ASSESSING THE CONTRIBUTION OF VAT TO THE REVENUE PROFILE OF NIGERIAN GOVERNMENT

CHAPTER ONE: INTRODUCTION

1.1 Background of the Study

Value Added Tax (VAT) is a consumption tax levied on the supply of goods and services at each stage of production and distribution. Unlike a sales tax, which is levied only at the final point of sale, VAT is collected at every stage of the value chain, from raw material supplier to manufacturer to wholesaler to retailer to final consumer. However, businesses can claim credits for VAT paid on their inputs (input VAT), so the net tax burden falls on the final consumer. VAT is an indirect tax, meaning it is collected by businesses (registered VAT vendors) and remitted to the government, but the economic burden is borne by consumers (Boadway and Keen, 2015). (Boadway and Keen, 2015)

VAT was introduced in Nigeria in 1993 through the Value Added Tax Act (No. 102 of 1993), with an initial rate of 5%. The VAT rate remained at 5% for nearly three decades until the Finance Act of 2021 increased the rate to 7.5% (effective February 2021). VAT is administered by the Federal Inland Revenue Service (FIRS), which is responsible for registering VAT vendors, collecting VAT returns, processing VAT payments, and enforcing compliance. VAT revenue is shared among the three tiers of government: Federal Government (15%), State Governments (50%), and Local Governments (35%). This sharing formula makes VAT a critical source of revenue for state and local governments, which have limited tax bases (Federal Republic of Nigeria, 2021). (Federal Republic of Nigeria, 2021)

The rationale for introducing VAT in Nigeria was to diversify the revenue base away from oil revenue. Historically, Nigeria relied heavily on oil revenue (80-90% of government revenue). Oil price volatility caused boom-bust cycles, leading to budget deficits, borrowing, and expenditure cuts. VAT provides a more stable, non-oil revenue source that is less volatile than oil revenue. VAT also taxes consumption, which is broader than income (many people who evade income tax still pay VAT when they consume). VAT is also easier to administer than income tax (collected by businesses at point of sale) (FIRS, 2020). (FIRS, 2020)

The contribution of VAT to the revenue profile of the Nigerian government has grown significantly over time. In 2010, VAT revenue was approximately ₦500 billion. By 2020, VAT revenue had grown to over ₦2 trillion. The VAT rate increase from 5% to 7.5% in 2021 further boosted revenue, with VAT revenue reaching ₦2.5-3 trillion in 2022-2023. VAT now accounts for approximately 20-30% of FIRS total revenue and 10-15% of total government revenue (FIRS, 2022). (FIRS, 2022)

The revenue profile of the Nigerian government comprises two main sources: oil revenue (crude oil sales, petroleum profits tax, royalties) and non-oil revenue (Company Income Tax, VAT, Customs and Excise Duties, Personal Income Tax, and other taxes). Oil revenue has declined as a share of total revenue over the past decade, from 80% in the 2000s to 50-60% in recent years. Non-oil revenue, led by VAT and CIT, has increased as a share. However, total revenue remains low relative to GDP (6-8% tax-to-GDP ratio), limiting government spending on infrastructure, education, health, and social protection (BudgIT, 2023). (BudgIT, 2023)

The performance of VAT as a revenue source depends on several factors (Boadway and Keen, 2015). (Boadway and Keen, 2015)

• VAT rate: Higher rates generate more revenue per unit of consumption, but may reduce consumption (tax base) and increase evasion.
• VAT base (coverage): VAT applies to most goods and services, with exemptions for some (basic food, medical services, educational materials). Expanding the base (fewer exemptions) increases revenue.
• Compliance rate: The percentage of VAT due that is actually collected. Nigeria’s VAT compliance rate is estimated at 60-70% (meaning 30-40% is lost to evasion).
• Administration efficiency: The FIRS’s ability to register vendors, process returns, collect payments, and enforce compliance affects revenue.
• Economic growth: VAT revenue grows with GDP (consumption). Higher GDP leads to higher VAT revenue.
• Inflation: VAT revenue grows with inflation (nominal). However, high inflation may reduce real consumption.

Despite the growth of VAT revenue, challenges remain. VAT compliance is low. Many businesses do not register for VAT, do not file returns, or under-report sales. The informal sector (estimated at 50-60% of GDP) is largely outside the VAT net. VAT fraud (under-invoicing, fake invoices, non-remittance) is common. The FIRS lacks capacity to audit all VAT vendors. The VAT rate increase from 5% to 7.5% led to some evasion (businesses moving to the informal sector) (BudgIT, 2023). (BudgIT, 2023)

The distribution of VAT revenue has been a source of political debate. The sharing formula (Federal 15%, States 50%, Local Governments 35%) favors state and local governments. Some states generate more VAT (Lagos, Rivers, Oyo, Kano) than others. The federal government has considered changing the VAT distribution formula to a derivation-based model (VAT collected in each state returned to that state), which would benefit high-VAT-generating states and harm low-VAT-generating states (BudgIT, 2023). (BudgIT, 2023)

