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FG moves to raise VAT rate to 7.2%

FG moves to raise VAT rate to 7.2%

Yesterday, the Federal Executive Council approved a c.40% increase in the rate of value-added tax (VAT) to 7.2%. Once signed into law, this would represent the first increase since the VAT was first introduced in Nigeria in 1993 and is in line with the Federal Inland Revenue Service’s (FIRS) plan to increase Nigeria’s revenue.

Will there be negative implications?

One thing to consider is the impact on inflation. VAT is an indirect tax, where the burden is borne by the final consumer. This is because upon resale of the vatable item, the seller recovers the initial VAT paid (Input VAT) and effectively shifts the burden to the consumer. Thus, it follows that prices of goods and services should rise in tandem with the higher VAT rate. Parallels could be drawn from other emerging markets. In April 2018, South Africa implemented an increase in VAT rate from 14% to 15%. Inflation promptly increased from 3.7% in March 2018 to an average of 4.3% over the next three months. Similarly, average inflation in Saudi Arabia jumped from 0.4% in December 2017 to an average of 2.9% in the next three months, following the introduction of a 5% sales tax (previously zero percent) in January 2018. July inflation for Nigeria came in at 11.1% y/y, above the CBN’s single digit target. This is likely to increase upon implementation of the VAT rate hike.

Is the move justified?

First, Nigeria has a revenue crisis, largely stemming from the country’s inability to adequately raise non-oil revenue which is typically constituted by tax revenue. Nigeria’s tax revenue to GDP ratio of 6% (as at 2016), pales in comparison to Sub-Saharan (SSA) peers such as Ghana (18%) and South Africa (29%). As such, the government has continued to strengthen its drive to raise higher tax revenues, particularly in the face of fast-rising expenditure. Whilst we know that one of the major impediments to raising taxes stems from Nigeria’s weak tax base, we also highlight that the country currently has one of the lowest VAT rates in the world (5.0%), behind 15.0% and 16.0% from peer countries, South Africa and Kenya. We believe the Nigerian government remains in a quagmire where expansionary fiscal policies introduced to drive stronger economic growth are somewhat counteracted by contractionary efforts, given the inefficacy of public sector processes. Overall, the successful deployment of the funds generated from this tax increase will determine the effects on the economy.