Effect of Tax Evasion and Tax Avoidance on National Budget

1.1 Introduction

The national budget is a financial plan that outlines the government's projected revenue and expenditure over a specific period, usually a fiscal year. It serves as a tool for managing public funds and allocating resources to various sectors such as education, healthcare, and infrastructure development (Fasina, 2018). Taxation is a fundamental aspect of any nation's economic system, as it is a primary source of revenue for funding government activities and development projects. The national budget, which is a key component of fiscal policy, relies heavily on tax revenues to meet the growing demands of the public sector. However, tax evasion and tax avoidance have become persistent challenges that undermine the effectiveness of tax collection systems and the integrity of national budgets (Ahmed, 2020).

This chapter will address the background information that motivated this study, the challenges that prompted it, its aim, and its objectives as a preface to subsequent sections of the study. Additional factors include the study's significance, scope, limitations, research questions and hypotheses, and the definition of technical terms.

1.2 Background of Study

Taxation is a crucial mechanism for generating revenue for governments worldwide, enabling them to fund public services and infrastructure projects that are essential for economic and social development. In most countries, including Nigeria, taxes represent the largest portion of government revenue, supporting activities in sectors such as education, healthcare, and transportation (Ogunleye, 2020). The national budget, which outlines government expenditure for a fiscal year, heavily relies on tax revenue to fulfill its various commitments. However, practices like tax evasion and tax avoidance pose significant challenges to this system, leading to budget deficits and undermining the effectiveness of fiscal policies (Igbokwe, 2020).

Tax evasion refers to the illegal act of deliberately underreporting or concealing income to avoid paying taxes. It is a criminal activity that deprives governments of much-needed revenue (Miller & Yockey, 2019). Tax avoidance, on the other hand, involves legally exploiting loopholes in tax laws to reduce one's tax liability without breaking the law (Slemrod, 2021). Although tax avoidance is not illegal, it often leads to an inequitable distribution of tax burdens, with wealthy individuals and multinational corporations being able to take advantage of complex tax planning strategies that smaller taxpayers cannot access (Alstadsaeter et al., 2020).

In the context of Nigeria, tax evasion and avoidance have been identified as significant obstacles to achieving optimal revenue generation. Despite the establishment of institutions like the Federal Inland Revenue Service (FIRS) and reforms aimed at improving the tax collection process, tax evasion remains widespread, particularly among corporate bodies and high-net-worth individuals (Ezeani & Ugwu, 2020). The revenue loss due to these practices limits the government's ability to fund its national budget adequately, leading to underfunded social services, budget deficits, and economic instability (Adebayo, 2020). Nigeria's tax system has been described as complex and prone to abuse, with several tax exemptions and incentives that can be exploited for tax avoidance (Omotoye, 2021).

The effect of tax evasion and tax avoidance on national budgets is significant, as they both reduce the revenue that governments can collect, leading to budget deficits and inadequate funding for essential public services such as healthcare, education, and infrastructure. Studies have shown that tax evasion, particularly among corporations and high-income individuals, contributes substantially to the loss of potential tax revenues in many countries (Johansson et al., 2019).

In Nigeria, like many developing nations, the issue of tax evasion and avoidance has been a persistent problem that hampers the government's ability to achieve its fiscal objectives. Despite efforts to strengthen tax collection systems and reform tax laws, these practices continue to affect the overall revenue generation, thereby influencing the allocation and implementation of the national budget (Ezeani & Ugwu, 2020). The persistence of tax evasion and avoidance not only strains the national budget but also contributes to inequality in the tax system, where the burden disproportionately falls on middle- and low-income earners.

Therefore, in Nigeria where the research was carried out, the activities that was conducted is to explore the impact of tax evasion and tax avoidance on Nigeria's national budget, examining how these practices affect revenue collection, government spending, and fiscal policy.

1.3 Statement of Problems

Investigation revealed that tax evasion is a prevalent issue where individuals and businesses deliberately fail to pay taxes owed, using fraudulent methods to conceal income and reduce their tax liabilities. This illegal practice deprives the government of much-needed revenue that is essential for the development of infrastructure, education, healthcare, and other critical sectors. The scope of tax evasion in Nigeria is vast, with an estimated significant amount of the potential tax base being uncollected due to this practice (Ogunleye, 2020).

In addition, tax avoidance, although legal, involves the strategic manipulation of tax laws to reduce tax liability through loopholes and discrepancies in the tax code. This practice is problematic because it disproportionately benefits the wealthy and multinational corporations while placing a greater tax burden on ordinary citizens. As large corporations and high-income earners exploit legal loopholes, the government loses out on substantial tax revenues, which could have been directed toward essential public services (Ezeani & Ugwu, 2020).

The combined effect of both tax evasion and tax avoidance is the creation of a budget deficit, as the government struggles to meet its revenue targets. Despite various tax reforms introduced over the years, the failure to effectively tackle these issues means that there is often a large gap between projected revenue and actual tax collections. This revenue shortfall negatively affects the national budget, limiting the government's ability to finance development projects and welfare programs for citizens. The persistence of tax evasion and avoidance indicates that the tax system in Nigeria requires further structural reforms, such as improving enforcement mechanisms and addressing the loopholes that facilitate avoidance (Adebayo, 2020). It is against the backdrop that this study seeks to address these problems by evaluating the effect of tax evasion and tax avoidance on national budget.

