THE EFFECT OF INDIRECT TAXATION ON CONSUMPTION IN NIGERIA

CHAPTER ONE: INTRODUCTION

1.1 Background of the Study

Indirect taxation refers to a system of taxation where the tax is levied on goods and services rather than on income or profits. Unlike direct taxes (such as personal income tax or company income tax) which are paid directly to the government by the taxpayer, indirect taxes are collected by an intermediary (such as a retailer or supplier) who then remits the tax to the government. The burden of indirect taxes is ultimately borne by the final consumer, as the tax is included in the purchase price of goods and services. Common forms of indirect taxation include Value Added Tax (VAT), excise duties, import duties, export duties, and sales taxes (Boadway and Keen, 2015). Indirect taxes are a major source of government revenue in many countries, particularly in developing economies where tax administration capacity may be limited. (Boadway and Keen, 2015)

In Nigeria, the primary forms of indirect taxation are Value Added Tax (VAT) , Customs and Excise Duties, and increasingly Sugar-Sweetened Beverages (SSB) Tax and other specific excise taxes. 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% (Federal Republic of Nigeria, 2021). VAT is levied on the supply of most goods and services in Nigeria, with some exemptions (e.g., basic food items, medical services, educational materials). Customs and excise duties are levied on imported goods (import duties) and certain domestically produced goods such as alcoholic beverages, tobacco, and petroleum products (excise duties). (Federal Republic of Nigeria, 2021)

Consumption is a fundamental component of aggregate demand in any economy. In macroeconomic terms, consumption (often denoted as “C” in the national income identity Y = C + I + G + NX) refers to total spending by households on goods and services. Consumption typically accounts for the largest share of Gross Domestic Product (GDP) in most economies, including Nigeria. According to the National Bureau of Statistics (NBS, 2021), household final consumption expenditure accounted for approximately 65-70% of Nigeria’s GDP over the past decade. This high share of consumption in GDP means that factors affecting consumption have significant macroeconomic implications, including effects on GDP growth, employment, and government revenue. (NBS, 2021)

The relationship between indirect taxation and consumption is a central concern in public finance economics. According to standard economic theory, an increase in indirect taxes (such as VAT) raises the price of goods and services, which reduces the quantity demanded, assuming other factors remain constant. This is the standard law of demand: as price increases, quantity demanded decreases. However, the magnitude of this effect depends on the price elasticity of demand for the taxed goods. For goods with inelastic demand (necessities such as food, fuel, basic clothing), consumption may not decrease significantly even with a tax increase. For goods with elastic demand (luxuries, non-essential goods), consumption may decrease substantially (Gruber, 2019). (Gruber, 2019)

The incidence of indirect taxation—who ultimately bears the burden of the tax—is also a critical consideration. While the statutory incidence of VAT and excise duties is on the seller, the economic incidence typically falls on consumers in the form of higher prices. However, the degree to which the tax is passed forward to consumers versus absorbed by producers depends on the relative elasticities of supply and demand. When demand is inelastic (consumers do not reduce consumption much when prices rise), producers can pass most of the tax to consumers. When demand is elastic (consumers are price-sensitive), producers must absorb more of the tax to avoid losing sales (Fullerton and Metcalf, 2002). This has implications for both consumption levels and tax revenue. (Fullerton and Metcalf, 2002)

In Nigeria, the increase in VAT rate from 5% to 7.5% in 2021 has raised important policy questions about its effect on consumption. Proponents of the VAT increase argue that it is necessary to generate additional government revenue for infrastructure development, education, healthcare, and other public services. The Nigerian government projects that the VAT increase will generate an additional ₦1.5-2 trillion annually. Opponents argue that the VAT increase is regressive (hitting poorer households harder because they spend a larger proportion of their income on consumption) and will reduce aggregate consumption, potentially slowing economic growth and increasing poverty (Okafor and Eze, 2021). (Okafor and Eze, 2021)

The regressivity of indirect taxes is a major concern in developing countries like Nigeria. Regressive taxation means that the tax takes a larger percentage of income from low-income households than from high-income households. Since low-income households spend a larger share of their income on consumption (and save a smaller share), they bear a heavier burden from VAT and excise duties as a proportion of their income. High-income households, by contrast, save and invest a larger share of their income, so the portion of their income subject to VAT is smaller. Studies have shown that VAT in Nigeria is regressive, meaning it disproportionately burdens the poor (Adeyemi and Ogundipe, 2019). (Adeyemi and Ogundipe, 2019)

Empirical evidence on the effect of indirect taxation on consumption in Nigeria is limited and inconclusive. Some studies have found that VAT increases lead to significant reductions in consumption, particularly for non-essential goods. Others have found that consumption is relatively inelastic to VAT changes, especially for essential goods where consumers have few substitutes. Eze and Okafor (2020) found that following the VAT increase in Nigeria, consumption of non-essential goods (e.g., electronics, restaurant meals, recreation) declined by 12-15%, while consumption of essential goods (food, housing, utilities) declined by only 2-3%. The study concluded that the consumption effect of VAT depends heavily on the type of goods. (Eze and Okafor, 2020)

Excise duties on specific products (alcohol, tobacco, sugary beverages, petroleum products) also affect consumption. Economic theory suggests that excise taxes are particularly effective at reducing consumption of goods with elastic demand. For example, tobacco consumption is generally price-elastic in the long run, meaning that significant tax increases can lead to substantial reductions in smoking, improving public health outcomes (the “sin tax” argument). Nigeria has recently introduced an excise tax on sugar-sweetened beverages (SSB tax) aimed at reducing sugar consumption and addressing rising obesity and diabetes rates (Federal Ministry of Health, 2022). (Federal Ministry of Health, 2022)

