DR. NNANTA, N. ELEKWA
SUB-DEPARTMENT OF PUBLIC ADMINISTRATION
AND LOCAL GOVERNMENT UNIVERSITY OF NIGERIA, NSUKKA
This paper suggests that borrowing can be considered as an alternative way to taxation in which government can secure the revenues that it needs to finance services. Taxation could be seen as a fiscal process of “exchange” whereby taxes are seen as prices that individuals pay for the benefits of public activity. Individuals acting through the political process (through elected representatives) subject themselves to reductions in real income of one kind (private goods and services) in order to be able to secure real income of another kind (public goods and services). Borrowing that is, the creation of public debt is a means through which governments may finance public services without reducing the real wealth of private individuals during the period when the funds are acquired. In so far as resource services are used up in the provision of public services, some reduction in resource use privately must take place when the expenditure is made. But the essence of the borrowing process, as opposed to taxation, is that government secures the revenues to finance its purchases on a voluntary exchange basis. Local governments borrow to provide the public facilities and services that are essential to the well-being and economic progress of residents. Local government borrowing that runs into several billions of naira a year has economic effects naturally as well as on individual local borrowers. The local economic effects of local government borrowing are influenced by several factors including the purpose of the extent and timing of such borrowing and there is a wide contrast between the immediate and later effects. The paper encourages local government practitioners to borrow as an alternative to taxes for the provision of local infrastructural facilities and economic well-being.
Taxation can be considered as the normal way in which a government secures the revenues that it needs to finance services (Buchanan 1970). This could -be seen as a fiscal process of “exchange” whereby taxes are seen as prices that individuals pay for the benefits of public activity. Individuals, acting through the political process (through electedrepresentatives) subject themselves to reductions in real income of one kind (private goods and services) in order to be able to secure real income of another kind (Public goods and services). Taxation may assume many forms, including inflation which is one means of taxation. Inflation can be studied from many aspects, but for the purpose of public finance, inflation may appropriately be considered as a method of taxation. The phenomenon stems from the power of governments to create money with which they may finance public expenditures. Federal government has this power through its monetary policies. The fundamental characteristics of all taxation is the compulsory reduction in real income or wealth imposed on the individual in order that government may finance the purchase of resource services which, in turn yield some addition to individual real income or wealth through public service benefits.
Local Government Revenue in Nigeria through Taxes
Under the 1979 constitution, the Local Government Edicts and the Allocation of Revenue Act, 1981 the local governments in Nigeria derive their revenue from the following sources:-
- their individual shares of the 15% allocation from the Federation Account;
- their shares of the allocation of 10% of the total revenue of their respective State Governments;
- internally generated revenue from the following sources among others:
- taxes and rates
- fees from licenses and facilities provided by local governments such as
markets and motor parks and finally revenues from commercial ventures (Dasuki Report, 1984).
In spite of all the constitutionally provided sources of fund for local governments, many local governments are still not able to provide services to their respective residents in local communities. These services cost money which the local governments do not have. Without adequate financial base, local governments cannot be expected to prosper. The grants which government makes available in respect of capital projects are normally on a percentage basis although in some cases, a fixed sum grant may be paid (Adebayo Adedeji and Rowlands 1972).
This method has been found to be inadequate because local governments cannot proceed with essential capital development projects as fund from these sources is inadequate. Now that local governments are searching for local and other sources of revenues to improve their financial base, there is the need to look at other methods of creative financing such as local government borrowing, the use of bonds and tax increment financing (Elekwa, 1992).
Principles of Debt Financing
For governments, as for private individuals, borrowing is essentially an alternative means of raising revenues to cover expenditures. Borrowing that is, the creation of public debt is a means through which governments may finance public services without reducing the real wealth of private individuals during the period when the funds are acquired (Buchanan 1970). Insofar as resource services are used up in the provision of public services, some reduction in resource use privately must, take place when the expenditure is made. But the essence of the borrowing process, as opposed to taxation, is that governmentsecures the revenues to finance its purchases on a voluntary exchange basis (Buchanan 1970).
