If Nigeria seeks different developmental outcomes, it must pay closer attention to the incentives embedded within its federal architecture. The task before the next government is, therefore, not merely to review revenue-sharing formulas or expand intervention programmes; it is to rebuild a federation in which authority, responsibility and fiscal reward once again reinforce one another, giving every tier of government a compelling reason to pursue development with purpose.
Nigeria’s federal system presupposes an implicit alignment among the three tiers of government in the pursuit of coordinated growth and national development. Yet, alignment is never automatic. In public policy, as in life, very little happens spontaneously. Every enduring system is built on relationships of cause and effect — authority and responsibility, action and consequence, effort and reward, incentives and sustained commitment.
Development is not Spontaneous.
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Communities invest because they expect returns. Businesses innovate because incentives reward productivity. Individuals acquire skills because opportunities exist to improve their livelihoods. Governments pursue reforms when institutional arrangements encourage performance and hold them accountable for results. In every sphere, incentives shape behaviour, and behaviour shapes outcomes.
The same principle applies to federations. A federal system is not merely a constitutional distribution of powers; it is an incentive structure. It determines who makes decisions, who bears responsibility, who receives the rewards of success, and who bears the costs of failure. When these relationships are well aligned, the constituent units compete, innovate and develop. When they are not, dependence gradually replaces enterprise, and political competition increasingly eclipses economic competition.
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The evolution of Nigeria’s fiscal federalism should, therefore, be understood not merely as a history of revenue allocation, but as a history of changing developmental incentives.
Before independence, Nigeria’s fiscal policy was anchored on the principle of financial responsibility. The regions benefited substantially from what they produced and were expected to “cut their coat according to their cloth,” creating a direct relationship between productive effort and fiscal capacity. This philosophy shaped the assignment of taxes and revenues. Agricultural exports, mining rents, royalties, import duties and, in varying degrees, excise duties, were substantially linked to the producing regions through the derivation principle, a feature recognised in historical analyses of Nigeria’s fiscal system, including those of the International Monetary Fund.
The derivation principle was, therefore, not merely a fiscal arrangement; it was a developmental instrument. By linking revenue to production, it created strong incentives for the regions to expand their productive bases, specialise according to their comparative strengths, develop location-specific capabilities and seek external markets. Fiscal policies were designed not simply to distribute wealth, but to encourage its creation.
This incentive structure explains why the regions aggressively invested in productive sectors. The Western Region expanded its cocoa economy — financing landmark investments such as free primary education and industrial estates from these revenues. The Northern Region developed its groundnut and cotton economies alongside agricultural marketing systems that supported rural productivity. The Eastern Region strengthened palm produce exports and commercial enterprise, using these revenues to expand public services and infrastructure. Competition among the regions was not simply political; it was fundamentally developmental because every improvement in productive capacity strengthened fiscal capacity.
As independence approached, however, a new objective emerged. Building a cohesive federation required balancing regional productivity with national solidarity. The establishment of the Distributable Pool Account reflected this shift. Fiscal need, continuity of government services and balanced development gradually came to play a greater role in determining revenue allocation. Derivation remained an important principle, but it no longer occupied the dominant position it once had.
This was neither irrational nor misguided. Nigeria was an emerging federation seeking political stability, national cohesion and more equitable development across its constituent regions. Redistribution therefore became an important complement to derivation. The philosophy of fiscal federalism was gradually transformed from one that primarily rewarded production to one that increasingly balanced production with redistribution.
States that successfully expand commercial activity naturally seek a stronger relationship between the wealth generated within their economies and the revenues available to sustain further development. Conversely, when fiscal rewards are only loosely connected to local productive effort, governments have weaker incentives to invest aggressively in expanding their productive economies. The VAT debate is, therefore, less about taxation than about the incentive architecture of Nigerian federalism – to invest in productive capabilities.
Even then, considerable regional autonomy remained, and healthy competition among the regions continued to shape developmental outcomes. It was the post-1966 centralisation of fiscal authority under military rule that fundamentally altered the federation’s incentive architecture. As more revenue streams were centralised and subnational governments became increasingly dependent on federally distributed revenues, the direct relationship between productive effort and fiscal reward gradually weakened. Nigeria did not merely change its revenue allocation system; it changed the developmental incentives upon which that system had previously rested.
