Nigeria is getting ready for its first increase in Value Added Tax (VAT) rate since 1993. The Minister for Budget and National Planning, Udoma Udo Udoma and the Chairman of FIRS, Babatunde Fowler announced this on 19 March 2019. By increasing the VAT rate with 50%, the government intends to fund the recent minimum wage of NGN30,000 per month. This implies that the current VAT rate of 5% will rise to 7.5%. FIRS later explained that the proposed hike is to improve the rate of tax compliance and not the tax rate. Nevertheless, Nigeria should expect a VAT hike by 2019 year-end.
In Nigeria, VAT is an indirect tax that is levied on the supply of taxable goods and services. Some goods and services may not attract VAT in Nigeria. These items typically fall under the zero-rated or VAT-exempt items. Zero-rated items include non-oil exports; goods and services bought by diplomats; and goods and services bought for use in charitable projects. Exempt items include plant and machinery used in export processing zones or free trade zones, basic food items, medical items, pharmaceutical goods, educational materials, and exported services. The rationale for government’s intervention in shielding certain items from VAT is to promote local content and also to ensure that essential goods and services are affordable to low-income earners.
Hence, planning for a VAT increase with the current state of the economy is similar to walking on a tight rope on the basis that any increment will have a high unfavorable impact on the masses. More so, an increase in the rate of indirect taxes affects the price of goods and services. This, in turn, affects a country’s rate of inflation.
The consequence of the VAT hike will be significant since the Central Bank of Nigeria (CBN) manages inflation by fixing a benchmark interest rate to reduce inflation and encourage investment. Since 2016 when Nigeria hit its worst economic recession in 25 years as a result of the fall in global oil price and a weak currency, the CBN pegged the lending rate at 14%. Currently, the rate is 13.5%. The rise in the VAT rate will likely increase the rate of inflation. As a result, the Central Bank of Nigeria will need to make policy statements in this regard.
Impact of the proposed VAT increase
Specific prediction about the inflationary weight of the VAT increase is hard to assess. This is because the complete impact depends on the nature of the business and the price elasticity of that item.
Several scenarios are possible and each option shows a different impact on price. A business could;
- pass on the entire increase of 2.5 percentage, which would affect prices on all goods and services except zero-rated and exempted items. The impact on inflation would be full.
- pass on a fraction of the increase, which would mean that the impact on inflation is less.
- leverage on the increase in VAT to fix price above 2.5% of the current amount. This will shove inflation up even further.
The Central Bank of Nigeria will need to assess the impact of a VAT increase on inflation. Nigeria needs an explanation from its central bank on how it intends to manage inflation.
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