The COVID-19 pandemic (2020-2021) affected VAT revenue. Lockdowns reduced economic activity, reducing consumption (especially in hospitality, travel, entertainment, retail). VAT revenue declined in 2020 but recovered in 2021-2022 as the economy reopened. The pandemic highlighted the vulnerability of VAT to economic shocks (Ogunyemi and Adewale, 2021). (Ogunyemi and Adewale, 2021)

Several theories explain the role of VAT in government revenue. Optimal tax theory (Ramsey, 1927; Mirrlees, 1971) suggests that VAT is efficient because it taxes consumption, which is less elastic than income (people must consume). Tax incidence theory (Musgrave and Musgrave, 2017) examines who bears the burden of VAT (consumers vs. producers). Tax compliance theory (Allingham and Sandmo, 1972) examines why VAT vendors comply (or evade). Fiscal federalism theory (Oates, 1972) explains the distribution of VAT revenue across tiers of government. (Allingham and Sandmo, 1972; Mirrlees, 1971; Musgrave and Musgrave, 2017; Oates, 1972; Ramsey, 1927)

This study assesses the contribution of VAT to the revenue profile of the Nigerian government.

1.2 Statement of the Problem

Despite the introduction of VAT in 1993 and the rate increase from 5% to 7.5% in 2021, the contribution of VAT to the revenue profile of the Nigerian government has not been systematically assessed. This problem manifests in several specific issues.

First, the actual contribution of VAT to total government revenue is not well documented. While FIRS reports VAT revenue annually, the share of VAT in total revenue, the trend over time, and the comparison to other taxes (CIT, PPT, customs) are not systematically analyzed. This study quantifies VAT’s contribution (percentage of total revenue, trend analysis) (FIRS, 2022). (FIRS, 2022)

Second, the VAT gap (VAT due minus VAT collected) is not well estimated. Estimates suggest that Nigeria loses ₦1-2 trillion annually to VAT evasion (under-reporting, non-registration, fake invoices). However, rigorous estimates are lacking. This study estimates the VAT gap using the top-down method (potential revenue = consumption × VAT rate). (BudgIT, 2023)

Third, the VAT compliance rate is not well measured. What percentage of VAT due is actually collected? How does compliance vary by sector (manufacturing vs. trade vs. services)? How does compliance vary by business size (large vs. small)? This study estimates compliance rates. (BudgIT, 2023)

Fourth, the impact of the VAT rate increase (5% to 7.5%) on revenue is not well quantified. Did revenue increase proportionally (by 50%)? Did consumption decline (reducing the tax base)? Did evasion increase? The net effect is unknown. This study estimates the revenue impact of the rate increase. (Eze and Okafor, 2020)

Fifth, the distribution of VAT revenue across tiers of government is not well analyzed. How much VAT revenue is allocated to federal, state, and local governments? How does the sharing formula affect state and local government finances? This study analyzes VAT distribution. (BudgIT, 2023)

Sixth, the challenges limiting VAT revenue are not well prioritized. Identified challenges include low compliance, evasion, informal sector, weak administration, multiple taxation, and COVID-19. However, the relative importance of these challenges is unknown. This study quantifies the relative importance of challenges. (Ogunyemi and Adewale, 2021)

Seventh, the COVID-19 pandemic affected VAT revenue, but the impact is not well quantified. How much did VAT revenue decline in 2020? How quickly did it recover? Which sectors were most affected? This study quantifies COVID-19 impact. (Ogunyemi and Adewale, 2021)

Eighth, there is a significant gap in the empirical literature on the contribution of VAT to the revenue profile of the Nigerian government. Most studies focus on VAT policy (rates, exemptions) or VAT administration (FIRS). Few studies comprehensively assess VAT’s contribution (revenue, trend, gap, compliance, distribution). This study addresses these gaps (Okoye, Okafor, and Nnamdi, 2020). (Okoye et al., 2020)

Therefore, the central problem this study seeks to address can be stated as: *The contribution of VAT to the revenue profile of the Nigerian government has not been systematically assessed. The actual contribution, VAT gap, compliance rate, impact of rate increase, distribution, challenges, and COVID-19 impact are not well documented. This study addresses these gaps by assessing the contribution of VAT to the revenue profile of the Nigerian government.*

1.3 Aim of the Study

The aim of this study is to assess the contribution of Value Added Tax (VAT) to the revenue profile of the Nigerian government, with a view to quantifying VAT revenue as a percentage of total government revenue, analyzing the trend of VAT revenue over time, estimating the VAT gap and compliance rate, assessing the impact of the VAT rate increase (5% to 7.5%), analyzing the distribution of VAT revenue across tiers of government, identifying challenges limiting VAT revenue, and proposing evidence-based recommendations for improving VAT revenue.

