VAT rate hike to ease fiscal deficit, threaten CBN’s single inflation target
President Muhammadu Buhari

VAT rate hike to ease fiscal deficit, threaten CBN’s single inflation target

The fiscal authority proposed increase in the applicable tax rate on sales of goods and services otherwise known as value-added tax, VAT, is a zero-sum game as it is expected to have multiple impacts on the economy if implemented.

While there is an urgent need for government to increase revenues from non-oil sources, some pundits have said that there will be marginal effects on total revenue strong enough to close the widening fiscal deficit but inflationary pressure is expected to bite more if implemented.

Analysts that spoke with MarketForces said the increase will threaten the monetary policy authority inflation target.

They stated that this may force the monetary policy to increase the interest rate, and noting that government plans to borrow about N2 trillion to finance the budget 2020, the overall advantage would be wiped off as FG would likely pay more on its debt instruments.

It would be recalled that the Federal Executive Council recently approved about a 50% increase in VAT from 5% to 7.5% (not 7.2% as widely reported) but critics say this would further pressure the economic performance.

Nigeria’s VAT rate at 5.0% is the lowest among African peers such as Kenya with a VAT rate of 16.0%, South Africa is 15.0%, Egypt 14.0% and Ghana is 12.5%.

Some financial experts and economists that attended the MarketForces Africa analysts’ forum at the weekend said that the monetary policy authority would not have work to do if government spending aligns.

“For a long time, because the government is always on the spending side, fiscal decisions often have an inflationary undertone, and it is the work of the monetary policy to create a balance”, they stated.

On one side, a hike in the VAT rate would increase revenue, thus closing gaps in fiscal deficits of the government. However, there is a possibility that it would push forth change in general prices of goods and services.

Afrinvest stated in a note that the increase in the 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.

The firm said it expects the increase in VAT to generate an additional N479.7 billion in revenues based on the N1.1 trillion collected in 2018.

“Based on the sharing formula, we expect the FG to receive an additional N72   billion (15.0%), States to receive N239.8 billion (50.0%) and local governments to get N167.9 billion (35.0%) upon implementation”, Afrinvest said.

It also stated that while the states would receive a significant boost, the increase is unlikely to make a dent on FG’s fiscal deficit which the firm estimates at N3.4 trillion 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  billion.

“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”, Afrinvest remarked.

Both demand and supply side in the market space are expected to feel the changes, analysts stated at the MarketForces forum at the weekend.

“Hike in rate would reduce the power of Naira from the consumption side. Quite a number of households would not be able to buy as many VATable products as they used to or be willing to part with more cash than they used to.

“Also, from the production side, manufacturers are going to incur more on VATable inputs in their various processing activities. However, they would be able to pass this on to customers but yet a timeline for recouping cash outlay is subjected to demands – and consumers have the right to postpone purchases.

“As no economic agent has right, economically speaking, to control demand and supply, it, therefore, means that in the supply chain, consumers would draw their preference based on their disposable income”, Economists in attendance at the forum draw the analysis.

Experts at Vetiva Capital noted that once signed into law, this would represent the first increase since the VAT was first introduced in Nigeria in 1993.

“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”, analysts added.

According to Vetiva, it follows that prices of goods and services should rise in tandem with the higher VAT rate. It said parallels could be drawn from other emerging markets.

In its review of the issue, Vetiva draws attention to related issues in South Africa, Saudi Arabia among others.

It was observed that in April 2018, South Africa implemented an increase in the 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 per cent) in January 2018.

“July inflation for Nigeria came in at 11.1% year on year, above the CBN’s single-digit target. This is likely to increase upon implementation of the VAT rate hike”, Vetiva Capital stated.

Some analysts however think while the move is right, the timing is wrong. Consultant at LSintelligence said: “Nigeria has lowest VAT rate in Sub-Saharan Africa and by extension in the whole of Africa”.

The firm said in a note that VAT at 7.5% is just okay and there is no right time really to make the adjustment.

It stated that given the fiscal condition of the government, the need for Federal Government to plug holes around its fiscal vulnerabilities is crucial. Thus, raising the VAT rate is the right thing to do but for the timing.

According to LSintelligence, the government may need to review VATable items on the list and educate people to ensure minors are not paying indirect taxes.  Then, the efficient collection is just as important.

“Champagne consumers and people buying luxury goods would be affected. It must be noted that income redistribution is one of the reasons taxable people pay a different amount per time.

“In Africa, this petrol-dollar powered economy charges the lowest VAT and that is one of the reasons for widening fiscal deficits.

“If the government can close gaps in revenues generation and apply the funds appropriately, we may be on the way to having a new Nigeria, altogether”, LSintelligence added.

Vetiva Capital added that 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.


According to the firm, 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.

“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”, Vetiva Capital reckoned.

Afrinvest said the increase is primarily to support the finances of states as the new minimum wage of N30, 000 (about $83) per month becomes effective.

VAT receipts to GDP are only 0.9% of GDP compared with 3.0% in Economic Community of West African States (ECOWAS) and Commonwealth countries according to PwC.

Analysts at Afrinvest 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.

According to the former minister of finance, Kemi Adeosun, Lagos and Abuja account for 55.0% and 20.0% of VAT revenues respectively, which means more pressure on consumers in both cities.

VAT rate hike to ease fiscal deficit, threaten CBN’s single inflation target.