In the fiscal policy-making circles, increasing Value Added Tax [VAT] is considered the most effective instrument for narrowing fiscal gap and the least in terms of political sensitivity. Revenue challenges have got to the point of desperation but despite the temptation, government has let the sleeping dog of petroleum pump price lie undisturbed.
The system has been starved of economic buffers in plenteous times but the administrative structure that hindered fiscal surpluses in the past is still in place. The absence of fiscal space has therefore bedeviled government’s operations for many years.
The revenue targeted with VAT increase is desperately needed by governments that are struggling to pay their workers. The federal government lacks the fiscal space needed to stimulate economic activity and the increase in VAT is not going to create it.
The Governor of the Central Bank of Nigeria (CBN), Godwin Emefiele, blames insufficient fiscal injections into the economy for the recession of 2016, the sluggish recovery and the sub-optimal growth ever since. He underscores fiscal gap as an imbalance in the macroeconomic policy equation that is hindering the ability to navigate the economy through recovery.
The task on hand for the present administration is clearly defined – which is to apply aggressive stimulatory fiscal injections to provide a life line to an economy suffering from financial anemia. The physicians in the government house have made their prescription – draw new tax money from the economy and re-inject into the system.
This is the cycle of revenue from VAT increase, which has no room for operating capacity enhancement. The process depicts a game of minus one plus one that cancels out. While that gives the politician a claim of doing something, it does not support any promises of stimulatory impact on the economy. The fiscal move lacks the external push needed to quicken the income-expenditure chain to a higher level.
Fiscal stimulus normally works to trigger a congealing multiplier chain of production and consumption functions as well as delivery of critical services. The quickening force is expected to originate from outside the system for it to be capable of recharging the weakening internal momentum. Monetary and fiscal governors cannot therefore reasonably hope to rev up an economy in need of stimulatory spending by raising taxes.
Low levels of efficiency and transparency in the public service add a major kink to the equation. All that will be withdrawn from the system by way of the new tax is not likely to return through productive spending. A good part of private sector’s investible funds can be expected to be shifted to financing public sector’s recurrent budgets through the tax. To the extent that this happens, the sum of all the game will be even less than zero.
VAT is paid on goods and services for both final consumption and investment spending. The increase amounts to taxing the private sector to fund the bloated recurrent expenditures of governments. To the extent it retards investment spending in the private sector and finances non-productive spending in government quarters, it will be a minus to the nation’s productive capacity.
The 2020 federal government’s budget is to run on a deficit of N2.2 trillion. Aggressive revenue target is expected to cover 79.5 percent of aggregate spending of N10.59 trillion. The revenue projected from VAT increase from 5% to 7.5% from February 1, 2020, is therefore going to finance recurrent expenditure and debt servicing.
The high prospects for revenue under performance will hit back on how debt servicing for the year is to be funded. There is a possibility of diverting part of new borrowings to service existing debts. The capacity for capital spending in the year may therefore be significantly lower than budgeted.
Budget numbers are not adding up to any promises of economic development through the increase in VAT. Various forms of corruption have always existed around the matters of finance and money in public quarters. Vague promises of what would be accomplished with tax increases have been one of the most disappointing forms of it.
Promises of infrastructure rehabilitation and upgrade preceded every petroleum subsidy withdrawal as well as the first time that VAT was introduced. Rather than improve, infrastructures keep deteriorating and the gap keeps widening.
It is not that government is not willing to build the infrastructures but that it is being economical with the truth about government finances. The tax increases are only helping to fund recurrent expenditures of the bloated government structure in place. They are largely insufficient to meet recurrent votes with nothing dropping over to the capital spending basket. All government’s capital expenditures have always been borrowed and that has been the trend running over several years.
The increase in VAT presents a temporary patch work on government’s fiscal dressing but no solution to the deep rooted issues in government finances. While it will help the government to narrow the fiscal gap in the interim, it will push prices up – which in turn, will raise government expenditure and consequently take the fiscal gap to a new level.
The final impact of the policy will be a higher level of price equilibrium in which the government itself and all economic units will need a new round of increased incomes for existing levels of consumptions. As many as are unable to pass on the price increase will join the crowding population below the poverty line.
The underlying factors indicate that government has become relatively small in terms of spending capacity and quite incapable of fiscal stimulus. Government revenue is hardly sufficient to pay salaries of public servants. Debt servicing has not been possible in recent years without recourse to new borrowings. New debts are used to window dress fiscal crisis; maintain the bloated size of government while the engine of state keeps losing its stimulatory power.
Inflation follows mounting deficit financing and this is offensive to investors who take steps to reduce real holdings of domestic currency in order to protect themselves from inflation tax. It is repulsive to foreign portfolio investors whose eyes are constantly on what will happen to the value of the naira.
Funding of fiscal deficits through bond sales is a signal for increased tax liabilities in order to meet the piling debt obligations of government. The increase in VAT is a manifestation of the signal for the potential tax liability. The cycle of borrowing to finance fiscal deficits and raising taxes continues – the effect on the economy of driving investment capital offshore also continues to intensify.