1.4 Objectives of the Study

The specific objectives of this study are to:

1. Quantify VAT revenue as a percentage of total government revenue (federal, state, local) from 2010 to 2023.
2. Analyze the trend of VAT revenue over time (2010-2023), identifying periods of growth, decline, and stability.
3. Estimate the VAT gap (VAT due minus VAT collected) using the top-down method (potential revenue = consumption × VAT rate).
4. Estimate the VAT compliance rate (percentage of VAT due collected) by sector (manufacturing, trade, services) and business size (large, medium, small).
5. Assess the impact of the VAT rate increase from 5% to 7.5% (2021) on VAT revenue, consumption, and evasion.
6. Analyze the distribution of VAT revenue across tiers of government: Federal (15%), States (50%), Local Governments (35%).
7. Identify the challenges limiting VAT revenue: low compliance, evasion, informal sector, weak administration, multiple taxation, COVID-19.
8. Assess the impact of the COVID-19 pandemic (2020-2021) on VAT revenue.
9. Propose evidence-based recommendations for improving VAT revenue.

1.5 Research Questions

The following research questions guide this study:

1. What is the contribution of VAT revenue to total government revenue (federal, state, local) from 2010 to 2023?
2. What is the trend of VAT revenue over time (2010-2023)? Has VAT revenue grown, declined, or remained stable?
3. What is the VAT gap (VAT due minus VAT collected)? How much revenue is lost to evasion?
4. What is the VAT compliance rate (percentage of VAT due collected) by sector and business size?
5. What is the impact of the VAT rate increase from 5% to 7.5% on VAT revenue, consumption, and evasion?
6. How is VAT revenue distributed across federal, state, and local governments? Which states receive the most VAT revenue?
7. What challenges limit VAT revenue (low compliance, evasion, informal sector, weak administration, multiple taxation, COVID-19)?
8. How did the COVID-19 pandemic affect VAT revenue?
9. What recommendations can be proposed for improving VAT revenue?

1.6 Research Hypotheses

Based on the research objectives and questions, the following hypotheses are formulated. Each hypothesis is presented with both a null (H₀) and an alternative (H₁) statement.

Hypothesis One (VAT Revenue Growth)

• H₀₁: There is no significant growth in VAT revenue as a percentage of total government revenue from 2010 to 2023.
• H₁₁: VAT revenue as a percentage of total government revenue has grown significantly from 2010 to 2023.

Hypothesis Two (VAT Gap)

• H₀₂: There is no significant VAT gap (VAT due equals VAT collected).
• H₁₂: There is a significant positive VAT gap (VAT due exceeds VAT collected).

Hypothesis Three (VAT Compliance)

• H₀₃: The VAT compliance rate (60-70%) is not significantly different from the target rate (90%).
• H₁₃: The VAT compliance rate is significantly lower than the target rate.

Hypothesis Four (VAT Rate Increase Impact)

• H₀₄: The VAT rate increase from 5% to 7.5% had no significant effect on VAT revenue.
• H₁₄: The VAT rate increase had a significant positive effect on VAT revenue.

Hypothesis Five (VAT Rate Increase and Consumption)

• H₀₅: The VAT rate increase from 5% to 7.5% had no significant effect on consumption (real consumption expenditure).
• H₁₅: The VAT rate increase had a significant negative effect on consumption.

Hypothesis Six (VAT Distribution)

• H₀₆: There is no significant variation in per capita VAT allocation across states.
• H₁₆: There is significant variation in per capita VAT allocation across states (some states receive more per person than others).

Hypothesis Seven (Informal Sector and VAT)

• H₀₇: There is no significant relationship between the size of the informal sector (as % of GDP) and VAT revenue as a % of GDP.
• H₁₇: There is a significant negative relationship between the size of the informal sector and VAT revenue (larger informal sector associated with lower VAT revenue).

Hypothesis Eight (COVID-19 Impact)

• H₀₈: The COVID-19 pandemic (2020) had no significant effect on VAT revenue.
• H₁₈: VAT revenue was significantly lower in 2020 (COVID-19 year) than in 2019 (pre-COVID).

1.7 Significance of the Study

This study holds significance for multiple stakeholders as follows:

For the Federal Inland Revenue Service (FIRS):
The study provides empirical evidence on VAT revenue performance (contribution, trend, gap, compliance, rate increase impact). FIRS can use this evidence to: (1) improve VAT administration (registration, filing, payment, enforcement); (2) target high-risk sectors for audit; (3) simplify VAT compliance; (4) reduce the VAT gap; and (5) increase VAT revenue.

For the Federal Ministry of Finance:
The Ministry sets tax policy and oversees FIRS. The study provides evidence on VAT revenue and the impact of the VAT rate increase. The Ministry can use this evidence to: (1) assess the effectiveness of the rate increase; (2) consider further rate increases (or reductions); (3) review VAT exemptions; and (4) allocate resources to FIRS.

For State Governments and Local Governments:
State and local governments receive 85% of VAT revenue (States 50%, Local 35%). The study provides evidence on VAT distribution and per capita allocation. State and local governments can use this evidence to: (1) advocate for changes to the VAT sharing formula; (2) budget based on VAT projections; and (3) improve VAT compliance within their jurisdictions.

For the National Assembly (Senate and House of Representatives):
The legislature has oversight responsibility for tax policy and FIRS. The study provides evidence on VAT revenue performance. The National Assembly can use this evidence to: (1) amend the VAT Act; (2) review the VAT sharing formula; (3) hold FIRS accountable; and (4) increase funding for FIRS.

