presented below:

The model shows that about48% of the systematic variation in income inequality in the short run have been explained by all the regressors namely (Ratio of total direct tax to total tax revenue(TDT/TTR ), Ratio of Company income tax to total direct tax(CIT/TDT), Ratio of Personal income tax to total direct tax(PIT/TDT), Ratio of Petroleum profits tax to total direct tax(PPT/TDT), Ratio of Private Credit to GDP(PC_GDP) and Labour Force participation(LFP).

This is indicated by the coefficient of determination (R2) of 0.48. After adjusting for the degree of freedom the model explain about 31% of the systematic variations in of the total systematic variations in income inequality (GINI) as shown by the adjusted R –square of 0.31. While about 69% of the systematic variations in income inequality (GINI) was left unexplained by the model which has been captured by the error term. This implies that other factors apart from Ratio of total direct tax to total tax revenue(TDT/TTR ), Ratio of Company income tax to total direct tax(CIT/TDT), Ratio of Personal income tax to total direct tax(PIT/TDT), Ratio of Petroleum profits tax to total direct tax(PPT/TDT), Ratio of Private Credit to GDP(PC_GDP) and Labour Force participation(LFP) are responsible for Nigeria’s income inequality between 1980 and 2011.

On the basis of the overall statistical significance of the model as shown by the F-statistics, it was observed that the overall model was statistically significant since the calculated F-value of 2.92 was greater than the critical F-value at 5% level of significance. Thus, all the explanatory variables jointly have a significant impact on income inequality in Nigeria in the short run.

The table also shows that in the short run, the ratio of Petroleum profits tax to total direct tax(PPT/TDT), and ratio of Private Credit to GDP(PC_GDP) had a significant impact on income inequality in Nigeria, since the calculated t-values of 2.7 and 2.9 were greater than the critical t-values at 5% level of significance. While the ratio of total direct tax to total tax revenue(TDT/TTR ), ratio of Company income tax to total direct tax(CIT/TDT), ratio of Personal income tax to total direct tax(PIT/TDT), and Labour Force participation(LFP) had no significant impact on income inequality in Nigeria, since their calculated t-values were less than the critical t-values at 5% level of significance.

The coefficient of the ECM was correctly signed and significant at 1% level. Thus, the model is able to correct for any deviation in economic growth from their long-run equilibrium values. The coefficient of the ECM with a value of 0.69 means that the speed of adjustment is about 69% which indicates a rapid speed of adjustment in the long run when there is a temporary disequilibrium. The Durbin Watson statistic of 2.2 indicates the absence of autocorrelation in the model.

4.5 Diagnostic Tests

In order to ensure validity and reliability of the results we conducted some diagnostic test.

4.5.1 Serial Correlation Test

The table above shows that the F-statistic and Obs*R-square values of 2.82 and 6.61 with p-values of 0.08 and 0.13 respectively indicates the absence of autocorrelation in model since the F-statistic and Obs*R-square with p-values of 0.08 and 0.13 are greater than the critical values at 5% level of significance. Thus, we can conclude that there is no presence of autocorrelation in the model.

4.5.2 Heteroskedasticity test

Source: Researcher’s Computation (2013)

The table above shows that the F-statistic and Obs*R-square values of 0.50 and 4.17 with p-values of 0.81 and 0.75 respectively indicates the absence of heteroskedasticity in model since the F-statistic and Obs*R-square with p-values of 0.81 and 0.75 are greater than the critical values at 5% level of significance. Thus, we can conclude that there is no presence of heteroskedasiticity in the model.

4.5.3 Ramsey Test

The table above shows that the F-statistic of 0.01 with p-values of 0.89 indicates that the model is correctly specified since the F-statistic with p-values of 0.89 is greater than the critical values at P > 0.05 level of significance. Thus, we can conclude that there is no misspecification of the model.

4.6 Discussion of Findings

Total direct tax to total tax revenue ratio to income inequality for the period 1980 to 2011 was positive though statistically insignificant which implies that total direct tax to total tax revenue increase income inequality in Nigeria having reported a positive coefficient of (0.327264) and an insignificant t-value of (1.592402) this was different from OECD (2012) findings that on the average across the OECD, three quarters of the reduction in inequality is due to transfers and the rest to direct household taxation.

According to Ramot and Ichihashi (2012) corporate and personal income tax rate Was found to be negatively associated with income distribution, this was similar to the results of this study that Company income tax to total direct tax ratio and personal income tax to total direct tax ratio was negative, although insignificantly related with income inequality in Nigeria. Also petroleum profits tax to total direct tax ratio reported a negative coefficient of (-1.821040) and robust t-value of (-2.705240) which show that in Nigeria as a developing country was able to use sub-component of direct taxes to reduce income inequality this results was contrary to Chu, Davoodi & Gupta (2000) findings that developing countries generally have not been able to utilize tax and transfer policies properly to reduce income inequality.

CHAPTER FIVE

SUMMARY OF FINDINGS, CONCLUSION AND RECOMMENDATION

5.1 Summary of findings

The following findings were reported:

Total direct tax to total tax revenue (TDT/TTR) was found to increase income inequality in Nigeria for the period study even though the effect was statistically insignificant.

Petroleum profits tax to total direct tax ratio (PPT/TDT) was found to reduce income inequality in Nigeria for the period under study having reported a negative coefficient and significant t-value of (-1.821040) and (-2.705240) respectively.

Company income tax to total direct tax ratio (CIT/TDT) reduce income inequality in the period under study having reported a negative coefficient of (-0.604959) and insignificant t-value of (-0.750784), although the effect was statistically insignificant.

Personal income tax to total direct tax ratio was found to reduce income inequality in the period under review.

Private credit to GDP ratio was found to reduce income inequality in Nigeria as it reported a negative coefficient (- 0.623358) and robust t- value of (-2.902908).

Labour force participation was found to increase income inequality in Nigeria between 1980 and 2011.

5.2 CONCLUSION

The broad objective of this study was to examine the impact of direct taxation on income inequality in Nigeria. It was establish from the above findings that the sub-component of direct taxation has helped to enhance income redistribution in Nigeria within the period of 1980 to 2011. Total direct tax to total tax revenue was found to increase income inequality even though the effect was insignificant. The findings also reveal that petroleum profits tax and private credit to GDP help to mitigate inequality in Nigeria under the period study.

5.3 Contribution to knowledge

The study made various contributions to knowledge. Mainly, there are few studies that focus on the impact of direct taxes and its sub-component effect on income inequality, in-addition, the study provide indepth understanding of the effect direct taxation has on income distribution in Nigeria as a country specific other than cross-country analysis.

5.4 RECOMMENDATION

The capacity to raise tax revenue should be enhanced, since we have been able to establish that the sub-component of direct tax help in redistribution of income within the period covers.

The petroleum profits tax act should be review to correct inefficiency and corruption in the system.

Tax administration in Nigeria should be improved, such that tax evasion and tax avoidance can be address effectively.

Bank borrowing be improved upon so as to increase the level of private credit to GDP.

The tax system in general should be properly regulated for effective redistribution of wealth in Nigeria.

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Appendix 1

Appendix 2

Diagnostics

First Difference