The Federal Executive Council (FEC) recently approved an increase in the Value Added Tax (VAT) rate to 7.2% from the initial 5.0% established since January 1, 1994. The increase is primarily to support the finances of states as the new minimum wage of N30,000/month becomes effective. The timeline for the implementation of the new rate is unclear, but the minister of Finance, Budget and National Planning hinted at 2020. As there are plans for wide consultation and amendment to the existing VAT Act, implementation may take longer than expected. The increase in VAT rate is unsurprising as governments have been keen but civil protests have led to reluctance despite Nigeria’s low VAT rate relative to peer economies. Nigeria’s VAT rate at 5.0% is the lowest among African peers such as Kenya (16.0%), South Africa (15.0%), Egypt (14.0%) and Ghana (12.5%). Similarly, VAT receipts to GDP is only 0.9% of GDP compared with 3.0% in Ecowas and Commonwealth countries according to PwC. We note that Nigeria's effective VAT rate is believed to be significantly higher than the current 5.0% due to the difficulty in claiming refunds, the high cost of compliance and non-allowable expenses for input VAT purposes.
We expect the increase in VAT to generate additional N479.7bn in revenues based on the N1.1tn collected in 2018. Based on the sharing formula, we expect the FG to receive additional N72.0bn (15.0%), states to receive N239.8bn (50.0%) and local governments to get N167.9bn (35.0%) upon implementation. While the states would receive a significant boost, the increase is unlikely to make a dent on FG’s fiscal deficit which we estimate at N3.4tn in 2019. We believe the FG requires a significant revenue boost, which would come elsewhere. Our analysis shows that removing petrol subsidies and adopting a market reflective exchange rate of N360/US$1.0 for the computation of oil receipts would increase FG’s revenue by N880.0bn.
While we align with the age-long call to boost non-oil revenue, we believe the FG has chosen an easy but less impactful route with the proposed increment in VAT. The increase should be part of a comprehensive fiscal reform package that would seek to boost collection efficiency, rein in recurrent spending, remove subsidies and widen the tax net. According to the former minister of finance, Kemi Adeosun, Lagos and Abuja account for 55.0% and 20.0% of VAT revenues respectively, meaning more pressure on consumers in both cities. We suspect that this is due to the large size of the informal economy which governments have been unable to integrate with the formal economy due to issues such as multiplicity of taxes. In the broader economy, we expect the adjustment to VAT to lead to higher consumer prices and in turn inflation. The attendant weakness to consumer spending would also impact growth negatively.