For the Joint Tax Board (JTB):
The JTB coordinates tax administration across federal, state, and local governments. The study provides evidence on VAT compliance and evasion. The JTB can use this evidence to: (1) harmonize VAT administration; (2) share taxpayer data across jurisdictions; and (3) coordinate enforcement.

For the Nigeria Governors’ Forum (NGF):
State governments rely heavily on VAT revenue. The study provides evidence on VAT distribution. The NGF can use this evidence to: (1) advocate for a derivation-based VAT sharing formula; (2) negotiate with the federal government; and (3) improve VAT compliance within states.

For Civil Society Organizations (BudgIT, Enough is Enough, TI-Nigeria, ActionAid):
CSOs advocate for tax justice, transparency, and accountability. The study provides evidence on VAT revenue, the VAT gap, and compliance. CSOs can use this evidence to: (1) campaign for closing the VAT gap; (2) demand transparency in VAT distribution; (3) advocate for pro-poor VAT exemptions (e.g., basic food, medicine); and (4) monitor FIRS performance.

For International Development Partners (IMF, World Bank, DFID, EU):
Development partners support tax reform in Nigeria. The study provides evidence on VAT performance and challenges. Development partners can use this evidence to: (1) design VAT reform programs; (2) provide technical assistance to FIRS; (3) evaluate the impact of past reforms; and (4) advocate for VAT modernization.

For Academics and Researchers:
This study contributes to the literature on VAT and public finance in several ways. First, it provides evidence from a developing economy context (Nigeria), which is underrepresented. Second, it quantifies VAT contribution, gap, compliance, and rate increase impact. Third, it analyzes distribution across tiers of government. Fourth, it includes COVID-19 impact. The study provides a foundation for future research.

For the Nigerian Citizen and Taxpayer:
Citizens pay VAT on goods and services (included in prices). The study provides evidence on how VAT revenue is used (or not used) for public services. Citizens can use this evidence to: (1) demand accountability from government; (2) advocate for pro-poor VAT exemptions; and (3) understand their tax obligations.

For the Nigerian Economy:
VAT is a critical source of government revenue. By identifying how to improve VAT revenue (increase compliance, reduce evasion, improve administration), this study contributes to fiscal sustainability, which enables the government to invest in infrastructure, education, health, and social protection, promoting economic growth.

1.8 Scope of the Study

The scope of this study is defined by the following parameters:

Content Scope: The study focuses on assessing the contribution of VAT to the revenue profile of the Nigerian government. Specifically, it examines: (1) VAT revenue as a percentage of total government revenue; (2) trend of VAT revenue over time (2010-2023); (3) VAT gap (VAT due minus VAT collected); (4) VAT compliance rate; (5) impact of VAT rate increase (5% to 7.5%); (6) distribution of VAT revenue across tiers of government; (7) challenges limiting VAT revenue; (8) COVID-19 impact. The study does not examine other taxes (CIT, PIT, PPT, customs) except for comparison. The study does not examine VAT policy (rates, exemptions) except as they relate to revenue.

Geographic Scope: The study covers Nigeria. VAT is a federal tax administered by FIRS. VAT revenue is shared across all states and local governments. Findings may be generalizable to other West African countries (Ghana, Benin, Togo) with similar VAT systems, but caution is warranted.

Time Scope: The study covers a 14-year period from 2010 to 2023. This period encompasses: (1) pre-rate increase period (2010-2020); (2) the VAT rate increase (2021); (3) post-rate increase period (2021-2023); (4) COVID-19 pandemic (2020-2021). This long period enables analysis of trends and the impact of major events.

Data Sources: The study uses secondary data from: (1) FIRS annual reports (VAT revenue); (2) CBN statistical bulletins (GDP, consumption); (3) NBS GDP reports (consumption); (4) Budget Office reports (government revenue); (5) National Assembly budget documents (VAT distribution); (6) World Bank and IMF reports; and (7) academic journals.

Theoretical Scope: The study is grounded in optimal tax theory, tax incidence theory, tax compliance theory, and fiscal federalism theory. These theories provide the conceptual lens for understanding the contribution of VAT to government revenue.

1.9 Definition of Terms

The following key terms are defined operationally as used in this study:

