What do I think of the proposed VAT increase?

Late last week the minister of finance announced that the government was going to increase the VAT rate from the current five percent to 7.2 percent. To be clear, the rate does not kick in immediately but there will be a consultative process culminating in the amendment of the VAT act.

Earlier in June the minister said there was a “strategic revenue growth initiative” which was designed to increase government revenues to 80 percent of the revenue target. I guess this is the first, or second, salvo in what looks like a series of initiatives to bolster government revenue. As we know, the government is almost bankrupt. Almost.

So, what do I think of this VAT increase? The stark reality is that the VAT rate in Nigeria is very low compared to almost anyone else. In South Africa VAT is 15 percent. In China it is 17 percent. In Ghana it is 12.5 percent. I could go on. Of course, there are those who argue that Nigeria does not actually have a VAT tax and that in practice it is a sales tax, and sales taxes are typically lower. Whichever way you slice it, the fact remains that our VAT (sales tax) rate is low and from that perspective there is room to increase it.

However, it is not that simple. It rarely is. For starters VAT is one of those taxes we economists like to call regressive; that is, the burden on the poor is higher than the burden on the rich.

Not that the poor pay more per person but that the fraction of income that gets captured in VAT taxes is higher for the poor. To be fair, many goods especially agricultural produce, are VAT exempt. But things like bread and gala and Fanta are not VAT exempt. For instance, rich people spend an infinitesimal amount of their income on food. But for the poor that fraction is a very large. Some segments of the population spend up to 70 percent of all their incomes on food. Most of that spending will face an increased VAT rate.

Then there is the problem with the economy. The economy has been doing like this and like that recently and looks to be slowing. It is not clear that increasing the VAT rate on its own will be bad for the economy. The impact depends on what the extra income from VAT receipts is spent on. If it is spent on productivity-enhancing infrastructure or on education and health then you can make the case that it will be good for the economy overall.

But we know that is not how our government spends money. The extra income will probably be spent on salaries. If that is the case then the VAT increase will be bad for the economy.

Should we really be trying to further slowdown a slowing economy? In most democracies, announcements for tax increases come hand in hand with announcements on spending plans. In our case the announcement was that we are cutting capital expenditure and raising money to pay the new wages for government officials.

I guess a bankrupt government is worse than a slowing economy.