1.4 Aim and Objectives of Study

The aim of the study is to investigate the effect of tax evasion and tax avoidance on the national budget in Nigeria. In achieving this aim, the following specific objectives were laid out as follows:

1. To analyze the impact of tax evasion and avoidance on the implementation of government development programs and public sector spending.
2. To evaluate the extent to which tax evasion and tax avoidance contribute to revenue shortfalls in Nigeria's national budget.
3. To identify the main factors that drive tax evasion and avoidance practices among individuals and businesses in Nigeria.
4. To assess the effectiveness of existing tax policies and enforcement mechanisms in curbing tax evasion and avoidance.
5. To propose recommendations for improving tax compliance and reducing the negative impact of tax evasion and avoidance on the national budget in Nigeria.

1.5 Research Questions

The study came up with research questions so as to be able to ascertain the above stated objectives. The specific research questions for the study are stated below as follows:

• Are there key factors that drive tax evasion and avoidance practices among businesses and individuals in Nigeria?
• How do tax evasion and tax avoidance affect the government's ability to fund developmental projects and public services?
• To what extent do tax evasion and tax avoidance contribute to revenue shortfalls in Nigeria's national budget?
• How effective are the current tax policies and enforcement measures in addressing tax evasion and avoidance in Nigeria?
• What impact do tax evasion and tax avoidance have on the overall fiscal health of Nigeria's economy?
• What reforms can be implemented to minimize the negative effects of tax evasion and avoidance on the national budget?

1.6 Research Hypothesis

In order to pursue the objective of this study, the following generalized statements have been designed to guide and aids in obtaining the result for the experiment to be conducted. For this work, the null hypothesis will be represented with H0 while the alternative hypothesis will be represented with hypothesis H1.

• H₀1: Tax evasion and tax avoidance do not have a significant effect on government revenue and the national budget in Nigeria.
• H₀2: Tax evasion and tax avoidance significantly reduce government revenue and negatively impact the national budget in Nigeria.

1.7 Significance of Study

The outcome of this research will contribute to the understanding of how these practices undermine government revenue, which is essential for funding public services, infrastructure, and development programs. The findings will be useful for policymakers in designing more effective tax policies and enforcement mechanisms that can curb tax evasion and avoidance, ultimately improving the country's fiscal health.

Additionally, the study will highlight the factors driving tax evasion and avoidance, which will help stakeholders in the tax system, such as the government and tax authorities, identify potential areas for reform.

For academics and researchers, the study will add to the existing body of knowledge on tax administration and its impact on economic development. It will provide a foundation for future research on tax compliance, fiscal management, and the effectiveness of tax systems in developing countries like Nigeria.

Ultimately, the findings will support the creation of a more robust and sustainable tax system, benefiting Nigeria's economy and its long-term development goals.

1.8 Scope of Study

The scope of the research is focused on the effect of tax evasion and tax avoidance on national budget in Nigeria.

1.9 Limitations of the Study

During the course of this study, there were some problems encountered which stood as limitations to the research work. Some of the limitations include:

1. Time Constraint: The time frame given to accomplish this project was very short due to school academic calendar and it was carried out under pressure which made the researcher not to implement some necessary features.
2. 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).
3. Initial Cooperation Delay from Respondents: Many respondents took longer than anticipated to complete the questionnaires or surveys, which delayed the entire data collection process and affected the study's timeline.

1.10 Definition of Terms

Tax Evasion :Tax evasion refers to the illegal practice of intentionally avoiding paying taxes owed to the government by underreporting income, inflating deductions, or hiding money in offshore accounts (Schneider, 2020).

Tax Avoidance: Tax avoidance refers to the legal use of tax laws and loopholes to reduce tax liabilities through strategic financial planning (Slemrod, 2019). Unlike tax evasion, tax avoidance does not involve illegal activities but may still be seen as unethical if it exploits gaps in tax laws to minimize contributions to the national revenue.

National Budget: The national budget is a financial plan that outlines the government's projected revenue and expenditure over a specific period, usually a fiscal year. It serves as a tool for managing public funds and allocating resources to various sectors such as education, healthcare, and infrastructure development (Fasina, 2018). The national budget is critical for national economic planning and policy implementation.

Government Revenue: Government revenue refers to the income generated by the government, primarily from taxes, fees, fines, and grants, which is used to fund government operations and development projects (Ogunleye, 2020). Tax evasion and avoidance directly reduce this revenue, leading to a shortfall in the national budget.

Tax Compliance: Tax compliance refers to the adherence of individuals and businesses to the tax laws of a country, ensuring that all taxes owed are paid on time and in full (Smith & O'Hara, 2021).

Fiscal Deficit: A fiscal deficit occurs when a government's total expenditures exceed its total revenue, excluding borrowing. This situation can arise due to a shortfall in tax collections caused by tax evasion and avoidance, ultimately affecting the government's ability to fund essential services (Adeyemi, 2022).