Effect of SME Sustainability on Tax Compliance and Fiscal Capacity in Nigeria

Abstract

Small and medium-sized enterprises (SMEs) play a vital role in economic growth, employment generation, and structural transformation in Nigeria, yet their contribution to domestic revenue mobilisation remains constrained by widespread tax non-compliance. This study examines the relationship between SME sustainability and tax compliance, and assesses how employment and income growth influence fiscal capacity. Using survey data from 2,554 SMEs across Nigeria, sustainability is measured through a composite index incorporating employment growth, turnover, output, sales performance, capital accumulation, and net worth, while tax compliance is proxied by firm-reported tax payment. Binary logit estimates reveal a positive and statistically significant association between SME sustainability and tax compliance. Marginal effects indicate that improvements in sustainability raise the probability of compliance by approximately 17.4 percentage points. Instrumental variable generalized method of moments (IV-GMM) results further show that employment and income growth significantly increase tax contributions, with income growth exerting nearly twice the fiscal impact of employment expansion. Diagnostic tests confirm instrument validity and the presence of endogeneity. The findings highlight the importance of aligning SME development policies with tax administration reforms to strengthen voluntary compliance and expand the tax base in Nigeria.