LSE’s Eustace Uzor offers potential solutions for improving fiscal governance in Nigeria’s subnational units

Uzor, Eustace

LSE Research Online

16.1.2017Reducing Incentives for Fiscal Indiscipline at Nigeria’sSubnational Government Levelblogs.lse.ac.uk/africaatlse/2017/01/16/reducing-incentives-for-fiscal-indiscipline-at-nigerias-subnational-government-level/LSE’s Eustace Uzor offers potential solutions for improving fiscal governance in Nigeria’s subnational units.The need to achieve fiscal convergence and consolidation in Nigeria cannot be overemphasised. This isespecially important considering that the economy recently slipped into recession, according to data from theNational Bureau of Statistics. One notable factor for this is the high level of fiscal indiscipline at the subnationallevel, which mainly derives from problematic incentives generated by unconditional fiscal transfers from thefederal government. Therefore, to incentivise improved fiscal performance at the subnational government level,reforms in compliance with fiscal rules, data openness, as well as the introduction of performance-based grantsare required. National anti-corruption agencies (ACAs) should also be used to signal threats of punishment forpoliticians and top bureaucrats in poor-performing states.One of the key reasons for poor financial management at the subnational level is the perception of soft budgetconstraints created by unconditional statutory monthly fiscal transfers from the federal government. Specifically,subnational governments receive nearly half (47.32 per cent) of Nigeria’s total consolidated revenue. With theexception of Lagos, all other states are reliant on transfers . As such, there is little or no incentive for stategovernments to manage their internally-generated revenue by either stepping up tax collection efforts, orbroadening their tax base. The scope for political corruption is therefore remarkably high. The recent diversion offederal bailout funds meant for unpaid workers’ salaries by state governments for undisclosed purposes is acase in point.Although most states in Nigeria adopted the 2007 Fiscal Responsibility Act (FRA) to institutionalise fiscalprudence, recent events show that sufficient progress has not been made. The ongoing fiscal sustainability crisisin nearly all subnational governments – after a decade-long oil price boom – is clear evidence of fiscalindiscipline and large-scale corruption. Other critical issues such as the lack of accountability in fund utilisationand the non-availability of public finance data for citizenship engagement still remain unresolved. This is ratherunsurprising, considering that Nigeria has a track record of poor political accountability and governance, ashighlighted in the 2015 Ibrahim Index of African Governance.1/2Theoretically, decentralised fiscal spending in countries like Nigeria ought to improve the effective and efficientdelivery of public services, since, as noted by renowned Professors Ferris and Graddy, lower-level governmentsare more knowledgeable about the costs, preferences, and the productive capacity of economic agents in theirjurisdiction. In practice, however, delegating responsibilities to states in a federal system creates principal-agentissues, since both levels of government serve different constituents, and therefore have divergent policyobjectives. In view of this, a principal-agent problem under adverse selection exists in Nigeria’s fiscal relationssince the federal government cannot directly verify the economic (and social) fundamentals of states as well asthe outcome of their respective policies. Therefore, while fiscal transfers may be well intentioned, their welfareeffects may not be optimal, in countries like Nigeria where strong incentive mechanisms are not in place toresolve agency issues at the subnational level.The federal government has a critical role to play in improving fiscal governance at the subnational level inNigeria, given its wider macro-economic implications. The current fiscal crisis in Nigeria is, therefore, a uniqueopportunity for the federal government to harden the budget constraint of subnational governments. As a firststep, future fiscal transfers, particularly financial bailouts, should be conditioned on compliance with specifiedfiscal rules (i.e. debt-sustainability ratio, infrastructure prioritisation), as well as the publication of subnationalpublic finance data. Specifically, while the former is expected to enhance fiscal convergence and consolidation inNigeria, the latter – data openness – would be key to improving the ability of citizens to hold political office-holders and bureaucrats at the subnational government level accountable.Beyond fiscal rules and an open-data policy, the federal government can incentivise improved fiscal performanceand accountability by providing performance-based matching grants to states. However, grant disbursementsshould be based on agreed performance metrics that are both measurable and verifiable by an independentparty. Furthermore, another policy option is to dramatically increase the threat of punishment for non-compliancewith fiscal rules. ACAs such as the Economic and Financial Crimes Commission (EFCC) can be used to curbfiscal indiscipline (and corruption) at the subnational government level. An important caveat to note, however, isthat this largely depends on the ability of ACAs to follow due process and withstand political pressures.Three key policy recommendations are proposed. First, future fiscal transfers should be conditioned on fiscalrules as well as the provision of actual revenue and expenditure data. This will significantly reduce the extent ofagency issues faced in federal-state fiscal relations. Second, an incentive structure, in the form of ‘performancegrants,’ should be instituted to incentivise and reward fiscal performance. ACAs could be used to signalpunishment in states, and consequently reduce the scale of political patronage and corruption. By minimisingproblems of asymmetric information and moral hazard in federal-state fiscal relations, it is anticipated that thesemeasures can help improve public service delivery in Nigeria.Eustace Uzor is a Masters Candidate in Development Studies at LSE. The views expressed in this post are those of the author and in no way reflect those of the Africa at LSEblog or the London School of Economics and Political Science.2/2

Reducing incentives for fiscal indiscipline at Nigeria’ssubnational government level

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