On Wednesday, 11th of September 2019, it was announced that the Federal Executive Council (FEC), presided over by President Muhammadu Buhari, has approved a 250bps increase in Value Added Tax (VAT) to move it from 5% to 7.5%. Following the due process, the implementation will not start until the approval by the National Assembly.
We recall that the issue surrounding a hike in VAT has increasingly been discussed recently, as the FG seeks to bridge its revenue shortfalls and reduce its dependence on oil as the primary source of revenue.
So, what is this VAT?
It is the tax you pay when you buy things (goods) like food, phones, soaps, generators, cars etc. or when you pay for a service (like transportation, phone airtime, cinema shows, sewing your cloth, making your hair, etc).
Don't let the name deceive you, there is VAT whether you think value has been added or not. The rate is 5%. This means for a price of N1,000 you will pay an extra N50 as VAT to government making your total bill N1,050. If the item is for your use or consumption, then that is where the VAT story ends. But if you resell the item or use it to produce something else which you will sell at say N1,500 then you need to charge VAT of N75 so the buyer pays N1,575. Since you paid VAT of N50 (input VAT) when you bought the item then you are entitled to deduct it from the VAT of N75 you've just charged (output VAT) and only pay the difference of N25 (N75 - N50) to FIRS.
Some sellers already include VAT in their listed prices and will sort out the VAT element with government (we call this VAT inclusive price) like in the case of recharge cards.
So why increase it now?
VAT replaced the sales tax in 1994 and was pegged at 5% by the military government of Sani Abacha. In 2007, former President Olusegun Obasanjo increased VAT to 10% on the eve of his departure from office but it was reversed by his successor, Umaru Musa Yar’Adua, following opposition from labour.
Even though the hike is still subject to an amendment of the VAT act of 1994 by the National Assembly, it has become progressively apparent since the dawn of the recession, that this policy direction was actually inevitable. Nevertheless, we note that while the best time to take this sort of action is usually when economic growth is northbound, we have sadly found ourselves in a rather perilous situation where revenue from oil receipts are declining amid persistent global tensions, and a bulky pre-existing budget deficit. Notwithstanding, we note that while there exists other (probably more economic) options available for the government to choose from, e.g. reducing government size, eradicating subsidies and eliminating fiscal duplications and promoting ease of doing business, this recent policy direction should bode well for government revenues, especially as minimum wage increase is on the horizon.
The FG retains only 15% of total VAT and the remaining 85% is shared between the state and local governments. In a statement by the Minister of Budget and National Planning, and Finance, Zainab Ahmed, she announced that the total revenue estimate is the sum of N7.5trillion for the year 2020 (when the VAT is expected to be implemented), and 2.09trillion would be accruing to the federation account and VAT respectively. By extension, it means the FG should be receiving a proposed aggregate of N4.26trillion from the federation account and the VAT pool, while the state and local governments are expected to receive N3.04trillion and N2.27trillion respectively. The quoted estimate translates to an 88% rise from 2018 levels of N1.11trillion.
However, a more realistic estimate off 2018 numbers, shows that the increased VAT is only expected to fetch c.N488billion. Now based on the revenue sharing formula (FG:15%, States: 50% and LGA:35%), it means the FG would earn an additional N73.2billion, States: N244billion and LGAs: N170.8billion. We spotlight that, while the states would indeed enjoy the increased revenue, it would not have any meaningful impact on FG’s revenues, nor would it help bridge the lingering fiscal deficit. Futhermore, it is reported that the FG alone would need an additional N300billion annually to cover all agencies of government, so how would the forecasted N73.2billion fund the deficit?
Figure I: VAT’s Contribution to Tax Revenue
Sources: NBS, Investment One Research
Furthermore, while the FG has tried to lull the country into a feeling of complacency, that all is well concerning rising debt levels, citing the low debt to GDP ratio - 27.37% when juxtaposed against our African peers like Ghana – 65.90%, Kenya – 56.95%, South Africa – 55.70% etc., the country’s debt service to revenue ratio – c.65% says otherwise. Nigeria’s continued dependence on oil for revenues makes these expensive debts a call for concern.
The excuse behind the hike in VAT is not farfetched, but that is all it is – an excuse. The decline in oil price has made it almost inevitable for the government to borrow to finance public expenditure. However, rather than approach multilateral agencies for cheap loans, which usually come in at a less that 1% interest rate, the FG has continually opted for the expensive commercial loans primarily to avoid the conditionalities and most importantly, the accountability associated with multilateral loans. Consequently, the government sold bonds of US$4.8billion and US$5.4billion in 2017 and 2018 respectively and will most likely sell some more to finance this year’s budget deficit. So, with the aim of hindering the debt service ratio from rising any further, the FG needed to find other means of increasing its revenue, most especially when it plans on increasing the minimum wage by 66% to N30,000.
Furthermore, when you juxtapose the nation’s Tax-to-GDP ratio and even our VAT rate with its peers, we see that it remains low on both fronts. So in the FG’s bid to diversify its revenue source, there comes the policy direction of the hike in VAT, to be complemented with the introduction of the Voluntary Asset and Income Declaration Scheme (VAIDS), Voluntary Offshore Assets Regularization Scheme (VOARS) and the general increase in the nation’s tax base – all in its efforts to boost tax revenues and by extension, its contribution to GDP. This could also serve as the basis on which the FG instructed banks and other service providers involved in online payment settlement to collect VAT on online transactions effective January 2020 and the re-introduction of VAT charges on transactions in the Nigerian Capital Market.
Figure II: VAT rates and Tax-to-GDP ratios across some countries.