Private individuals purchase government securities, not as a result of compulsion imposed upon them by the political structure, or even in the sense of exchanging current income for public benefits, but in exchange for a government promise or obligation to provide them with future income. From the foregoing, we can make the following conclusions, that the government borrowing and taxation are contrasting methods of financing public services. In the one-case-taxation-individual, real wealth is currently reduced in “exchange” for goods and services directly provided by government, the terms of the “exchange” in this case, being dictated by the political decision process. In the other case, that of borrowing, individuals give up no real resource services to secure the current benefits of public services; they secure these through the government’s contracting of an obligation to pay some income in future time periods to certain creditors, whether these be citizens or foreigners.
From this conception, it follows that the real burden of debt-financed public spending must rest with taxpayers during the future periods when the previously issued debt requires servicing and amortization. As contrasted with taxation, which must impose some current real cost on individuals, debt creation provides one way of financing public services without current cost. It provides a means whereby taxpayers in any given period may shift or postpone the real payment for public services until future periods. Only to the extent to which taxpayers anticipate these future payments and capitalize these into a currently valued reduction in wealth can a “burden” be located at the point of debt issue.
This simple analysis concludes that the real cost of public debt, or rather of debt-financed expenditures, must be shouldered by those individuals and groups who must pay taxes to service and to amortize the debt obligations.
External and Internal Public Debt
A government borrows internally or domestically when it sells securities to its citizens. In purchasing the bonds, the individuals voluntarily give up command over current usage of resources in exchange for the governments’ promise to pay a return in future period. The government uses this purchasing power to acquire resources and services from the private economy. The citizens of the private economy have a smaller total or real goods and services available for private disposition than before the sale of public debt, but they hold debt instruments in the place of the differential amount of private goods, that is, claims against the government which are at least equal to the private goods in value. No person in this initial period in which the public borrowing and the public expenditure take place suffers any loss in utility as a result of the operation. It is important to emphasize that this conclusion, holds even if the public expenditures are completely wasteful (Buchanan 1970). With external borrowing, the government sells securities to citizens of foreign countries or other communities within the country, who give up units of their own purchasing power in exchange. The government uses this purchasing power to acquire goods and services abroad, and from other parts of the country or to exchange with citizens who desire to acquire goods, and services abroad and from other parts of the country. The total amount of resources available for disposition in the private economy is not changed. As with domestic or internal public debt reaction, no one suffers any reduction in utility during the initial period of debt issue or expenditure and if the project isat all beneficial, some individuals find their utility increase (Buchanan 1970). Since there is no reduction in the amount of goods available privately, there are no claims to wealth, no debt instruments, held by citizens. It is also noted here that at least, in the initial period, there is no basic difference between the external and the internal public debt.
Similar results hold if we consider comparable situations in a period subsequent to that in which the government borrows and spends. For an internal or domestic debt, sufficient taxes will have to be levied to finance the interest charges. These payments will be made to bond holders who, in this case, are citizens living in the domestic economy. If, instead, the debt is externally held, the tax payments must be made to foreign citizens or people in other parts of the country outside the community. On this level of comparison, the external debt seems clearly to be more burdensome than the internal debt, since there is no offsetting receipt of interest by local bondholders. The interest payments represent a net drainage of funds out of the domestic economy.
Local Government Borrowing
Local Governments have an enormous responsibility for providing the public facilities and services that are essential to the well-being and economic progress of a predominantly urban population, but, on the other hand, their resources are variously limited and their power to use these resources restricted. They lack the monetary powers of the federal government and the fiscal powers of the federal and state governments. They have only such power to incur debt as is granted to them by state constitutions, state statutes, or the charters under which they operate. The use of municipal credit has contributed, and can continue to contribute markedly to advancement of the local and national economics, but under these conditions, local governments face the necessity of employing credit as productively and discriminately as possible.
The judicious planning and management of municipal debt are inseparable from forward looking, overall financial planning and management for any local government. They demand a substantial amount of professional competence and skill, but more than this, they call for a quality of judgement and policy determination that comes only from a sound understanding of the necessary programs and long range objectives of the community, the extent of the resources of the community that can be made available for advancing these programs, and the ways in which borrowing can be made to contribute most equitably and effectively to the desired results.
