The implementation of the new VAT rate is expected to kick off in January 2020 with many saying the government’s timing of the policy is faulty
Understanding the new tax legislation
The Federal Government has proposed fundamental changes to Nigeria’s tax regulations. This is contained in the Finance Bill which proposes a 50 percent increase in the VAT rate in the country, from 5 to 7.5 percent. This increase, among other changes in the country’s tax administration, is meant to primarily finance the government’s budget deficit. In particular, additional revenue projected to be generated from the rate hike is intended to finance health, education and infrastructure projects. Given that States and Local Governments receive 85 percent of all VAT revenues, it will also go a long way in funding the new Minimum wage increase by the government. The Finance Bill has been successfully passed by the Senate and House of Representatives and is currently awaiting harmonization between the two chambers before it is sent to the President for his assent. It is expected to take effect in January 2020.
Putting the Debate in Context
There are justifiable reasons for advocating for an increase in the VAT rate in Nigeria. First is that the current rate, at 5 percent, is presently the lowest in Africa (with a regional average rate of 16 percent) and the 3rd lowest globally after Aruba (1.5 percent) and Andorra (4.5 percent). Moreover, the efficiency of the VAT collection process of the country which stands at 0.2 is below the African average of 0.3. Also, in terms of its share in GDP, revenue from VAT accounts for, on average, 0.8 percent of Nigeria’s GDP which is far below an average of 5 percent in comparable African countries.
Second is the dwindling price of crude oil in the international market which has made it imperative to fund the short fall in government revenue from other sources.
It is evident that the country’s tax system is long overdue for reform, with the increase in VAT rate being an essential part of the reform process. However, the timing of the increase and the implications of such a move on the economy make it an important policy issue that needs to be properly examined, considering the economic and developmental challenges currently confronting the nation.
Implications of VAT Increase
The direct effect of the rise in the VAT rate on the economy is an increase in government revenue. The figure below presents the total amount collected in VAT by the FIRS from different sectors of the economy since 2015. It shows that the total amount that accrued to the government from VAT collections has steadily increased over the years, with significant gains recorded in 2017 and 2018. This suggests that substantial progress has been made by the government towards improving revenue collection from VAT even under the current rate. The 50 percent increase in the rate from 5 to 7.5 percent, is estimated to result in an additional N550 billion going by 2018 collections.
Revenue collected from VAT across the Federation by the Federal Inland Revenue Services (FIRS) is distributed among the federal (15 percent), states (50 percent) and local governments (35 percent) respectively. As such, states and local governments who receive the bulk of revenue generated from VAT would have additional funds to finance health, education and the minimum wage increase, among other pressing issues. The federal government would also have more revenue to fund its annual budgets, while reducing the excruciating budget deficits.
Implication for consumers
According to traditional microeconomic theory, the imposition of VAT on goods and services has a distortionary effect on the economy as it results in what is known as a deadweight loss. This represents efficiency and productivity loss to the economy as a result of changes in demand and supply. In essence, the gain in terms of increase in government revenue is outweighed by the loss in transactions that should have taken place in the economy (but did not occur due to price increases brought about by the VAT). This in turn makes businesses and consumers worse off than before the imposition of the tax.
There is also the canonical argument of the difference between the statutory and economic incidence of a tax. While the statutory incidence relates to the individuals or businesses responsible for remitting the tax to the government according to the tax rules, the economic incidence refers to who eventually bears the cost of the tax increase. As such, even though VAT is imposed on producers across different chains of production, consumers can in fact be the ones bearing most of the burden of the tax hike as producers pass it on to them in terms of price increases.
Applied to the Nigerian context, the increase in the VAT rate means that prices of goods will increase as producers and suppliers pass on the increase in terms of higher prices of goods to consumers. This will result in a fall in disposable income of households, especially for those with low income, which can in turn result in lower aggregate demand in the economy.
Consumers are currently reeling under the pressure of shrinking disposable income brought about by government policies implemented in successive rounds. The prolonged closure of the border has increased the prices of basic food items. The Central Bank also recently imposed charges on transactions made through the POS, as well as on cash deposits and withdrawals beyond a certain limit. The VAT increase, combined with the effect of these policies, will have a negative effect on the income of households.
Implications for businesses
With a threshold of N25 million, many small-scale businesses, whose transaction values fall below this figure (both in a single transaction and cumulatively in a year), are automatically exempted from remitting VAT under the proposed law. Despite this, they could, however, still be indirectly affected by the rate increase since they purchase inputs from producers and suppliers who will increase their prices in order to pass on the incidence to others in the production or supply chain.
Medium to large scale businesses that make sales well above this threshold will be directly affected by the tax increase. Since VAT is collected from producers at each stage of the production process where value is added to a good, producers can pass the incidence of the tax increase upward in the production or supply chain. As such, while they in fact remit the statutory incidence of the tax to the authorities, the economic incidence is borne by others.
Recommendations
The variance between projections and the actual revenue collected from VAT points to the urgency to broaden the country’s tax base. While the increase in the rate will result in more revenue for the government, there is the need to further broaden the tax base to capture more businesses, especially those currently operating in the informal sector. Nigeria is home to one of the largest informal economies in the world. Ensuring that more businesses are duly registered and remit their VAT will increase its collection in the country. The provision in the Finance Bill that companies and individuals must provide their Tax Identification Number (TIN) before they can open new bank accounts or continue to operate already existing ones is a step in the right direction.
There is also the need to keep improving the ease of doing business in the country given that businesses thrive under conducive regulatory and macroeconomic environments. The recent improvement in the Nation’s ranking in the ease of doing business index released by the World Bank shows significant progress has been made by Nigeria in terms of regulations that make it easy to conduct business in the country. Government should therefore consolidate on this progress by addressing areas where the country is presently lagging behind. In particular, it must improve the ease of tax payment where Nigeria currently ranks 159 out of 190 countries globally. This will involve putting mechanisms in place to help firms reduce the administrative cost of remitting taxes as well as simplifying the post-filing processes, such as tax refund and tax audit. There is also the need to improve the ease with which businesses in the country can access reliable electricity supply.
There is also the need for government to put in place mechanisms to prevent leakages in the revenue collection system and prevent tax evasion and corruption by tax officials. as well as ensure that the additional revenue generated by government from the VAT increase is used to fund productive activities that will benefit final consumers, especially poor households who ultimately bear the greatest burden of the tax increase. This can be achieved by enforcing compliance in line with the provisions of the Finance Bill to ensure that all businesses remit the full amount they owe in tax. Since VAT is collected at multiple stages in the production process where value is added to a good, there is the need to put in place mechanisms to ensure that no producer or supplier at any stage of the production process is able to evade the payment of tax. Corruption of tax officials can be curbed by enforcing the use of IT in the payment of taxes and reducing physical interface between the tax payer and officials of revenue agencies.
It is imperative that the revenue generated by the government from the VAT increase is utilized to fund productive activities that will benefit the final consumers, especially poor households who will bear the greatest burden of the tax increase. The increase in the minimum wage, which is a major reason advanced for the hike in the VAT rate, may not be sufficient to offset the effect of the increase on the welfare of households, in terms of high prices that would be passed on to them by the producers. Many households, especially those in rural communities are self-employed. As such, the increase in the minimum wage will have little direct effect on their disposable income. It is therefore important for government (especially at the state and local government levels) to target the additional spending on education, health, and infrastructure on poor households who need them the most.
Source: Preston Consult
