Yesterday, the Federal Executive Council approved a c.40% increase in the rate of value-added tax (VAT) to 7.2%. Once signed into law, this would represent the first increase since the VAT was first introduced in Nigeria in 1993 and is in line with the Federal Inland Revenue Service’s (FIRS) plan to increase Nigeria’s revenue.
Why is the FIRS doing this?
With many of the recently inaugurated gubernatorial class inheriting piles of unpaid salaries and pensions, the recently approved minimum wage hike was unlikely to be effectively implemented across defaulting states. According to the Minister of Finance, the hike is aimed at increasing revenue allocation to States and Local governments in a bid to expedite the implementation of the minimum wage. The VAT was selected because of state and local governments are the primary beneficiaries of the revenue (Federal – 15%, State – 50%, Local – 35%), as opposed to the general revenue sharing formula (Federal – 52.7%, State – 26.7% and Local – 20.6%).
Furthermore, we note that this move is a continuation of the FIRS’ move to improve non-oil revenues in Nigeria, following previous programs such as the VAIDS and VOARS. The taxes collected by the FIRS form a major part of Federation revenues (FIRS contributed c.60% of Federation Account Income over the past three months). Recently, the Service has also announced a VAT on online transactions scheduled to commence in January 2020 and has been considering the idea of a separate VAT on luxury items. Overall, if deployed effectively, the additional funds could support government revenue at all levels, reducing deficits and external financing requirements.
Will there be negative implications?
One thing to consider is the impact on inflation. A VAT is an indirect tax, where the burden is borne by the final consumer. This is because, upon resale of the vatable item, the seller recovers the initial VAT paid (Input VAT) and effectively shifts the burden to the consumer. Thus, it follows that the prices of goods and services should rise in tandem with the higher VAT rate. Parallels could be drawn from other emerging markets. In April 2018, South Africa implemented an increase in the VAT rate from 14% to 15%. Inflation promptly increased from 3.7% in March 2018 to an average of 4.3% over the next three months. Similarly, average inflation in Saudi Arabia jumped from 0.4% in December 2017 to an average of 2.9% in the next three months, following the introduction of a 5% sales tax (previously zero per cent) in January 2018. July inflation for Nigeria came in at 11.1% y/y, above the CBN’s single-digit target. This is likely to increase upon implementation of the VAT rate hike.
Building on this, a rise in the general price level without an equivalent rise in income levels could further constrain spending power. For a country dealing with fragile economic growth amid depressed consumption, a disproportionate rise in income levels upon implementation of the hike could result in further weakness in economic growth, particularly if the fiscal
multiplier of funds disbursement remains weak. Thus, it would be important for the implementation to coincide with the minimum wage increase.
Is the move justified?
First, Nigeria has a revenue crisis, largely stemming from the country’s inability to adequately raise non-oil revenue which is typically constituted by tax revenue. Nigeria’s tax revenue to GDP ratio of 6% (as at 2016), pales in comparison to Sub-Saharan (SSA) peers such as Ghana (18%) and South Africa (29%). As such, the government has continued to strengthen its drive to raise higher tax revenues, particularly in the face of fast-rising expenditure. Whilst we know that one of the major impediments to raising taxes stems from Nigeria’s weak tax base, we also highlight that the country currently has one of the lowest VAT rates in the world (5.0%), behind 15.0% and 16.0% from peer countries, South Africa and Kenya. We believe the Nigerian government remains in a quagmire where expansionary fiscal policies introduced to drive stronger economic growth are somewhat counteracted by contractionary efforts, given the inefficacy of public sector processes. Overall, the successful deployment of the funds generated from this tax increase will determine the effects on the economy.