Among the general considerations that must underlie the decisions of the responsible local officials are:-
- the purposes for which it is appropriate to borrow;
- how much debt the community may safely incure;
- the means which are to be used for controlling authorization of debt; and
- the most suitable means of borrowing in each case ( Moak and Hill House, 1975).
One good reason for this is the increasing diversity and complexity of municipal undertakings involving the incurrence of debt. The kinds of major and minor revenue -producing enterprises that municipalities engage in have multiplied, user charges have-replaced taxes for the support of some facilities and borrowing has been expanding for urban renewal, industrial aid and related means of economic rehabilitation and advancement. Another reason is the bewildering hodgepodge of local governments which is becoming less and less well identified with the economic communities they attempt to serve and thus less and less able to do the unified planning and financing that the communities need. A related reason is the increasing intergovernmental character of certain basic types of projects, such as water supply, storm drainage and flood control, water pollution control, and all kinds of metropolitan transportation and terminal facilities. Local governments as they come more and more to join with their neighbours in financing such projects or share in the formation of special districts and authorities for the purpose, face new and often intricate problems of debt policy and planning. Any realistic appraisal of the purposes and problems of local government borrowing, as can be seen, must concern itself with the technical aspects of planning and managing debt; the appropriate place of credit in the overall financial policies of local governments, and how well local governments are equipped by their structure and fiscal powers to make judicious and effective use of their power to borrow.
The Purpose of Borrowing
The purpose for which local governments may borrow and the amounts of debt which they may incur are regulated variously by state constitutions, legislatures and local charters. But within these legal restrictions, local governments generally have very considerable range for exercise of good judgement and foresight, or the opposite, in the formulation and execution of debt policy (Moak and Hill House, 1975).
The Role of Borrowing
The question of the appropriate role of borrowing (the use of public credit) in the conduct of local government is essentially one of how local government capital expenditures should be financed- when they should be met from current or accumulated revenues and when from loans, which are in anticipation of future revenue. Part of the answer can be found in the nature of the responsibilities assigned and the revenues available to local governments. Each local government is responsible for the administration of some of these functions, expensive capital facilities are required and unless they are available when they are needed and to the extent they are need substandard financially wasteful performance is virtually inevitable.
To meet the totality of operating capital requirements as needed and provide for emergencies that may arise from time to time, there is likely to be considerable year-to-year fluctuations in the level of expenditures. But the revenue systems of most local governments are neither very broad nor very flexible. To keep tax rates and charges fluctuating in a correspondingly wide range would be demoralizing to the tax and rate payers. The primary purpose of municipal borrowing, therefore, is to permit timely financing of need expenditures without causing such fluctuations when they cannot be otherwise avoided by careful planning. An alternative to borrowing is the accumulation of surplus and reserves.
Some clarification of these goals is possible by review of the purpose for which local governments borrow. There are two general classes of borrowing to be considered (based upon the term of borrowing):
(i) temporary loans and
(ii) long-term loans (Moak and Hill House, 1975).
(iii) Short -Term Borrowing
Local governments engage in temporary borrowing for three general purposes:
- in anticipation of the receipt of revenue;
- to meet emergencies not foreseen in the budget; and
- in anticipation of the issuance of bonds for capital purposes.
Revenue Anticipation Borrowing
Many local governments, although operating with balanced budgets, engage regularly in temporary borrowing in anticipation of revenues to meet current operating requirements. The ability to do such borrowing helps to assure the uninterrupted functioning of government operations and the regular and prompt payment of debt services and other fixed charges. The need for revenue anticipation notes ordinarily arises from a delayed flow of revenue because major elements of revenue are due, and in the fiscal year.
Temporary Borrowing for Emergencies
Budgets should be sufficiently flexible to provide for the minor contingencies which arise in the regular conduct of operations, but from time to time, local governments find it necessary to finance sizeable emergency expenses for which insufficient or no provision has been made in the budget. Emergencies of a major character may include disasters caused by such natural forces as flood, fire and drought.
