…perhaps the FIRS could increase VAT on luxury items to 15 per cent, and leave the rate at 5 per cent for the other items. Proposing a uniform increase on VAT rate across board may be a lazy approach to fiscal policy management, and may make Nigeria to be further disadvantaged in attracting foreign investment, given the state of energy and security in the country.
It was in the news last week that the Federal Government of Nigeria is planning to increase the value added tax rate (VAT) from 5 per cent to 7.5 per cent – a proposed fifty per cent increase. Some have harangued that the increase is justified because the rates applicable in other jurisdictions is as high as 20 per cent in the European Union (EU), and averages 19.3 per cent amongst the Organisation for Economic Co-operation and Development (OECD) member States (although it could be as low as 7.7 per cent in Luxembourg). Some have also argued that increasing the VAT rate is a means of shoring up the revenue base of the tiers of government, so that they would be able to meet their minimum wage obligations.
The need to either shore up federally collected revenues became even more imperative as the mid-year review of the 2019 budget performance showed that VAT collections had fallen by 15 per cent when compared with 2018, due to insecurity in the country, leading to a fall in the capacity utilisation of industries, with a knock-on effect on consumers’ purchasing powers. For this proposal to be operationalised, it would have to be passed into an Act by the National Assembly.
How is VAT supposed to operate? In the OECD environment, inclusive of the EU, VAT operates on the principle that it is the final consumer that bears the burden of the tax. For instance, consider a value chain consisting of six economic agents in this order: the farmer, wholesaler of farm produce, manufacturer of raw materials, manufacturer of finished products, retail shop, and the final consumer. Each of them is to charge VAT only on the value being added and at the same time recover all the VAT paid on inputs. In essence, each economic agent in the chain charges 5 per cent on the value being added. Ultimately it is the final consumer that bears the VAT burden which, when added together, will equal an effective rate of exactly 5 per cent of the final price paid. This is what is known as the Income Model of VAT.
We believe this is an opportunity to rethink the whole taxation system to make it focus on encouraging local production and employment, long-term economic growth through the widening of the tax base, while also reflecting the true federal status of Nigeria.
On the contrary, Nigeria’s VAT regulator, the Federal Inland Revenue Service (FIRS) does not operate the Income Model but the Gross Product Model, whereby each economic agent cumulatively adds 5 per cent to the gross price charged and not to the value added. Therefore, it is unjust to compare the operation of VAT in Nigeria with those of the EU. Using the case study illustrated earlier, the effective rate borne by final consumer could be as high as between 30 and 40 per cent, depending on the length of the value chain, making Nigeria one of the highest VAT levying jurisdictions in the world. Adding the incidence of the sales tax being levied by some state governments to the VAT, then one clearly sees the reason why Nigeria’s business operating environment may not be beneficial to manufacturers. If the proposed 50 per cent VAT rate hike is implemented, it is likely to have immediate inflationary implications, which could worsen the already precarious unemployment situation, often coming hand-in-hand with other unintended negative social costs. So, how can government generate additional revenue to plug the holes in public finances occasioned by falling VAT receipts?
We believe this is an opportunity to rethink the whole taxation system to make it focus on encouraging local production and employment, long-term economic growth through the widening of the tax base, while also reflecting the true federal status of Nigeria. For instance, in Canada, 13 per cent VAT is charged locally, out of which 5 per cent goes to the government at the centre, whilst the respective regions keep 8 per cent. A similar model could be replicated in Nigeria, whereby the respective State Internal Revenue Service (SIRS) administers VAT and remits an agreed percentage to the central government. This is likely to increase the aggregate VAT collectible, since it would be locally driven. This year, Ghana embarked on aggressive tax reforms, which moved from a focus on taxation to encouraging local manufacturing. VAT has now been abolished on many items, such as the sale of real estate, equity shares, financial services, and airline tickets. In addition, they have significantly reduced the VAT payable by small and medium-scale enterprises (SMEs) from 17.5 per cent to a flat rate of 3 per cent. They are also in consultation with the Economic Community of West African States (ECOWAS) to abolish all import duties on raw materials and machineries imported into Ghana. It would be shocking if the managers of the Nigerian economy have not considered the implications of these on the long-term flow of capital within the ECOWAS region.
Pending when a long-term solution would be found to the punitive Gross Income Model and centralised administration of VAT, which has been largely inefficient, perhaps the FIRS could increase VAT on luxury items to 15 per cent, and leave the rate at 5 per cent for the other items. Proposing a uniform increase on VAT rate across board may be a lazy approach to fiscal policy management, and may make Nigeria to be further disadvantaged in attracting foreign investment, given the state of energy and security in the country. In 2007, shortly before the departure of the President Obasanjo regime, a 100 per cent hike in VAT rate to a 10 per cent flat rate was operationalised. It was however reversed immediately the President Yar’Adua government settled down, as the proposal was not passed into law by the National Assembly. The same fate may attend this proposed hike if the manufacturers’ association and the labour unions are able to convince the lawmakers to reject the bill.
Posi Olatubosun, FCCA, is a senior lecturer in a London university, while Olaniyi Olagoke, FCA, is the managing partner of Olaniyi Olagoke & Co. Chartered Accountants, Lagos.