The Nigerian fiscal space is currently embattled by the tussle between some state governments and the federal government on the collection of the value added tax (VAT) revenue. 15 This is premised on the demand for equity by large revenue generating states like Lagos. VAT revenue generation in Nigeria has been largely dominated by the federal capital territory and two of the 36 states of the federation (Lagos and Rivers). The three states accounted for 74% of the total VAT generated in the first eight months of 2021 (8Mâ€™21).16 However, the revenue is collected centrally and shared among the 36 states leaving most states highly dependent on support from the federal government.
Regional Analysis of VAT Generation in Nigeria
Given that it is a consumption tax, VAT generation thrives in states with robust economic activities and a significant level of formal business operations. The South West generated the highest proportion of total VAT collected in 8Mâ€™21, as it hosts the countryâ€™s commercial city, Lagos. North central has the second-highest VAT generation, which is mostly sourced from the capital city, Abuja. However, these regions eventually receive just approximately half of the VAT generated from their regions while poor performing regions, like the South East and North East, get more than four times the VAT generated from their regions.
Impact of Decentralized VAT Collection
The ongoing clamor for the decentralization of VAT collection means that low revenue generating regions will be at risk of huge revenue shortfalls. This will further weigh on their ability to meet their fiscal obligations. According to the State of State Report 2021, only three states have the capacity to meet their operating expenses as measured by their 2020 fiscal performance.
On the other hand, a change in the distribution of the VAT revenue could spur states in low VAT generating regions to build their revenue generation capacity and reduce dependence on the federal government. The current revenue sharing practice provides a disincentive for fiscal responsibility by low revenue generating regions. Besides low VAT revenue, the South East, North West and North East also have low internally generated revenue (IGR) compared to the other regions.
While decentralization puts the economy at risk of regional inequality, a drive towards domestic resource mobilization has the potential to promote regional development. A focus on domestic revenue generation will create a healthy competition among the regions to attract investments and encourage increased private sector activities. Therefore, the ongoing VAT collection debate represents a clarion call to the regions to pursue some level of self-reliance. Specifically, there is the need to:
Identify potential sources of higher revenue: Due to location and other non-economic unique differences, regions have their respective areas of comparative advantage. These can be potential sources of higher revenue if well developed. For instance, oil-rich South-South region can benefit immensely from the newly enacted Petroleum Industry Act (PIA)21 through increased investment and the positive spillover effect on overall economic activities. The regions can also take advantage of their respective mineral reserves by encouraging increased mining sector activities.
Improve the business environment: A thriving private sector is imperative for increased VAT generation. However, higher private investment is largely dependent on the attractiveness of the region for business operations. According to the Q2 2021 capital importation report, only three states (Lagos, Abuja and Ogun) attracted new investments during the quarter.
Step up efforts to combat insecurity: Insecurity has been a major constraint to private sector activities in Nigeria, particularly in the North and South Eastern regions. This is due to frequent banditry attacks, herdsmen conflict and the activities of the Boko Haram Islamic insurgency group. There is therefore the need for state governments to unite efforts to address insecurity in the regions.
Develop an efficient tax collection system: Beyond a taxable economy, it is important for the regions to strengthen their tax administration system in order to ensure efficient VAT collection. Increased private sector activities without a corresponding improvement in the tax administration capacity will undermine the expected increase in VAT generation in the regions.
Despite the immediate adverse impact on revenue for almost all the states of the federation, a ruling in favor of the decentralization of VAT collection in Nigeria is likely to compel state governments to improve their revenue generation capacity. This will facilitate increased private sector activities, which will aid regional development and support overall economic growth.