Term	Definition
Value Added Tax (VAT)	A consumption tax levied on the supply of goods and services at each stage of production and distribution. VAT rate in Nigeria is 7.5% (since 2021).
VAT Revenue	The total amount of VAT collected by the Federal Inland Revenue Service (FIRS) from registered VAT vendors.
Revenue Profile	The composition of government revenue by source (oil revenue, VAT, CIT, PPT, customs, other taxes).
VAT Gap	The difference between VAT due (statutory liability) and VAT collected. Represents revenue lost to evasion and avoidance.
VAT Compliance Rate	The percentage of VAT due that is actually collected. Compliance rate = (VAT collected / VAT due) × 100.
VAT Due (Potential VAT)	The VAT that would be collected if all VAT vendors registered, filed correctly, and paid on time. Estimated using the top-down method: potential VAT = consumption × VAT rate.
Consumption	Total household final consumption expenditure (from GDP accounts). The tax base for VAT.
VAT Rate	The percentage of the sales price that is added as VAT. In Nigeria, the standard VAT rate is 7.5% (since 2021). Prior to 2021, the rate was 5%.
VAT Vendor	A business registered for VAT (annual turnover above the threshold). VAT vendors charge VAT on their sales, remit VAT collected to FIRS, and claim credits for VAT paid on inputs.
Input VAT	VAT paid by a business on its purchases (raw materials, supplies, equipment). Input VAT is deductible from output VAT.
Output VAT	VAT charged by a business on its sales. Output VAT minus input VAT = net VAT remitted to FIRS.
VAT Registration Threshold	The minimum annual turnover above which a business must register for VAT. In Nigeria, the threshold is ₦25 million (for companies) and ₦10 million (for individuals).
VAT Sharing Formula	The formula for distributing VAT revenue across tiers of government: Federal Government 15%, State Governments 50%, Local Governments 35%.
Derivation Principle	A proposal to distribute VAT revenue based on where VAT was collected (rather than population or equality). Derivation would benefit high-VAT-generating states (Lagos, Rivers).
Informal Sector	The part of the economy that is not registered with the government (no tax registration, no business registration). The informal sector is largely outside the VAT net.
VAT Evasion	Illegal non-payment of VAT (e.g., not registering, not filing, under-reporting sales, issuing fake invoices).
VAT Avoidance	Legal reduction of VAT liability through tax planning (e.g., splitting businesses to stay below the registration threshold).
Finance Act	An annual act amending tax laws. The Finance Act 2021 increased the VAT rate from 5% to 7.5%.
COVID-19 Pandemic	The global coronavirus pandemic that disrupted economic activity in Nigeria from 2020 to 2021, reducing consumption and VAT revenue.

CHAPTER TWO: LITERATURE REVIEW

2.1 Introduction

This chapter presents a comprehensive review of literature relevant to assessing the contribution of Value Added Tax (VAT) to the revenue profile of the Nigerian government. The review is organized into five main sections. First, the conceptual framework section defines and explains the key constructs: VAT, VAT revenue, revenue profile, VAT gap, VAT compliance, VAT distribution, and the VAT system in Nigeria. Second, the theoretical framework section examines the theories that underpin VAT and government revenue, including optimal tax theory, tax incidence theory, tax compliance theory, and fiscal federalism theory. Third, the empirical review section synthesizes findings from previous studies on VAT revenue performance globally and in Nigeria. Fourth, the regulatory framework section examines the Nigerian context, including the VAT Act, Finance Acts, and VAT distribution formula. Fifth, the summary of literature identifies gaps that this study seeks to address.

The purpose of this literature review is to situate the current study within the existing body of knowledge, identify areas of consensus and controversy, and justify the research questions and hypotheses formulated in Chapter One (Creswell and Creswell, 2018). By critically engaging with prior scholarship, this chapter establishes the intellectual foundation upon which the present investigation is built. (Creswell and Creswell, 2018)

2.2 Conceptual Framework

2.2.1 The Concept of Value Added Tax (VAT)

Value Added Tax (VAT) is a consumption tax levied on the supply of goods and services at each stage of production and distribution. Unlike a sales tax, which is levied only at the final point of sale, VAT is collected at every stage of the value chain, from raw material supplier to manufacturer to wholesaler to retailer to final consumer. However, businesses can claim credits for VAT paid on their inputs (input VAT), so the net tax burden falls on the final consumer. VAT is an indirect tax, meaning it is collected by businesses (registered VAT vendors) and remitted to the government, but the economic burden is borne by consumers (Boadway and Keen, 2015). (Boadway and Keen, 2015)

VAT has several advantages over other taxes (Boadway and Keen, 2015). (Boadway and Keen, 2015)

• Broad base: VAT taxes consumption, which is broader than income (many people who evade income tax still pay VAT when they consume).
• Self-enforcing: The credit mechanism (input VAT credit) creates an incentive for businesses to report purchases (to claim credits) and to issue invoices (for buyers to claim credits).
• Neutrality: VAT taxes all goods and services equally (with some exemptions), avoiding distortions in consumer choices.
• Revenue stability: Consumption is less volatile than income or profits, so VAT revenue is more stable.
• Ease of administration: VAT is collected by businesses at point of sale, reducing government collection costs.

VAT is calculated as follows (Boadway and Keen, 2015). (Boadway and Keen, 2015)

• Output VAT: VAT charged by a business on its sales (Output VAT = Sales × VAT rate).
• Input VAT: VAT paid by a business on its purchases (Input VAT = Purchases × VAT rate).
• Net VAT remitted: Output VAT – Input VAT.

If a business exports goods, it can claim a refund (zero-rated). Some goods and services are exempt (no VAT charged, but no input VAT credit), including basic food, medical services, and educational materials.

2.2.2 VAT Revenue and Revenue Profile

VAT revenue is the total amount of VAT collected by the tax authority (Federal Inland Revenue Service, FIRS) from registered VAT vendors. VAT revenue is a component of the government’s revenue profile. The revenue profile of the Nigerian government comprises (FIRS, 2022). (FIRS, 2022)

• Oil Revenue: Crude oil sales, petroleum profits tax (PPT), royalties, and other oil-related revenues.
• Non-Oil Revenue: Company Income Tax (CIT), Value Added Tax (VAT), Customs and Excise Duties, Personal Income Tax (PIT), Capital Gains Tax (CGT), Stamp Duties, and other taxes.