Temporary Borrowing for Capital Financing
Such borrowing takes the form of bond anticipation notes, capital notes, and special assessment notes. Temporary notes in anticipation of bond revenues are issues, and may sometimes be renewed, for limited periods after bonds have been authorized. Such, notes are ordinarily retired from the proceeds of bond sales. By their use, the borrower may be able to reduce the cost of interest during construction of large projects through temporary financing as funds are required.
Long-term borrowing is ordinarily to finance the acquisition of land or capital improvements thereupon. However, numerous bond issues can be sold .to pay costs arising from emergencies, judgemets and even the funding of current deficits or accumulated unpaid operating expenses. The major portion of all local debt is long-term debt.
Purposes of Debt Issuance
Debt may be for purposes that provide a compensating addition to the financial ability of a community, regardless of the sources of the revenue for its support. Tax-supported debt for some purposes created economic activity which generates taxes in excess of the cost of the facilities and related governmental support requirements. A well devised urban renewal project may produce a clearly identifiable net increment to the tax base, or it may avoid a general deterioration of the business district. Borrowing for General Improvements
Most of the basic, tax-supported functions of local government require capital facilities for their operation. The physical plant of a typical local unit includes land, structure and equipment. Since structures and equipment wear out or become obsolete,their replacement alone calls for a continuous flow of capital expenditures except in very small local governments. Sometimes neglect in the up-keep and maintenance of facilities necessitates major repairs that a local government may classify as capital outlay. In addition to the expenditures needed to keep the physical plant in good condition, there are varying requirements for capital expenditures to upgrade or expand the physical plant.
Long-Term Borrowing for Emergencies
Major emergencies may require not only temporary borrowing but also the spreading of costs over a period of years through issuance of long-term debt. Justification for such a policy lies in the fact that new facilities represent an upgrading of the quality of the plant being replaced. In the absence of such consideration, the practicalities of the situation are frequently such that spreading the costs offers only feasible course of action.
Borrowing for Revenue-Producing Enterprises
The revenue-producing undertakings of local governments are increasing, and borrowing for such purposes has increased enormously. This development has had marked influence on local government structure, administrative organisation, revenue systems and instruments of borrowing. Both deferral and state governments should participate in this development to bring about new intergovernmental arrangements respecting local government.
Borrowing for Infrastructural Facilities Development and Extension
Local Governments can borrow for infrastructural facilities and at times through floatation of bonds for rail-road extension, real estate and industrial development. What constitutes a public purpose for which local governments may tax, borrow, and spend is a question that has continued to receive steadily widening interpretation with the growth of urbanism and public responsibilities in a community which is virtually non-existent in Nigerian cities today.
2. The use of Bonds
A local government can have immediate access to monies that would be received through tax increments over a long period of time by selling bonds at the outset of a project. The use of term bonds with stated, single maturity dates that actually are retired in installments, by purchase or call sinking funds accrue, has become quite common in the financing of revenue-producing enterprises by obligations payable only from the earnings of the projects.
The device because it avoids some of the rigidities of both sinking fund, serial bonds, has proved particularly useful in financing new undertakings whose prospective earnings are largely or entirely a matter of estimate and are likely to follow varying growth patterns (Lennox L.Moak and Hill House, 1975). Local Governments generally finance construction of public facilities by general obligation bonds. If local governments had taxing powers in Nigeria to raise a portion of the money required to provide services to the citizens, general obligation bonds would have been a sure way of financing revenue-yielding projects and enterprises. The issuance of these bonds would have required approval of two-thirds of the voters within the local Government area.
This is necessary because, for the payment of such bonds, local governments pledge their full faith and credit and financial resources. General obligation debt has been payable, in the first instance, from the property tax, but in practice, it is sometimes paid from other resources of revenue (Moak and Hill House 1975and Johnson, 1992). A municipal bond which would be considered more favourable by bond investors is the lease revenue bond. These bonds are used of raise money for the construction of particular facilities by the local government. The local Government then leases these facilities to businesses, individuals and the lease payments are used for annual payment to the bond holders.