The shift came with consequences that went beyond public finance.
When governments become less dependent on the productive capacity of their economies, the incentive to invest patiently in the foundations of long-term development also weakens. This observation applies not only to subnational governments but equally to the federal government. As the relationship between production and public finance becomes more distant, governments increasingly focus on managing and distributing available revenues, rather than expanding the productive base from which sustainable revenues are generated.
The consequences are far-reaching. Education gradually shifts from being viewed as an investment in future productivity to a recurrent expenditure. Healthcare becomes increasingly reactive rather than developmental. Agricultural extension services deteriorate or disappear altogether. Industrial policy loses strategic focus, while public infrastructure increasingly becomes something to be financed through centrally distributed resources, rather than through expanding local economic activity.
Over time, the entire machinery of government risks becoming oriented towards allocating existing wealth, rather than creating new wealth. Yet, no federation can sustainably distribute prosperity that it has not first produced. Perhaps, nowhere is this more evident than in the contemporary debates surrounding Value Added Tax. The legal and constitutional arguments have dominated public discourse, but they obscure a more fundamental issue. The debate is ultimately about incentives and not distribution.
States that successfully expand commercial activity naturally seek a stronger relationship between the wealth generated within their economies and the revenues available to sustain further development. Conversely, when fiscal rewards are only loosely connected to local productive effort, governments have weaker incentives to invest aggressively in expanding their productive economies. The VAT debate is, therefore, less about taxation than about the incentive architecture of Nigerian federalism – to invest in productive capabilities.
The same logic applies to many of today’s policy debates. Consider the growing consensus around the establishment of state police. Strengthening subnational policing may well improve security and bring law enforcement closer to local communities. It is an important reform. Yet, insecurity itself is often the consequence of much deeper developmental failures. Weak educational systems, declining agricultural productivity, limited employment opportunities, deteriorating local infrastructure and fragile institutions create fertile conditions for insecurity to thrive.
State police may, therefore, become an important institutional reform, but it cannot by itself restore the developmental incentives that have gradually weakened over decades. It addresses an important symptom without necessarily correcting the conditions that produced it.
Successful federations understand a simple principle: incentives shape behaviour; behaviour shapes investment; investment builds capability; and capability ultimately drives development. Governments invest where incentives reward investment. They innovate where innovation strengthens their own fiscal future. They build capabilities because those capabilities expand their own prosperity. This is not limited to profit-making institutions; it is a universal principle of productivity.
This observation extends beyond security. The decline in educational quality, weakening primary healthcare systems, poor rural infrastructure and increasing dependence on monthly federal allocations are not isolated policy failures. They are interconnected outcomes of an incentive structure that has progressively weakened the relationship between productive effort, fiscal reward and governmental responsibility.
This is not an argument against national solidarity or redistribution. Every federation must balance efficiency with equity and national cohesion. Nor is it an argument that Nigeria’s Constitution alone explains every developmental challenge. Rather, it is an invitation to reconsider the purpose of fiscal federalism itself.
Fiscal federalism should not primarily be viewed as an exercise in revenue allocation; its deeper purpose is to create developmental incentives.
The question before Nigeria is, therefore, not simply who should receive public revenue, but whether the manner in which revenue is generated, retained and distributed encourages governments to expand productive capacity, invest in their people and compete to create wealth.
Successful federations understand a simple principle: incentives shape behaviour; behaviour shapes investment; investment builds capability; and capability ultimately drives development. Governments invest where incentives reward investment. They innovate where innovation strengthens their own fiscal future. They build capabilities because those capabilities expand their own prosperity. This is not limited to profit-making institutions; it is a universal principle of productivity.
Development follows incentives.
If Nigeria seeks different developmental outcomes, it must pay closer attention to the incentives embedded within its federal architecture. The task before the next government is, therefore, not merely to review revenue-sharing formulas or expand intervention programmes; it is to rebuild a federation in which authority, responsibility and fiscal reward once again reinforce one another, giving every tier of government a compelling reason to pursue development with purpose.
In the end, sustainable development is not distributed; it is produced. And governments, like individuals, produce most effectively when the incentives encourage them to do so.
Dipo Baruwa is a business climate development analyst.
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