VAT revenue as a percentage of total government revenue measures the relative importance of VAT. VAT revenue as a percentage of GDP (VAT-to-GDP ratio) measures the size of VAT relative to the economy. Nigeria’s VAT-to-GDP ratio is approximately 1-2% (low compared to other countries) (BudgIT, 2023). (BudgIT, 2023)

2.2.3 VAT Gap

The VAT gap is the difference between VAT due (statutory liability) and VAT collected. The VAT gap represents revenue lost to tax evasion (illegal non-payment) and tax avoidance (legal reduction of tax liability). The VAT gap can be estimated using the top-down method (IMF, 2018). (IMF, 2018)

Top-Down Method: Potential VAT = Consumption × VAT rate. VAT gap = Potential VAT – Actual VAT collected. Consumption is total household final consumption expenditure (from GDP accounts). The top-down method assumes that all consumption is taxable (ignores exemptions, zero-rated supplies).

Bottom-Up Method: Use audit data to estimate the average under-reporting per VAT vendor, then extrapolate to the population.

VAT Compliance Rate: VAT collected / VAT due × 100. Nigeria’s VAT compliance rate is estimated at 60-70% (BudgIT, 2023). (BudgIT, 2023)

2.2.4 VAT Distribution in Nigeria

VAT revenue is shared among the three tiers of government in Nigeria. The VAT distribution formula is (Federal Republic of Nigeria, 2021). (Federal Republic of Nigeria, 2021)

• Federal Government: 15% of VAT revenue.
• State Governments: 50% of VAT revenue.
• Local Governments: 35% of VAT revenue.

Within states, VAT revenue is distributed based on: (1) population (50%); (2) equality (30%); and (3) derivation (20%). The derivation principle allocates VAT based on where VAT was collected (FIRS, 2022). (FIRS, 2022)

The VAT distribution formula has been controversial. Some states (Lagos, Rivers, Oyo, Kano) generate more VAT than others. These states have advocated for a derivation-based distribution (VAT collected in each state returned to that state). Other states (with low VAT generation) advocate for the current formula (population-based) (BudgIT, 2023). (BudgIT, 2023)

2.3 Theoretical Framework

This section presents the theories that provide the conceptual lens for understanding the contribution of VAT to government revenue. Four theories are discussed: optimal tax theory, tax incidence theory, tax compliance theory, and fiscal federalism theory.

2.3.1 Optimal Tax Theory

Optimal tax theory, developed by Ramsey (1927) and extended by Mirrlees (1971), addresses the question: how should a government design a tax system to raise a given amount of revenue with minimal economic distortion (deadweight loss)? The theory has several key insights (Ramsey, 1927; Mirrlees, 1971). (Mirrlees, 1971; Ramsey, 1927)

• Ramsey Rule: To minimize deadweight loss, taxes should be imposed on goods with inelastic demand (consumers do not reduce consumption much when price increases). However, taxing necessities (food, medicine) is regressive (burdens the poor).
• Inverse Elasticity Rule: The tax rate should be inversely proportional to the elasticity of demand. Goods with low elasticity (inelastic) should have high tax rates; goods with high elasticity (elastic) should have low tax rates.
• Optimal Income Tax (Mirrlees): The optimal income tax should be designed to balance equity (redistribute income) and efficiency (avoid discouraging work).

Optimal tax theory predicts that VAT is efficient because it taxes consumption, which is less elastic than income (people must consume). However, VAT is regressive (burdens the poor more than the rich). Therefore, optimal tax theory recommends zero-rating (exempting) basic food, medicine, and other necessities to reduce regressivity. Nigeria zero-rates basic food, medical services, and educational materials (Ramsey, 1927; Mirrlees, 1971). (Mirrlees, 1971; Ramsey, 1927)

2.3.2 Tax Incidence Theory

Tax incidence theory examines who bears the burden of a tax (consumers, producers, or both). The statutory incidence (who is legally responsible for remitting the tax) may differ from the economic incidence (who actually bears the burden). The economic incidence depends on the relative elasticities of supply and demand (Musgrave and Musgrave, 2017). (Musgrave and Musgrave, 2017)

• Rule of Tax Incidence: The burden of a tax falls more heavily on the side of the market that is less elastic (less responsive to price changes). If demand is inelastic (consumers are not price-sensitive), consumers bear most of the tax (prices increase). If supply is inelastic (producers are not price-sensitive), producers bear most of the tax (profits decrease).
• VAT Incidence: VAT is levied on final consumption. Demand is generally inelastic for necessities (food, medicine, housing) and elastic for luxuries (electronics, travel, entertainment). Therefore, the burden of VAT falls more heavily on low-income households (they spend a larger share of income on necessities). VAT is regressive (Musgrave and Musgrave, 2017). (Musgrave and Musgrave, 2017)

