The Impact of Tax Reforms on Investment Decisions

The Impact of Tax Reforms on Investment Decisions


The Impact of Tax Reforms on Investment Decisions


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Chapter one on The Impact of Tax Reforms on Investment Decisions



Taxation constitutes a major source of revenue to both developed and developing countries. Tax generated revenues are used to finance public utilities, perform social responsibilities and grease the administrative wheel of the government. The Institute of Chartered Accountants of Nigeria (2006) and the Chartered Institute of Taxation of Nigeria (2002) define tax as an enforced contribution of money to government pursuant to a defined authorized legislation. The World Bank (2000) defines tax as a compulsory transfer of resources to the government from the rest of the economy. Tax is a compulsory levy imposed on individuals and corporate identities regardless of the status (Nightingale, 2002; Soyode & Kajola, 2006).

In Nigeria, tax administration has been encumbered by several factors ranging from inadequate and unreliable data, paucity of administrative capacity, shortage of skilled manpower, corrupt tax officials, high incidence of tax avoidance and evasion, complex tax codes and the hydra – headed monster of multiple taxation (Odusola, 2006). Nigerian government has embarked on several tax reforms, since the year 1991. Prior to tax reforms, tax administration reflected inefficiencies, characterized by deficiencies in the tax administration and collection system, complex legislations and apathy on the part of those outside the tax nets (Ndekwu, 1991 cited in Ariyo, 1997). According to Odusola (2006), the need for tax policy reforms in Nigeria may be summarized as: (i) the compelling need to diversify the revenue portfolio for the country in order to safeguard against volatility of crude oil prices, and (ii) to promote fiscal sustainability and economic viability at the lower tiers of government.

Countries have recognized the importance of attracting investment as a means of revitalizing their economies and stimulating growth. This has prompted many countries to work on developing favorable conditions to promote investment. The level of development of any nation depends on the level of the investment irrespective of private and foreign direct investment. Many countries impose tax on the income or capital of some types of legal entities in order to establish or invest for creating employment opportunity for their citizen.

Investment has been confirmed as the engine of economic growth in many economies, especially in developing economies like Nigeria. Corporate Taxes are a crucial factor when deciding to invest. However, the inflow of investment is attracted not only by tax factors but also by a number of other factors such as macroeconomic stability, legal and regulatory framework to support well structured, skilled labor and a flexible labor market, the available natural resources, financing, degree of openness, the growth of the market size, purchase power of local markets; institutional factors, commerce and location. The inflow of Investment brings several benefits in particular by way of economic growth, infrastructure, human resources, technological development, and employment generation, economic and social well-being of the people in the country. The sensitivity of investment to tax varies depending on the conditions of the country, the tax policies of the companies and the period of time in analysis. it also depends mainly on the conditions of the country, the investment policies established there, types of industry, and commercial activity covered.

According to Lipsey (1979) the determents of investments are national income, rate of investment and expectations. The level of demand for goods is the prime determinant of investment, Lipsey (1979) argues that the higher the level of demand and income, the higher the willingness amongst firms to invest, because of the favorable expectations about the future. These are strong limitations to the ability of firms in obtaining funds by borrowing. Therefore they tend to finance their investments more from retention out of profits. But the higher level of demand will possibly result in higher a profit which means more for retention and thus limits the ability to invest. The accelerator theory on the other hand assumes a capital output ratio and that the industry would be operating at its full capital if demand for its products increases and the industry is to produce the higher level of output, capital stock must increase and this necessitate new investment.

Firms in most cases finance their investment with borrowed funds, as long as the rate of return on capital i.e the marginal efficiency of capital (MEC), is greater than the interest rate charged on borrowed funds, firms would always like to add to their existing capital being equal to that rate of discount which would make the present value of the series of annuities given by the returns expected from the capital assets during its life just equal to the supply price.

Marginal efficiency of capital (MEC) is concerned with the profitability of firms as an additional amount of capital will bring to the economic enterprises. It is therefore not of place to expect the firm to be actually aware of a factor as direct taxation on the expected rate on capital aspect. Consequently, it is presumed that since taxes lower the expected returns they will lower investment expenditures.

The government on the other hand does grant tax incentives with a prior view that the action world call forth net investment. The link between such tax incentive, example accelerated depreciation according to Martion (1987) reduce whatever curtailing effect the income tax may have on investment. The neoclassical theory of demand assumed perfect certainty, fixed relative prices and interest rate, technology and substitutability of capital for other inputs. It is proposed that initial allowance and tax credits on net investment favour short live investment. The efficiency of these incentives is explained in terms of neutrality.