The local government can use tax increment funds to subsidize renters lease payments. Lease revenue bonds can be used successfully in several development and redevelopment projects. However, there is need to point out that a local government may resort to general municipal revenues to pay principal and interest payments on lease revenue bonds.
3 Tax Increment Financing
The increment (or tax allocation) financing attempts to use the projected increase in tax revenue due to establishing a higher economic use of property in a project area resulting from development or redevelopment activity (Elekwa 1992). The tax revenue which results from this increase in assessed value is used to pay off debts incurred by the local government in improving a project area.
The process begins with a local government’s designation of a project area and the adoption of project or redevelopment plan. At this time, the local assessed value of the property in the projects are is determined and declared to be the “base assessed value” for a project (Los Angeles Community Design Centre 1980). From this point on until the project ends, the local government will have access to any tax revenues generated by an increase in the assessed value of a project above the project’s base assessed value as long as there is demonstrated indebtedness on the part of the local government these funds which are available to a local government are referred to as tax increments.
The rationale behind this system of finance is that the funding necessary for project development and redevelopment projects can be obtained by the redistribution of tax revenues, rather than an increase on the total amount of taxes. In theory, an increase in tax revenues from an “undeveloped” site or “blighted” project area would not have been available to the usual taxing agency, the state; without the local government financing development and redevelopment projects through tax increment (Elekwa 1992). Therefore, the intent is that the use of these tax revenues by local government leaves the taxing agency the state no worse off than it was prior to development or redevelopment project. If successful, once a local government was paid off all its indebtedness and a development or redevelopment project has been completed, the taxing agencies will enjoy a significantly increased tax revenue from this project area.
A tax increment can include not only an increased in assessed valuation due to investment caused by the local government but increased assessed value due to inflation.
In addition, tax increment funds will be affected by changes in the tax rate or by private investment in the project area which would have occurred regardless of development and redevelopment activities. Tax increment monies can be used by a local government to pay off debts directly, or as security for the sale of bonds. The total amountof tax increment funds available from any particular project or redevelopment project will not occur to a local government if that local government’s debts are less than the total available tax increment funds. Any excess funds above a local government’s needs will be allocated to the usual taxing agency (Elekwa 1992).
The basic premise which is intrinsic to the successful use of tax increment financing is that there will be an increase in total assessed valuation in any particular development or development project as a result of a local government’s activities. This increase in any particular development or development project as a result of a local government’s activities. This increase in assessed valuation is dependent on a local government’s ability to attract private development into a project area.
Initial investment by a local government in the project area is often necessary to attract private development. The funds for these initial expenditures, however, are dependent on an increased valuation resulting from private development (Los Angeles Community Design Centre, 1989).
Economic Effects of Local Borrowing
Local government borrowing that runs into several billions of naira a year has economic effects nationally as well as on the individual local borrowers.
Immediate and Subsequent Local Effects
The local economic effects of local government borrowing are influenced by several factors including the purpose, extent and timing of such borrowing and there is a wide contrast between the immediate and later effects (Lenox L. Moak and Albert M. Hill House 1975). In economic terms, the immediate effect of a local bond issue is usually inflationary. If for example, borrowing is superimposed on the existing level of expenditures, there is a quick step up public spending without a corresponding increase in taxes. If it replaces some part of existing expenditure from current revenue, the level of public spending can be maintained with a reduction or leveling if in taxes that permits increased private spending. If the bonds are sold outside the community, as is usually the case, the purchase of bonds absorbs little local spending power; and the deposit in local banks of bond proceeds supplied from outside sources increases local reserves and promotes easier local credit.
When borrowing is to finance construction, the initial impact of the bond proceeds spent locally is on local construction workers, constructors and suppliers, and- local consumer goods and services industries and giving a multiplying effect to the initial stimulus. The nature of the stimulus, however, varies with the condition of the local economy (Moak and Hill House, 1975).
“If times are full for the construction industry, employment and income rise and some of the affluence is transmitted throughout the community without much change in the prince level. On the other hand, if the industry already is functioning at capacity, the demand for labour material and equipment becomes highly competitive and the main effect is to force up prices giving the local government less for its money.”