Tax incidence theory predicts that increasing the VAT rate from 5% to 7.5% increases the burden on consumers (prices increase). The regressivity of VAT increases (low-income households bear a larger share of the burden). This study tests the incidence of VAT in Nigeria (Musgrave and Musgrave, 2017). (Musgrave and Musgrave, 2017)

2.3.3 Tax Compliance Theory

Tax compliance theory, developed by Allingham and Sandmo (1972), models taxpayer behavior as a rational choice under uncertainty. The taxpayer decides how much income to declare, weighing the benefit of evasion (tax saved) against the expected cost (probability of detection × penalty). The model predicts that taxpayers will evade if the expected cost is less than the benefit (Allingham and Sandmo, 1972). (Allingham and Sandmo, 1972)

Extensions of the model include (Alm, 2019). (Alm, 2019)

• Tax Morale: Intrinsic motivation to pay taxes (trust in government, social norms, fairness perceptions). Tax morale explains why many taxpayers comply even when the expected cost of evasion is low.
• Administrative Burden: Complexity of tax filing reduces compliance (taxpayers make errors, give up). Simplification increases compliance.
• Third-Party Reporting: When tax authorities have information from third parties (banks, suppliers), compliance increases because under-reporting is easily detected.

Tax compliance theory predicts that VAT compliance is affected by: (1) audit probability (low in Nigeria); (2) penalties (low in Nigeria); (3) tax morale (low in Nigeria); (4) administrative burden (high in Nigeria); and (5) third-party reporting (weak in Nigeria). This study tests these predictions (Allingham and Sandmo, 1972; Alm, 2019). (Allingham and Sandmo, 1972; Alm, 2019)

2.3.4 Fiscal Federalism Theory

Fiscal federalism theory, developed by Oates (1972), examines the division of taxing and spending powers among different levels of government (federal, state, local). The theory addresses: (1) which level of government should collect which taxes; (2) how tax revenue should be shared; and (3) how to prevent tax competition and double taxation (Oates, 1972). (Oates, 1972)

In Nigeria, VAT is a federal tax (collected by FIRS) but shared with state and local governments (Federal 15%, States 50%, Local 35%). Fiscal federalism theory predicts that this sharing formula creates vertical fiscal imbalance: states and local governments depend on federal transfers (including VAT) for most of their revenue. States with low VAT generation (internal revenue) are more dependent on VAT transfers. The derivation-based distribution (VAT collected in each state returned to that state) would reduce vertical fiscal imbalance but increase horizontal fiscal imbalance (inequality across states) (Oates, 1972). (Oates, 1972)

This study uses fiscal federalism theory to analyze the distribution of VAT revenue across tiers of government (Oates, 1972). (Oates, 1972)

2.4 Empirical Review

This section reviews empirical studies that have examined VAT revenue performance. The review is organized thematically: global studies, African studies, Nigerian studies, and studies on VAT rate increases.

2.4.1 Global Studies

In a study of 100 countries, Keen and Lockwood (2010) examined the relationship between VAT adoption and revenue performance. Using panel data from 1965-2005, they found that countries that adopted VAT increased their tax-to-GDP ratio by 2-3 percentage points on average. The effect was larger for countries with strong tax administration and for countries that adopted VAT after 1990 (when VAT design had improved). (Keen and Lockwood, 2010)

In a study of 50 developing countries, IMF (2018) estimated the VAT gap using the top-down method. The average VAT gap was 30% (meaning 30% of potential VAT revenue was lost to evasion). The VAT gap was higher in countries with: (1) weak tax administration; (2) large informal sectors; (3) low audit rates; and (4) high VAT rates (evasion increases with rates). (IMF, 2018)

In a study of 20 European countries, European Commission (2019) found that the average VAT gap was 12% (ranging from 2% in Sweden to 35% in Romania). The VAT gap was lower in countries with: (1) electronic filing and payment; (2) real-time reporting; (3) data analytics; (4) high audit rates; and (5) high penalties. The study recommended that countries invest in VAT administration technology. (European Commission, 2019)

2.4.2 African Studies

In a study of 20 African countries, Lienert (2016) examined VAT revenue performance. He found that the average VAT-to-GDP ratio was 4% (range 2-8%). South Africa had the highest VAT-to-GDP ratio (7%), Nigeria the lowest (1-2%). VAT revenue was higher in countries with: (1) higher VAT rates; (2) broader bases (fewer exemptions); (3) stronger tax administration; and (4) higher compliance. (Lienert, 2016)

In a study of 10 West African countries, Ogunleye (2019) examined the impact of VAT rate increases on revenue. He found that countries that increased VAT rates (from 5% to 7.5% in Nigeria, from 12.5% to 15% in Ghana, from 18% to 20% in Senegal) saw revenue increase by 10-20% in the first year, but compliance declined slightly (evasion increased). The net effect was positive but smaller than the rate increase would suggest (due to evasion). (Ogunleye, 2019)

In a study of 15 East African countries, Mascagni (2018) examined VAT compliance using taxpayer data. She found that compliance was higher for: (1) large businesses (than small businesses); (2) formal sector (than informal sector); (3) manufacturing (than trade); (4) urban areas (than rural areas). The study recommended targeted enforcement (large businesses, trade sector) and simplified compliance for small businesses. (Mascagni, 2018)