Sources: Trading Economics, Wikipedia, Investment One Research
Nonetheless, we highlight that there are other, more economically viable routes the government can take, such as the removal of subsidies and adopting a more realistic official exchange rate of N360/USD, instead of the N305/USD currently being used. A devaluation of the official rate alone, could fetch the government alone, an additional N350billion from oil receipts alone. Another fundamental issue that is as important, but conveniently avoided, is the cost of governance in Nigeria – it is just ridiculously high. The size of the government in enormous and requires c.N2.2trillion in personnel costs alone (according to 2019 budget). So why not reduce the size of the government and save some extra income?
Similarly, one could argue that there still exists an enormous informal activity sector including artisans, traders in markets etc. and rather than increasing VAT, the government could intensify its efforts to increase the tax net.
What does this mean for the average Nigerian?
As we know, more than 50% of Nigerians live in extreme poverty, so for this example, we use a rice famer or a small garri producer.
These people would face the cost through two key means: What they eat and What form of transport they use.
Charges on transport operators would go up, through higher VAT collection for daily fees/charges/council money/toll gate fairs etc. Imagine that being complemented by a hike in fuel (PMS) price (which also has VAT but is being borne by the government – story for another day).
Now, the rice farmer or garri producer, who has to transport his goods from the farm to the market, will use a diesel truck (diesel is not subsidized), so higher VAT equates higher transport costs, and the farmer needs to make profit, so higher food prices for everyone, including the poor.
Secondly, these people do not use gas to cook like we do, the use kerosene (also not subsidized). They buy the garri or rice (which now costs more – smuggled or not) and have to cook it with a more expensive kerosene on stoves.
Stoves are not made locally; they are imported from China... I’m sure you get the point already.
Well, in April 2019, the National Assembly passed The Nigerian Police Fund Trust Fund Act and it was signed into law by the President on 2nd of July 2019. The Act establishes a Fund; proceeds from which will be used to train police personnel and procure security machinery and equipment.
Essentially, the Act imposes a levy of 0.005% of the "net profit" of companies 'operating business' in Nigeria. The Fund will also consist of 0.5% total revenue accruing to the Federation Account, in addition to proceeds from grants, intervention funds, aids, donations, investment income and so on. The fund will also be wound up 6 years after its establishment. The assets and liabilities will be transferred to the Nigeria Police Force.
Now, while it may seem like 0.005% levy may not be very significant – 0.005% of N100,000 = N5.00, however it places additional costs on corporate taxpayers. Since it is imposed on companies 'operating business' in Nigeria, it is likely to also apply to permanent establishments of foreign companies.
Although funding of the police and improving security is a priority issue, it could be funded through more allocations from already existing revenue streams. Introducing earmarked taxes could create concerns around the stability of the tax regime in Nigeria.
While it is pretty obvious the government is attempting to improve its fiscal stance, its fiscal governance must carefully consider the possible impacts including intended and unintended consequences
· Firstly, the most obvious impact would be an increase in government revenues, which should discourage it from engaging in more borrowings, thus creating allowance for some funds to be diverted into growth promoting areas and to be used to fund the minimum wage – effectively improving consumer spending.
· However, we recall that in 2014, Dr. Okonjo-Iweala set up a committee to revive activities on the NSE, following the financial crisis and extended periods of negative market sentiments recorded on the local bourse in previous years. Following the decision reached by the committee, the Minister announced a waiver of stamp duties and exemption of VAT on transactions on the Exchange. We also spotlight that while the policy did not necessarily yield fruits (due to many other domestic and external factors), as the NSEASI and the NSE market cap dropped 34.34% and 2.94% respectively, between July 2014 and July 2019, the recent re-introduction of VAT charges would not serve to incentivize increased market participation.
· Similarly, the hike in VAT could lead to a spike in inflation, as it inevitably translates into a rise in the costs of goods and services. This would then transcend into a limiting factor of economic growth as it in adversely thwarts consumer purchasing power, netting off the impact of the potential boost in economic activities. So when you add this to the uptick in electricity tariff, and the lingering insecurities affecting food production, we get a big bowl of inflation rising far ahead of the CBN’s single digit 2020 target… in an economy growing less than 2%. The endpoint of it all would be an increase in the poverty rate of Nigeria.
· Furthermore, while it is necessary for the government to do something regarding taxation of the digital economy, the overall objective should be to ensure a level playing field between online and offline transactions, to prevent non-taxation as well as avoid double taxation or excessive compliance obligations. The future is online, so the government should encourage players in this space and not scare them away.
· Additionally, we believe the effect of this decision would do more harm than good, as it would counter the FG’s already lackluster efforts to lift more Nigerians out of poverty. More effort should be put towards increasing the tax net and not necessarily increasing VAT rate and fiscal governance must get better and all “politically correct” speech concerning our debt not being a problem should be shelved.
· Finally, it is almost an economic law that tax increases hurts GDP growth. Even Donald Trump understood this and that was why he reduced taxes in the U.S. – to boost GDP growth. David Romer – an American economist and author of a standard textbook in graduate macroeconomics, put forward a research paper on how tax increases reduces GDP. He said “Tax changes have very large effects: an exogenous tax increase of 1% of GDP, lowers real GDP by roughly 2-3%”. When GDP grows faster, naturally tax revenues grows too, as income also goes up. So if we were in an economy growing at 6-7% per year, the government could raise taxes, to skim of some additional revenue. However, in an economy barely growing at 2%, the government is in adversely asking factors of production to part with more surpluses than they can afford to. In simpler terms, the government is reducing the monies available for consumption of goods and services from other sectors of the economy, which ensure the circulation of money and overall growth of the economy.
At this point, we will like to continue our tasks at our respective working points.