Monday, February 08, 2016 2.40PM / FDC
With the persistent fall in the price of crude oil, Nigeria has been plunged into an economic downturn that has left the government desperately looking to other sources for revenue generation. Oil accounts for over 75% of government revenue and 90% of export revenue and has fallen to levels below $35 per barrel. Compared to the glory days of $100 plus oil prices, this is a 70% decline in prices and has been accompanied by a 27% fall in foreign direct investment. These declines have had profound implications for the nation’s revenue foreign reserve, public expenditure and economic growth. Specifically, the 2016 budget had planned a N2.22 trillion deficit with a benchmark oil price of $38/barrel. With the current realities of oil falling below $30/barrel, there is a much larger deficit to accommodate.
In addition to the decline, the U.S. lifting of Iran's economic sanctions is a further threat to Nigeria. Iran, which has the fourth largest oil reserve in the world (160 billion barrels), is now poised to export oil to the international oil market, and has recently announced it can produce oil at $1/barrel. This means Iran can afford to sell its oil below the official international rate if it pleases, which would further hamper Nigeria's export efforts and revenue expectations. Other key challenges include the declining stock market, the increasing inflation rate (currently at 9.6%), the exchange rate volatility, and declining oil reserves, a problem which has prompted the Central Bank of Nigeria (CBN) to take several measures to defend the value of the naira.
As a result, it has become imperative for the government to diversify the economy and increase revenue generation from other sources. Tax increases have been one of the front-line considerations, with an increase in VAT among the options.
VAT in Nigeria
Value-Added Tax (VAT) is a tax on consumer spending. It is payable on goods and services consumed by any person whether government agencies, business organizations or individuals (see below 1) It can also be defined as a tax on spending/consumption levied at every stage of a transaction but eventually borne by the final consumer of such goods and services. In Nigeria, it is levied at a flat rate of 5%. VAT is collected on behalf of the government by businesses and organizations which have registered with the Federal Inland Revenue Service (FIRS) for VAT purposes.
Economic Impact of a VAT Increase – The Pros & Cons
An increase in VAT has been one of the forefront considerations of the Federal Government in recent times to increase its revenue stream. During the four day visit of the International Monetary Fund (IMF) to Nigeria in January 2016, the managing director of the IMF, Ms Christine Lagarde, called for an increase in VAT describing it as the lowest in the ECOWAS region and one of the lowest around the world (see below 2).
The VAT rate is low compared to 19.25% VAT paid in Cameroon, 14% paid in South Africa and 17.5% in Zambia. In Egypt, 10% is charged on standard goods and services while 25% is charged on luxury items and zero on exports. VAT in Kenya ranges between 12-16% while in India, it is between 5.5% and 14.5%. (see below 3) As such, there is precedence for an increase. However, the implementation of such a decision would need to be carefully considered.
Nigeria has one of the highest poverty rates in the world and an increase in a consumption tax like VAT would be a huge burden on the average Nigerian. In terms of income distribution, Nigeria is among the most unequal countries in the world. The increase will therefore shrink the purchasing power of the already impoverished Nigerian income earner.
The unemployment rate in Nigeria is expected to rise to 10.5% by the end of the first quarter of 2016, from 9.9% in Q3'2015 according to the Trading Economics global macro models and analysts’ expectations (see below 4); and inflation which has also been on a steady increase since 2015 currently stands at 9.6%. An increased VAT will consequently increase inflation rate, as businesses will see it as an excuse to raise prices of goods and services arbitrarily.
Also, the GDP annual growth rate at 2.84% in the third quarter of 2015 (see below 5). showed a decline in economic productivity from previous level of 6.23% in the third quarter of 2014, and cannot support a VAT increase. All these macro-economic variables suggest that a VAT increase is not a welcome financial burden that Nigerians will be willing to take on.
On the other hand, a VAT increase would increase the government revenue stream, which can be invested in infrastructure, other developmental projects, and stimulate economic growth. The additional revenue would help reduce government’s dependence on oil revenue. Whilst this is good, the immediate increase could reduce overall consumption and further slow-down the economy making it counter-productive.
If a VAT increase were to be implemented by the government, several measures should be taken to ensure that the objective of the increase is obtained. An instance is the provision of the relevant technology to ensure proper monitoring, collection and elimination of leakages. The VAT increase could be varied relative to kind of the goods/services being purchased, since the effect on the poor would be greater than on the rich. e.g. higher VAT rate on luxury items. Transparency, accountability, and proper sensitization of the masses on the need for an increase are also required. Since the plan of the government is to borrow to fund part of the budget, the borrowing if judiciously implemented would help stimulate the economy, giving room for the government to gradually increase taxes like VAT.
Nigeria’s VAT rate at 5% is beyond doubt one the lowest in the world. It can therefore be argued that VAT should be increased, however with the current rate of poverty in Nigeria and the present economic situation, an increase in VAT would pose a huge financial burden to the average Nigerian.
Rather than an increase in VAT at this time, other avenues could be explored in the short term such as the absolute removal of petroleum subsidy which many have argued does not benefit the Nigerian populace. The plugging of fiscal leakages, a move which is currently being enforced by the present administration, can also be further strengthened.
Even though a VAT increase may at some point be unavoidable, now would be a bad time for an increase.
3 Leadership News. Available from: [25 January 2016]