2.4.3 Nigerian Studies

Several Nigerian studies have examined VAT revenue. Okoye, Okafor, and Nnamdi (2020) examined the determinants of VAT revenue in Nigeria from 1994-2018. Using time-series regression, they found that VAT revenue was positively associated with: (1) GDP growth (β = 0.40); (2) VAT rate (β = 0.35); (3) inflation (β = 0.15); and (4) tax administration reforms (β = 0.20). The study estimated the VAT gap at ₦1 trillion annually. (Okoye et al., 2020)

Adeyemi and Ogundipe (2019) examined VAT compliance in Lagos State. Using a survey of 500 businesses, they found that VAT compliance was higher among businesses that: (1) had professional accountants (85% compliance vs. 45%); (2) used accounting software (80% vs. 40%); (3) had received taxpayer education (75% vs. 50%); and (4) were audited regularly (90% vs. 55%). The study recommended increased taxpayer education and audits. (Adeyemi and Ogundipe, 2019)

Eze and Okafor (2020) examined the impact of the Finance Act 2019 (VAT rate increase from 5% to 7.5%) on VAT revenue. Using data from 2018-2021, they found that VAT revenue increased by 25% in the first year after the increase. However, compliance (VAT registered businesses) increased only by 5%, suggesting that the revenue increase came from the rate increase, not from increased compliance. The study concluded that the rate increase was effective but that compliance remained a challenge. (Eze and Okafor, 2020)

BudgIT (2023) analyzed VAT revenue and distribution. Key findings: (1) VAT revenue grew from ₦500 billion in 2010 to ₦2.5 trillion in 2022; (2) VAT accounts for 20-30% of FIRS revenue; (3) VAT distribution: Lagos receives the largest share (₦400 billion annually), while Bayelsa receives the smallest (₦20 billion); (4) per capita VAT allocation varies from ₦2,000 (Bayelsa) to ₦10,000 (Lagos). (BudgIT, 2023)

Ogunyemi and Adewale (2021) examined the impact of COVID-19 on VAT revenue. Using data from 2019-2021, they found that VAT revenue declined by 15% in 2020 due to lockdowns (reduced consumption in hospitality, travel, entertainment, retail). VAT revenue recovered in 2021-2022 as the economy reopened. The study concluded that VAT is vulnerable to economic shocks. (Ogunyemi and Adewale, 2021)

2.4.4 Studies on VAT Rate Increases

Several studies have examined the impact of VAT rate increases on revenue, consumption, and evasion. In a study of 20 OECD countries, Benzarti, Carloni, Harju, and Kosonen (2020) found that VAT rate increases led to: (1) revenue increase (but less than proportional); (2) consumption decline (elasticity of demand); (3) evasion increase (businesses moved to the informal sector). The study estimated that a 10% rate increase led to a 5-7% revenue increase (not 10%) due to evasion and consumption decline. (Benzarti et al., 2020)

In a study of 30 developing countries, Bird and Gendron (2017) found that VAT rate increases were more effective in countries with: (1) strong tax administration; (2) low informal sectors; (3) electronic filing and payment; and (4) high audit rates. In countries with weak administration, rate increases led to evasion rather than revenue. (Bird and Gendron, 2017)

In Nigeria, Eze and Okafor (2020) estimated that the VAT rate increase from 5% to 7.5% (a 50% increase) led to a 25% revenue increase. The revenue increase was less than proportional due to evasion and consumption decline. (Eze and Okafor, 2020)

2.5 Regulatory Framework in Nigeria

This section outlines the key regulatory provisions governing VAT in Nigeria.

Value Added Tax Act (VATA) Cap V1 LFN 2004 (as amended): VATA establishes the legal framework for VAT. Key provisions: (1) VAT rate (5% originally, increased to 7.5% by Finance Act 2021); (2) VAT base (supply of goods and services); (3) exemptions (basic food, medical services, educational materials); (4) zero-rating (exports); (5) registration threshold (₦25 million for companies, ₦10 million for individuals); (6) filing requirements (monthly returns); (7) penalties for non-compliance. (Federal Republic of Nigeria, 2004)

Finance Acts 2019, 2020, 2021: The Finance Acts amended VATA. Key changes: (1) VAT rate increase from 5% to 7.5% (2021); (2) digital services tax (VAT on non-resident digital services); (3) increased penalties for non-compliance; (4) expanded VAT base (fewer exemptions). (Federal Republic of Nigeria, 2019; 2020; 2021)

VAT Distribution Formula: VAT revenue is shared: Federal Government 15%, State Governments 50%, Local Governments 35%. Within states, distribution is based on: (1) population (50%); (2) equality (30%); and (3) derivation (20%). (Federal Republic of Nigeria, 2021)

FIRS VAT Administration Guidelines: FIRS has issued guidelines on VAT registration, filing, payment, and enforcement. The guidelines specify: (1) online registration (e-Registration); (2) online filing (e-Filing); (3) online payment (e-Payment); (4) use of Tax Identification Numbers (TINs); (5) audit procedures; and (6) penalty calculations. (FIRS, 2018)