Broadway (1978) looks at efficient or neutral incentives as one that does not distort the allocation of capital among investment of varying durabilities. An analytical definition of neutrality is that given by Musgrave (1959) which submits that the tax structure including any investment incentives built into it is said to be neutral if it reduce the internal rate of return after tax by the internal rate its return after tax by the same proportion on all investment. Another approach to neutrality was that made by Nickel (1978). He argued that corporate tax has no effect on investment if interest payment are not tax deductible but all capital expenditure may be immediately offset against tax. He also believed that this will hold true if tax rate remain constant.

Foreign investment plays an essential role in accelerating the industrial development of many underdeveloped nations. This is true in that many of them do not have the money or technological known how that will enable them exploit their natural endowments, moreover, the marketing of such goods are closely controlled by larger international concern. In recognition of this roles, the various government of under developed nations do offer some tax incentives in order to attract foreign investments. However, Kaldor (1970) thought that the amount of investment which large international companies will undertake in these sectors will depends on their estimate of annual growth of world consumption. He therefore believed it is unlikely that any special concessions (in the tax holidays etc) granted by the producing countries will have any appreciable effect on the total flow of investment from foreign lands.


Multiplicity of taxation constitutes a major challenge to tax administration in Nigeria even in the post-tax reforms era. Companies are subjected to several tax levies at all the levels of government. This has the concomitant outcome of raising cost of production, making locally produced goods loose international competitiveness and prevent inter-state commerce (Chartered Institute of Taxation of Nigeria, 2002). In addition, I observe that the corporate income tax rate is so high that it creates investment disincentive effect, since it erodes private investment profit. In Nigeria, the investment rate has been so low with investment constituting less than ten percent of the GDP (UNCTAD, 2005). In this study, an attempt is made to examine the impact of tax reforms on investment decision in Nigeria.


This study sought to know the impact of tax reforms on investment decisions in Nigeria. Specifically, the study sought to;

  1. assess the relationship between tax reforms and investment decisions in Nigeria.
  2. examine the challenges of tax reforms on investment decisions in Nigeria.

Research Questions

  1. What is the relationship between tax reforms and investment decisions in Nigeria?
  2. What are the challenges of tax reforms on investment decisions in Nigeria?

Research Hypothesis

Ho: There is no relationship between tax reforms and investment decisions in Nigeria.

Significance of the Study

This study will be of immense benefit to other researchers who intend to know more on this study and can also be used by non-researchers to build more on their research work. This study contributes to knowledge and could serve as a guide for other study.

Scope/Limitations of the Study

This study is on the impact of tax reforms on investment decision in Nigeria.

Limitations of study

Financial constraint: Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview).

Time constraint: The researcher will simultaneously engage in this study with other academic work. This consequently will cut down on the time devoted for the research work.

Definition of Terms

Tax Reform: Tax reform is the process of changing the way taxes are collected or managed by the government and is usually undertaken to improve tax administration or to provide economic or social benefits.

Investment Decision: The Investment Decision relates to the decision made by the investors or the top level management with respect to the amount of funds to be deployed in the investment opportunities. Simply, selecting the type of assets in which the funds will be invested by the firm is termed as the investment decision.


Ariyo, A. (1997). Productivity of Nigerian Tax System: 1970-1990. Department of Economics, University of Ibadan, Research Paper 67.African Economic Research Consortium, Nairobi November, 1997

Broadway, R. (1978). “Investment Incentives, Corporate Taxation, and efficiency, in the Allocation of capital” The Economic Journal vol. 88 (September). P. 480-481.

Chartered Institute of Taxation of Nigeria (CITN) (2002)

Kaldor Hicks (1970). Economics Dynamics of law – Stonnic Publishers. New York.

Lipsey, R. G. (1979). Tax evasion and its effects on the economy. Joanee publishers Ltd. Onitsha. Miscellaneous taxation provision Decree 1985.

Musgrave, A. R. (1959). Public finance Seligman, B. B. U.S.A.

Ndekwu, E. (1991). An Analytical Review of Nigeria’s Tax System and Administration, Lagos

Nickel & Company, (1987). LLC Publication on personal income tax program. U.S.A

Nightingale, K. (2002). Taxation Theory and Practice, 4th ed. England Pearson Educational Ltd

Odusola, A. (2006). Tax Policy Reforms in Nigeria. Research Paper No. 2006/03, United Nations University, World Institute for Development Economic Research

Odusola, A. (2006). Tax Policy Reforms in Nigeria. Research Paper No. 2006/03, United Nations University, World Institute for Development Economic Research

World Bank (2000).Lessons of Tax Reform, Washington DC.




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