February 25, 2019

State governments: no choice but to change their ways

The proposals for an increase in the national minimum wage offer the perfect opportunity for some commentary on state government finances. Although the Senate is yet to give its approval, the proposals are to lift the minimum of N18,000 per month to N30,000 for the federal government, and to N27,000 for state governments and the private sector. An earlier push by governors to cap the increase for states to N22,700 tells us that their capacity to pay is limited.

Our preferred data source is the CBN, and a look at its series for 2017 shows why the governors are worried. Aggregate spending on personnel amounted to N942bn, and internally generated revenue (IGR) to N765bn. The gap may not seem that wide in aggregate. However, the number of better-managed states is relatively small, and no fewer than 28 of the 37 states (including the federal capital territory) earned less in IGR than they paid out on personnel. Most likely, the true picture is worse since in 2017 more than half the states were said to be in arrears on their salary and pension payments.

So we return to what we already know: that state government finances are in a mess. Admittedly, 2017 was not a great year for oil revenues and therefore for monthly statutory allocations from the Federation Account Allocation Committee (FAAC). Which leaves the majority of states dependent upon the monthly payout, relieved at the pick-up in the oil price in recent weeks and yet not in a position to meet the minimum wage proposals (whenever they take effect).

There are possible political and managerial exits from the financial mess. The formulae for revenue distribution between the three tiers of government could be adjusted, subject to constitutional change. We could be persuaded by the merits of an argument that the states should receive more than the current 50 per cent share of the VAT Pool, compared with 15 per cent for the FGN and 35 per cent for the local governments. However, such adjustments would remove the incentive for state governments to overhaul the management of their finances. Their challenge is to increase the size of the cake by their own efforts.
Thankfully we no longer hear calls for the creation of new states. (They were made from time to time by the previous Senate president.) Since we struggle to see how some states can become viable units, there is a case for mergers. Some states have begun to launch shared initiatives and projects, so this is not as far-fetched an idea as it might seem.

Rather than enter this political minefield, we will focus on the managerial solution. The FGN could give a helping hand by raising the 5 per cent standard rate of VAT. The states earned N474bn from the Pool in 2017. A doubling of the rate would, taken in conjunction with IGR and allowing for some leakages from non-payment, have allowed the states to meet their personnel payments in full in 2017 and pay a large chunk of aggregate overheads of N714bn.
We have seen suggestions that a rise in VAT could be accompanied by a reduction in companies’ income tax, from which the FGN would be the loser. Not surprisingly, the idea is not popular in Abuja, where a hike in VAT in isolation has been resisted. A higher rate for luxury goods is considered acceptable but not a more general increase. This would give the FGN additional firepower for its capital spending plans, ease the pressure on state government finances and bring Nigeria closer into line with its fellow members of the Economic Community of West African States.

Alongside this putative helping hand from the FGN, the managerial solution to the mess has several components, none of which are new. On the revenue side, the sharp fluctuations in IGR for most states tell us that they rely on one-off inflows rather than a secure revenue stream from regular levies such as land taxes and service fees. The collection of revenue can be enhanced by the use of technology for online payment and transfer. Lagos State anticipates a fourfold rise in receipts from consumption taxes as a result. Another route is asset sales, which Kaduna State has launched.

Turning to the expenditure side, there are sizeable efficiency gains to be had. None of them are new: the removal of ghost workers and pensioners, the replacement of cash with electronic transactions wherever possible, a greater monitoring of expenses, a firmer management of contracts for public works and services, and the creation of an efficiency unit similar to the body within the federal ministry of finance.

If we returned to an oil price of US$100/b for, say, three years, the mess would be largely cleared by far higher FAAC payouts. This is possible although not our expectation. Equally, we could sink to US$40/b for three years, and the majority of states would find themselves in an even greater mess. Which brings us back to the managerial solution. States governments that are not minded to change their ways should recall that the Buhari administration has already given them five separate debt relief packages, the two largest of which are one-offs (the conversion of eligible bank borrowings into FGN long bonds and the Paris Club refunds). The packages reduced the mess but were a long way from eliminating it, and the larger ones are not repeatable.

Gregory Kronsten
Head, Macroeconomic & Fixed Income Research