At the current rate of 5%, Nigeria’s record VAT collection of N1.1 trillion in 2018 amounts to 0.9% of GDP compared to about 3.8% for commonwealth and ECOWAS countries.
The federal government has now approved a rate increase to 7.5% subject to consultation and amendment to the law. It is important to note that s38 of the VAT Act empowers the finance minister to amend the rate of VAT by an order published in the Gazette. All things being equal, a 2.5% increase in rate will mean an additional N550 billion annually (FG N82.5 billion, States N275 billion and LGs N192.5 billion) at the level of 2018 collection.
What are the likely implications of a rate increase?
While an increase of 2.5% may appear small, it is in fact a 50% increase in VAT cost to many businesses and consumers. The negative impact will include increase in prices leading to higher inflation, less disposable income for already poor households resulting in lower consumption and a decline in GDP growth rate. Also because input VAT on capital expenditure is not allowed as a credit in Nigeria, the cost of real investments will go up and more people will evade the tax as compliant entities become less competitive.
On the positive side, additional VAT revenue will help reduce budget deficits, reduce government debt and fund social services especially at sub national level.
What should government do to limit the negative impact of a rate increase?
A fundamental principle of taxation is that people should pay according to their abilities. The question is, can everyone afford a 7.5% VAT rate, the answer is NO. But are there people who should pay 7.5% or more, the answer is YES.
In order to limit the impact of an increase government should implement counter or palliative measures to protect businesses and the poor.
- Exempt or zero rate essential consumptions (foods, education, primary healthcare, etc). Exemption should not be limited to only unprocessed food items. In other words, a VAT increase should not “affect the price of bread”.
- Create a VAT registration threshold to eliminate VAT compliance burden for small businesses (in other countries you don’t have to worry about charging VAT if you are a small business such as annual turnover of less than equivalents of N13m in Ghana, N17m in Kenya and up to N23m in South Africa).
- Allow businesses to account for VAT on cash basis rather than on invoice which creates a cash flow problem (especially because borrowing rate is high). This will also limit the impact on cost of production and investment.
- Make the VAT refund system work so that business in a refund position are paid promptly, Rwanda pays VAT refund within 30 days.
- Lead by example, ensure that government and all MDAs fully comply by remitting VAT collected from their contractors.
- Ensure transparent reporting and efficient utilisation of the revenue for public services and infrastructure to act as palliatives and catalyst for growth.
- Implement the new minimum wage to reduce the contractionary effect of a rate increase in a low growth economy.
- To ensure a level playing field, ensure that every business above the threshold is compliant, and limit arbitrary waivers to expand the VAT base.
Ultimately, whether the rate increase will have an overall positive or negative impact on the people will depend on how it is implemented.