Tax Hikes Suppress Economic Growth

Published on 7th August 2007

Economic growth anywhere in the world does not depend on chance or luck. It is purely based on pro-growth economic policies that must be embarked on. Defying this basic reasoning, Nigeria’s federal government raised the Value Added Tax (VAT) rate from 5 percent to 10 percent. It justified the increase by saying that it was in line with the ECOWAS policy directives, which require the harmonization of VAT and excise duties within the sub-region to 15 percent with 2009 as deadline.

Although the increase in the VAT has been suspended, there is concern that the VAT rate would be raised to 10 percent eventually in months ahead. The Value Added Tax was introduced in 1993 to replace the sales tax. It is a consumption tax, thereby having a wide base relatively with few exemptions. It is a single rate tax (5 percent), which makes it easy to administer. It uses an input-output method that makes it self-policing. When paid by a business on purchases, it becomes an input tax, which is recoverable from VAT charged on company’s sales, known as output tax.

The Value Added Tax (VAT) has become a major source of revenue for most developing countries including Nigeria. In view of this, there is penchant to increase tax rate to get high revenue. According to the World Bank, in Cote D’Ivore VAT is 20 percent. This constitutes 4.8 percent of the GDP and 28.7 percent of the total tax revenue.

In Ghana, VAT is 12.5 percent. This constitutes 3.8 of the GDP and 23.5 percent of the total tax revenue. In Senegal, VAT is 20 percent and this is 6.2 percent of the GDP and 37 percent of the total tax revenue. However, in Nigeria, VAT is 5 percent. This constitutes 1.6 percent of the GDP and almost 19 percentof the total tax revenue.

The high and growing revenue accruable to government through VAT is a motivating factor for countries within the sub-region to raise and harmonize VAT and excise tax. It is however, economic folly to expect more revenue from any hike in tax rate. This simple reason had dawned on many notable leaders at periods when economic performance was low.

Let’s, take the US, which relies so much on tax for example. Irrespective of their political affiliations, realizing that high tax rates were hindering the economy, Harding/Coolidge cut tax in the 1920s. Kennedy (in the 1960s) and Reagan (1980s) did the same. What was unique in the tax cut across the board then was the recognition that tax reduction stimulates growth and minimizes tax avoidance.

None of these leaders embarked on tax cut because of realities in North/South America but in view of grave economic recession of those periods back home. Admittedly, it is not in doubt that Nigeria is a leading member of the ECOWAS. The economic realities in Nigeria are quite different from what is obtainable in other West African countries.

Last year, the National Assembly had appropriated the 2007 budget on the basis of a 5 percent VAT. In the first place, it is illegal to increase VAT when the 2007 budget was based on 5 percent VAT rate. Anyone advocating for increase in VAT and any other forms of taxes at this period must be a complete stranger in Nigeria. Already, businesses are complaining about multiple of taxes. This is further aggravated by the zero power supply. Many businesses have resorted to running on private power generators. This has also increased the transaction costs. These added costs are being passed on to consumers.

It is ironical that VAT increase was contemplated at a time when consumer spending is at low ebb and gross inefficiency in public infrastructure prevails. Ultimately, a 5 percent increase in VAT rate would further reduce individuals’ purchasing power. This is because the prices of such consumable like beer, fuel, and services would go up by an additional 5 percent.

Most of the countries in ECOWAS particularly Ghana have lower transaction costs. Recently the Ghanaian government harmonized its tax regime and introduced a flat tax. In Nigeria the infrastructure that is supposed to provide the needed support to the economy is inefficient. Promises are made with respect to upgrading these infrastructures but all to no avail.

Policies geared towards infrastructure development and upgrading are made almost every day but the implementation is always a tall order. Economic growth and right economic policies go hand in hand.

Unfavorable tax burdens only worsen the economic power of any country. As already indicated, economic boom and recession are not dependent on chance or luck. What really makes the difference is a viable economic policy. This is the only tool that can uplift Nigeria from slow economic growth.

The current economic realities in Nigeria cannot accommodate any increase in any form of taxation. The concern over the economic impact of VAT would be felt by everyone, rich and poor alike. Apart from driving up prices, it will worsen the present state of our manufacturing sector. It would also slice the amount of revenue that the government has projected from the increase in VAT. The increase will reduce consumer demand. When consumption falls, labour productivity and level of employment are negatively affected.

The Common External Tariff treaty agreed upon by the Nigerian government with other ECOWAS countries has no economic relevance to what is at stake back home. What is paramount now is to retain the present rate of 5 percent, harmonize the tax system and above all block all drainpipes in tax collection system.

In addition government policies should be geared towards wealth creation. Allied to this is respect for property rights, the rule of law and non-government intervention in the working of markets.

If the government plays its constitutional role as a provider of enabling environment for businesses to thrive, the economy will blossom and the impacts would trickle down. An average Nigerian is economically alive. All that is required is a homegrown enabling environment.

The pro-VAT increase officials should learn from Arthur Laffer, the father of the Laffer Curve and Supply-side economics when he said: "Lower tax rates change economic behavior and stimulate economic growth, which causes tax revenue to exceed static estimates. Under some circumstances, tax cut can lead to more tax revenue. The exact opposite occurs when following tax increases, and revenues fall short of static projections."

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