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Has Nigeria’s standard VAT rate increase been counterproductive? 06 Feb 2023

The Federal Government of Nigeria introduced the Value Added Tax (VAT) in 1994, at a standard rate of 5 percent on all goods and services to enhance the revenue base of the country. VAT is charged on the supply of all goods and services except those that are exempted under the VAT Act, which include but not limited to oil exports, medical services, pharmaceutical products, basic food items, educational books and materials, all export services, and petroleum and agricultural products.

In the recent amendments to the Nigerian Finance Act in 2019, which took effect from 2020, the standard VAT rate was raised from 5 percent to 7.5 percent on the value of goods and services supplied; VAT-able items were also increased to include intangible or incorporeal items such as copyright, trademarks, right to mineral resources and others. In addition, VAT exemption was given to businesses that have less than N25 million in annual turnover, while companies engaged in upstream petroleum operations were no longer allowed to enjoy exemption from registration status even if their annual turnover is below the N25 million threshold.

Furthermore, the deadline for remitting VAT returns was set to the 21st day of the following month. Failure to register and/or collect VAT by taxable persons attracts N50,000.00 in penalty for the first month of default and N25,000.00 for every subsequent month that default continues, while 10 percent of the amount of VAT will be applied as fine for the unremitted returns.

These amendments, particularly the increment in the standard VAT rate, have implications for the economy. It, therefore, becomes expedient to evaluate the effects of the new rate on macroeconomic factors such as revenue generation, performance of light manufacturing industries (food and beverages, textile and garments, electronics and computer assembly, wire and cable, etc.), inflation rate, and aggregate consumption in the last three years.

The 50 percent increment was justified, among other reasons, by the need for government to improve on taxation as a means of generating more revenue to fund the minimum wage and other projects. Although many Nigerians kicked against the VAT rate increase, it is interesting to note that Nigeria still charges a significantly lower standard VAT rate compared to many West African countries such as Ghana (12.5 percent), Cote d’Ivoire (15 percent), Senegal (18 percent), Sierra Leone (15 percent), Cape Verde (15 percent) and Benin (18 percent). This notwithstanding, the following are some of the economic impacts of the VAT rate hike in Nigeria.

First, since the new rate of 7.5 percent came into effect in 2020, the contribution of VAT revenue receipt to non-oil revenue has increased from 32 percent in Q4 2019 to 40 percent in Q2 2022. This implies that VAT receipts on goods and services supplied have generated more revenue to the national treasury as expected.

But conversely, the proportion of income generated from corporate tax has declined compared with the periods before 2020. This is evident in the total contributions of corporate tax, company income tax, capital gains tax and stamp duties to non-oil revenue, the sum of which has dwindled from 45 percent in Q4 2019 to 33 percent in Q2 2022. The 12 percentage points decrease should be worrisome when compared to the 8 percentage points gain from VAT receipts.

Second, the manufacturing sector has been the worst hit by the VAT rate increment. The hike in the VAT rate and the subsequent imposition of excise duties of N10/litre on sugar in 2022 (an essential input for light manufacturing industries such as food and beverages), under the disguise of tackling obesity and other related diseases, has been unfavourable to the manufacturing sector. The sector embattled by shortage of foreign exchange for the procurement of imported raw materials now has higher VAT rate and a new sugar tax to contend with.

Many of the manufacturing industries are not coping well with the ensuing high cost of production and this has resulted in continued deterioration of manufacturing sector output, as some companies have been forced to shut down their factories while others are operating below full capacity. As a result, the rates of unemployment and underemployment have continued to soar, with the national unemployment rate rising from 23.1 percent in Q3 2018 to 33.3 percent in Q4 2022.

Third, as the manufacturing sector performance slumps, leading to shortfalls in the supply of goods and services in the country, the Nigerian economy has witnessed the situation of “too much money chasing too few goods.” The inflation rate has increased by 9.27 percentage points, from 12.20 percent in February 2020 to 21.47 percent in November 2022. To worsen the situation, interest rate was raised from 11.5 percent in 2020 to 16.5 percent in 2022, ostensibly in an attempt to curtail inflationary pressure. But the strategy is inappropriate for a demand-pull inflation. A supply-side intervention would have better stemmed rising prices caused by supply shocks. Using interest rate hikes to address supply-side rupture is grossly inappropriate.

Fourth, standard VAT rate increment affects household income and consumption. High VAT rate has a negative effect on aggregate consumption because it reduces dispensable income. VAT as a consumption tax is levied at every stage of production through the distribution chain to the final consumers who ultimately bear the tax burden. As such, VAT is regressive in nature. It’s burden falls more heavily on the low-income earners who happen to spend a bigger proportion of their income on consumption.

Beyond the above state fallouts from hiking the VAT rate, there is the need for quantitative assessments of the tax management system and administration in consolidating the gains expected from VAT revenue collection. Electronic tax management system, such as electronic fiscal devices (EFDs), electronic tax registers (ETRs), and other information and communication technology (ICT) facilities, was introduced to enhance the efficient collection and administration of VAT revenue. Despite the putative introduction of the electronic tax system, the mode of VAT registration still entails manual processes such that companies must file an application (start of activity documents) with relevant tax offices before tax identification number (TIN) is assigned. In other climes, tax registration is compulsory for every business entity and that includes VAT which does not need any special registration.

In addition, the modes of administration (such as calculation of VAT returns) are done manually and not yet fully automated. These and many other inefficiencies have led to the payment of needless fines and penalties by taxpayers, thereby adding more burdens on manufacturing firms and final consumers.

Overall, one wonders why any government would seek to generate more revenue by increasing the tax burden on the poor masses through VAT rate increase, as opposed to rigorously pursuing progressive taxation that takes more from the rich. One also wonders how many rich people are paying their fair share of taxes. Indeed, it is curious why a flat VAT rate on goods and services is preferred to a variable system with a relatively lower rate for basic commodities with options of complementary subsidies to make basic food items affordable to the poor masses?

Has the VAT increment done well in addressing the issue of dwindling revenues, which was the very reason officially put forward for the policy? But among the policy options is expanding the tax net instead of increasing the burden on the existing taxpayers. And how has the government addressed the issues of tax evasion and inequitable tax avoidance?

The impacts of the VAT rate increase on domestic savings and export-oriented production are also worthy of evaluation with a view of ascertaining the worth of a fiscal action that has simply been endured more by the poor masses in the last three years.

Olusola Dahunsi, PhD, who is a chartered accountant, is a lecturer in the Economics Department at KolaDaisi University, Ibadan.