The local economy, receives part and sometimes, a rather limited part, of the immediately stimulating effect according to (Moak and Hill House 1975) some of bond proceeds are spent for construction materials, equipment and services in other parts of the country. This external stimulus including the upwards pressure on interest, rates and contraction of bank reserves in the financial centers where the bonds are purchased may be relatively negligible in one transaction by a single community. If similar transactions are to take place in many communities simultaneously, its cumulative effect will impact the National Economy involving actions from the central Bank or Federal Reserve System.
As noted by (Moak and Hill House 1975), the subsequent economic effect on local community is more or less the reverse of the immediate effect. Inflationary spending of the bond proceeds is replaced by annual mandatory, principal and interest charges as the revenues are raised to pay for what the community has bought on the installment plan. How heavy the burden depends largely on what benefits the acquisition is producing. If the nature of the benefits is such as to increase the taxable resources or income of the community or to decrease the cost of living and doing business in the community, or the cost of performance of public services for the community, the burden may be minimized or offset entirely. Borrowing for many purposes that are desirable from community point of view produces less tangible or slowly realization benefits and clearly imposes an increased burden on the current generation if taxpayers; especially of the services are not evenly distributed to the tax payers.
The debt of most local governments is- similar to the external debt of national government in that the local governments usually pay the bulk of their debt service requirements to outside investors. Local debt involves a process of redistribution of income within the community but can result in a loss of income by payments to other areas.
The ability of the people of a community to support borrowing for public goods and services is no more unlimited than their ability to support borrowing to private goods and services. If borrowing persists for purposes that do not produce benefits commensurate with the costs, several results ensue (Moak and Hill House 1975).
- The rise of taxes and charges for debt services places a progressively heavier burden on the local population.
- There is a growing tendency to skimp on operation and maintenance
requirements because of the financial pressure of debt service.
- Interest rates are forced upward as the local governments bonds become less
attractive for investment.
- The reserve of credit that should be available for emergency purposes
disappears. In such cases borrowing can become an instrument of economic
retrogression instead of economic progress.
In the most essential respects, debt issue for the individual and debt issue for the government (which, in its turn, can best be considered as individuals acting politically) are
In each case, borrowing (debt issue) constitutes an alternative to the more normally accepted means of raising revenues. Borrowing in either case is a means of securing additional current purchasing power without undergoing supplementary current cost. The cost of spending are effectively shifted to future time periods. In such periods, creditors hold a primary claim against the revenue or income of either the individual or the government. It is always more rational for the individual or government to borrow than to raise the money in more normal way. The desirability of borrowing depends on the expected productivity of the spending and the time pattern of the expected yield.
Other sources of revenue different from those specified by the constitution, Local Government Edicts and the Traditional Allocation of Revenue Act of 1981 have been discussed. To operational these suggested other sources of revenue, it will require the co-operation of the three levels of government on inter-governmental basis.
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Adebayo Adedeji and L. Rowlands (ed.) (1972); Local Government Finance in Nigeria: Problems and Prospects. Ile-Ife: University of Ife Press.
Dasuki Report (1984); Federal Military Government of Nigeria local Government: Report by the Committee on the Review of Local Government Administration in Nigeria, Lagos.
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Lennox, L. Moak and Albert N. Hill House (1975); Concepts and Practices in Local Government: Local Government Finance. Municipal Officers Association of the United States and Canada, 180 North Michigan Ave, Chicago, Illinois 60601.
Los Angeles Community Design Center, California Re-development Policy (1980): 541 S. Spring Street, Los Angeles 90013.
William C. Johnson (192); Public Administration, Policy, Politics and Practice. Sluice Dock, Guildord Connecticut: The Dushkin Publishing Group.
Elekwa N.N. (1995) “Diversification of Local Government Revenue Base and Creative Financing” in Emezi and F.C. Okoli edit Proceedings of the National Seminar/Workshop on Internal Revenue Generation, Strategies Problems and prospects for Local Government /UNN Catchment’s Area).Public Administration and Local Government in Association with Data Search Limited at Nsukka