Role of VAT in developing countries

Each time a customer makes a purchase from a store, a receipt is given out noting that Value Added Tax has been added to the net price. VAT, which is similar to a turnover tax, is assessed on all prior business-to-business transactions in the supply chain, as well as sales to final consumers.

VAT is considered a flat tax on an item. It is similar to a sales tax in some ways, except that with a sales tax, the consumer pays the entire amount owed to the government at the point of sale. Different parties to a transaction pay different portions of the tax amount with VAT.

In Nigeria 

Medical and pharmaceutical products, basic food items, books and educational materials, newspapers and magazines, baby products, commercial vehicles and their spare parts, agricultural equipment and products, as well as veterinary medicine are all specifically exempt from VAT in Nigeria, as stated in the first schedule of the VAT Act.

VAT is charged at a flat rate of 7.5 per cent on all goods and services sold in Nigeria, unless they are on the VAT exempt list or are zero-rated, as specified in Section 4 of the VAT Act. Exported goods are one example; all exported goods are zero-rated, which means they are VAT-able but at a zero per cent rate. This means that VAT is collected from the foreign buyer, but any input tax is refunded.

The Federal Inland Revenue Service has implemented FIRS VAT-Collect, a platform for automatic tracking and remittance of VAT. Domestic airlines (for instant remittance of VAT on ticket sales) and other retailers are among the system’s users.

Non-resident companies providing services to Nigerian customers must charge, collect and remit VAT to the FIRS in the currency of the transaction.

NBS figures

VAT for Q2 2022, according to the National Bureau of Statistics, was reported at N600.15bn, a 1.96 per cent increase from N588.59bn in Q1 2022. In Q2, local payments totalled N359.12bn, with foreign VAT payments totalling N111.13bn. On a quarter-on-quarter basis, electricity, gas, steam and air conditioning supply recorded the highest growth rate with 116.47 per cent, followed by accommodation and food service activities with 42.44 per cent. On the other hand, activities of extra-territorial organisations and bodies had the lowest growth rate with -42.39 per cent, followed by activities of households as employers, undifferentiated goods and services activities of households for own use with -36.57 per cent.

In terms of sectoral contributions, the top three largest shares in Q2 2022 were manufacturing with 33.08 per cent Information and Communication Technology with 18.98 per cent, and mining and quarrying with 10.60 per cent. Conversely, the activities of households as employers, undifferentiated goods and services for own household use recorded the least share with 0.03 per cent, followed by activities of extra-territorial organisations and bodies with 0.05 per cent; and water supply, sewerage, waste management and remediation activities with 0.13 per cent. However, on a year-on-year basis, VAT collections in Q2 2022 increased by 17.16 per cent from Q2 2021.

The VAT collected in the first, second and third quarters of 2021 were N496.39bn, N512.25bn and N500.49bn, respectively, against N324.58bn, N327.20bn and N424.71bn in the same periods in 2020.  This indicates increased revenue in the first three quarters of 2021. This surge shows year-on-year growth rates of 52.93bn in Q1 2021, 56.56bn in Q2 and 17.84 per cent in Q3.

Poor gets poorer

With a VAT system, lower-income consumers would pay a much higher proportion of their earnings in taxes. Despite that VAT levies goods and services at every stage of production and sale, the net economic burden is similar to that of a sales tax. Sales taxes drive a wedge between what the buyer ultimately pays and what the seller actually gets. The tax has the potential to either increase the final price that consumers pay or decrease the amount of money that businesses have to pay their employees and investors. Theory and data indicate that VAT is transferred to consumers through higher prices. In either case, whether nominal incomes fall or rise, the decline in real household income is the same.

The burden of a VAT is regressive when measured as a share of current income because lower-income households spend a larger proportion of their income on consumption than higher-income households. The tax burden as a share of income is highest for low-income households and falls sharply as household income rises. The burden of a VAT is more proportional to income when measured as a percentage because income saved today is typically spent in the future.

