In September 2019, the Federal Government formally announced plans to increase the Value Added Tax (VAT) rate. A 50% increase from 5% to 7.5% was included in the finance bill, which, yesterday, was signed into law by President Buhari. The VAT increase forms part of the government’s revenue mobilisation efforts to deal with the expenditures of the minimum wage increase, development of capital projects and infrastructure; and consequently, lead to a reduction in future budget deficits—in the recently signed 2020 budget, revenues were short of spending by ₦2.28 trillion.
Two years ago, we argued that Nigeria was going broke. The government simply isn't making enough non-oil revenues at a sustainable level. Taxes are supposed to be the main outlet for a government to make money, yet our tax to GDP ratio stands at 6% which pales in comparison to the OECD average of 34% and the African average of 17%.
This doesn’t tell the full story
According to the National Bureau of Statistics (NBS), the total revenue generated from VAT in 2018 stood at ₦1.108 trillion. Therefore, on paper, it would appear that at the current level of remittance, a 50% increase in the VAT rate could generate at least, an additional ₦550 billion annually for the Nigerian government.
However, it's not that simple. An increase in the VAT rate does not automatically mean increased tax revenue for the government; as a matter of fact, if the VAT system as a whole is not properly structured, there is a chance that revenues may fall.
The VAT rate is only one component in a VAT system and whether or not the proposed increase will indeed achieve the desired objective will depend on the efficiency of the VAT system. This efficiency depends on the tax base, as well as evasion and avoidance rates. It can be shown that as the tax rate increases, efficiency falls: people work harder to avoid paying the tax or in some cases, people can no longer afford to pay it.
An increase in VAT leads to price rises as businesses pass the additional costs to consumers. And at a macro level, this can reduce household consumption as incomes are squeezed by the extra cost—businesses also lose out as they lose customers. This can lead to a fall in GDP and incomes which reduces the amount of revenue that the government gets from VAT. This is a real economic issue and research is usually conducted to estimate the optimal tax rate in each country at that time.
Nigeria is different
So, is it worth increasing the tax rate?
Indeed, Nigeria has one of the lowest VAT rates in the world. In Ghana, the VAT rate is 12.5%, while it stands at 15% and 16% in South Africa and Kenya respectively. However, there is more to a tax system than the rate itself.
Before the finance bill came into force yesterday, VAT was applicable to small, medium and large-scale businesses under the same rate of 5%. In essence, even if you were a small business with a turnover of ₦10,000 annually, you were still required to register for VAT and file returns with the FIRS every month. In Ghana, Kenya and South Africa, small businesses are not subject to VAT. A minimum threshold of around ₦13m annual turnover is prescribed for Ghana whilst the threshold is placed at ₦17m for Kenya and ₦23m for South Africa.
In addition, for countries with higher VAT rates, extra effort is placed on reducing burdens outside of paying the tax rate itself. For example, the ability to obtain input credit on all expenses incurred, including investments in assets. Input credit ensures that persons involved in the production of raw materials do not incur VAT costs at that stage. This approach is employed by other developing countries to incentivise manufacturers to produce. While this measure exists in Nigeria, we still practice a modified VAT system where taxpayers can only claim a limited portion of input VAT.
As a result, the burden of a 5% VAT rate in Nigeria is not directly comparable with other countries. If we can reduce burdens outside of the tax rate itself then there is room for the rate to be higher.
Which way forward?
The finance bill is definitely a step in the right direction. As part of the amendments proposed, the Bill prescribes a minimum threshold for VAT registration and remittance. It is proposed that only businesses with an annual turnover of ₦25 million and above will be required to charge, collect and register for VAT. This will enhance the competitiveness of small businesses and reduce the burden on the FIRS to administer VAT on these small businesses.
To reduce the burden of the VAT increase on consumers, the finance bill broadens the basic food items exempt from VAT. While this is a good move; in typical Stears fashion, we believe there's room for more. While final goods are exempt, producers cannot claim a credit for the VAT they pay on inputs to produce it. Hence, there is still scope to make these basic food items cheaper to reduce their burden on the poor who spend most of their income on food. Making the goods zero-rated will remove any VAT payments on the production and sale of these items.
With taxes, getting the balance between increasing revenue and the impact on consumers is key. Nigeria currently has a very fragile economy and as such, every economic and tax policy must be well thought out, with a solid strategy put in place for its implementation. Indeed, the government needs to fund the increase in the minimum wage and with our low tax rates, taxation seems a viable option. That said, we must avoid a scenario where the burden impacts the economy negatively overall. The VAT rate increase will be of little use if the workers earning the increased minimum wage end up in a no better position than before both policies were introduced.