Benefits of VAT

The benefits of VAT include being based on consumption, which would give it a steady revenue base; being neutral, as it would be imposed on all types of businesses; providing stronger incentives for businesses to control costs; encouraging or, at least, not discouraging saving; having the potential to raise significant sums of money at a low tax rate; being easy to administer; removing export barriers under certain conditions; and aiding in the creation of a more equitable tax system.


Some of the criticised drawbacks include being regressive, encouraging excessive spending, lacking a counter-cyclical balance, harming new and marginal business ventures, complicating administrative procedures, triggering inflationary tendencies, acting as a ‘hidden tax’, conflicting with the current structure of state and local sales taxes, and failing to effectively encourage exports in many cases.

But finance analyst, Ogidiaka Ovie, argued that an increase in VAT would help boost the economy, as well as increase revenue for the Federal Government.

His words, “An increase in VAT, which translates into increased revenue for the Federal Government, helps to boost the economy, creates jobs, helps the government in its basic function of security, infrastructural development and social contribution for the welfare of the general public.”

In developing countries

According to a study, developing nations encounter significant obstacles when attempting to set up effective tax systems. First, most people in these nations work in agriculture or small, unofficial businesses. The base for an income tax is, therefore, difficult to determine because they are rarely paid a regular, fixed wage, their earnings fluctuate, and many are paid in cash, off the books. Additionally, workers in these countries are less likely to spend their earnings at large retailers, who keep meticulous records of their sales and inventories. As a result, modern methods of generating income, like income and consumer taxes, have a smaller impact on these economies, and it is almost impossible for the government to impose high tax rates.

Without an educated and trained workforce, when funds are scarce to pay tax officials well and computerise the process or even to provide effective telephone and mail services, and when taxpayers have limited access to account-keeping resources, it is challenging to establish an efficient tax administration. As a result, instead of creating logical, contemporary and effective tax systems, governments frequently choose the route of least resistance, creating tax systems that enable them to take advantage of whatever options are available.

The informal nature of the economy in many developing nations makes it difficult for statistical and tax offices to produce accurate data, in addition to their financial constraints. Policymakers are unable to evaluate the potential effect of significant changes to the tax system because of the lack of data. As a result, even when significant structural changes are clearly preferrable, marginal changes are frequently chosen over them. This perpetuates inefficient tax structures.

Income tends to be unevenly distributed within developing countries. Although raising high tax revenues in this situation ideally calls for the rich to be taxed more heavily than the poor, the rich taxpayers frequently have the political and economic clout to block fiscal reforms that would raise their tax rates. This helps to explain why many developing nations haven’t fully tapped into personal income and property taxes, as well as why their tax systems rarely achieve satisfactory progressivity, that is, where the wealthy pay proportionately more taxes.

Rather than pursuing the ideal, tax policy in developing nations frequently focuses on the art of the possible. Therefore, it is not surprising that the design of the tax systems in these countries has been relatively unaffected by economic theory, particularly the literature on optimal taxation.

While VAT has been implemented in most developing nations, according to a publication by the International Monetary Fund, it frequently suffers from lack somehow. Many significant industries have been excluded from the VAT net, most notably services, the wholesale and retail sector, or the credit mechanism is overly restrictive; meaning there are delays or denials in providing adequate credits for VAT on inputs, particularly when it comes to capital goods. These features lessen the advantages of introducing VAT in the first place because they permit a significant amount of cascading (increasing the tax burden for the final user). In developing nations, addressing these flaws in the administration and design of VAT should take precedence.

A lot of the developing nations, including many members of the Organisation for Economic Cooperation and Development, have two or more VAT rates. Multiple rates are politically appealing because they ostensibly – though not always – serve an equity objective. But in developing nations as opposed to industrial ones, the administrative cost of addressing equity issues through multiple taxes may be higher. A multiple-rate system’s cost needs to be closely examined.

In other climes

For the more than 160 nations that impose it, VAT has grown to be a significant source of income, accounting for more than 30 per cent of their total tax revenue. The United States stands out as an exception because there is no VAT there. It contributes between four and seven per cent of the Gross Domestic Product in advanced economies and over seven per cent in low-income developing nations.

The VAT has come under a lot of criticism because it is such a prominent source of income, sometimes justified and sometimes not.

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