The COVID-19 pandemic has further complicated the relationship between indirect taxation and consumption in Nigeria. During the pandemic, household incomes fell due to job losses and business closures, reducing purchasing power. The VAT increase (effective February 2021) occurred during a period of economic recovery from the pandemic, making it difficult to isolate the effect of the tax increase from other factors. However, Ogunyemi and Adewale (2021) found that consumption remained relatively resilient, with the VAT increase having a smaller-than-expected effect, possibly due to pent-up demand following lockdowns and government social protection programs. (Ogunyemi and Adewale, 2021)

Several mechanisms explain how indirect taxation affects consumption. First, the income effect: when indirect taxes increase the prices of goods and services, the real purchasing power of household income falls. Consumers may reduce overall consumption because their income buys less. Second, the substitution effect: as some goods become relatively more expensive (due to higher VAT or excise duties), consumers may switch to cheaper substitutes. For example, if VAT on restaurant meals increases, consumers may eat at home more often. Third, the expectations effect: if consumers expect future tax increases, they may accelerate consumption before the increase (anticipatory behavior) or defer consumption after the increase (Gruber, 2019). (Gruber, 2019)

The effect of indirect taxation on consumption also varies across different consumer groups. Urban consumers may have access to a wider range of substitutes (e.g., shopping across state lines where VAT enforcement may differ) and may be more responsive to price changes than rural consumers. High-income consumers may have more ability to shift consumption patterns (e.g., buying imported goods subject to different tax rates) than low-income consumers. Younger consumers may be more price-sensitive than older consumers. Understanding these heterogenous effects is important for policy design (Fullerton and Metcalf, 2002). (Fullerton and Metcalf, 2002)

The Nigerian tax system has undergone significant reforms in recent years. The Finance Acts of 2019, 2020, and 2021 have introduced multiple changes to indirect taxation: increase of VAT rate from 5% to 7.5%; introduction of VAT on digital services provided by non-resident companies (e.g., Netflix, Amazon, Google); introduction of excise duties on certain luxury goods; and harmonization of excise duty rates across tobacco and alcoholic beverages (Federal Inland Revenue Service [FIRS], 2021). These reforms are part of the government’s strategy to increase non-oil revenue and reduce dependence on oil revenues, which have been volatile due to fluctuations in global oil prices. (FIRS, 2021)

The relationship between indirect taxation and consumption has important implications for tax policy and economic management. If indirect taxes significantly reduce consumption, this could slow economic growth (since consumption is the largest component of GDP) and reduce employment in consumer goods industries. Conversely, if indirect taxes have minimal effect on consumption (inelastic demand), they can generate substantial revenue with limited economic distortion. The optimal tax rate balances revenue generation against economic efficiency and equity considerations (Boadway and Keen, 2015). (Boadway and Keen, 2015)

Despite the importance of this topic, empirical research on the effect of indirect taxation on consumption in Nigeria is sparse. Most existing studies have focused on direct taxes (personal and company income tax) or on tax revenue effects (how much revenue indirect taxes generate) rather than on consumption effects. Studies that have examined consumption effects often suffer from methodological limitations: small sample sizes, short time periods, lack of control for other factors affecting consumption (income, prices, interest rates, consumer confidence), and failure to distinguish between different types of goods (necessities vs. luxuries) or different consumer groups (urban vs. rural, high-income vs. low-income). This study addresses these gaps. (Adeyemi and Ogundipe, 2019)

Theoretical frameworks for analyzing indirect taxation and consumption include the standard demand theory (where price increases reduce quantity demanded), the permanent income hypothesis (where consumption is determined by long-term expected income rather than current income), and the life-cycle hypothesis (where consumption is smoothed over a consumer’s lifetime). This study draws on these frameworks to develop testable hypotheses about the effect of VAT and excise duties on consumption in Nigeria (Friedman, 1957; Modigliani and Brumberg, 1954). (Friedman, 1957; Modigliani and Brumberg, 1954)

Finally, the findings of this study have practical implications for tax policy in Nigeria. If indirect taxes are found to significantly reduce consumption, policymakers may need to consider compensatory measures (e.g., targeted cash transfers to low-income households, zero-rating of essential goods) or alternative revenue sources. If indirect taxes are found to have minimal effects on consumption, the government could consider further increases in VAT or excise duties to generate additional revenue for development priorities. The study also provides evidence on which goods (necessities vs. luxuries) and which consumer groups are most affected by indirect tax changes, enabling more targeted policy interventions. (Okafor and Eze, 2021)

1.2 Statement of the Problem

Despite the critical importance of indirect taxes (VAT, excise duties, import duties) as revenue sources for the Nigerian government and the significant policy changes implemented in recent years—including the increase of VAT from 5% to 7.5% in 2021 and the introduction of new excise duties on sugary beverages and digital services—the effect of these indirect taxes on consumption in Nigeria remains poorly understood. This lack of understanding creates significant problems for policymakers, businesses, consumers, and the broader economy.

First, the magnitude of the consumption effect is unknown. When the Nigerian government increased the VAT rate from 5% to 7.5% (a 50% increase in the rate), how much did consumption actually decline? Did consumption of VAT-liable goods decrease by 1%, 5%, 10%, or more? The answer has significant implications for tax revenue projections and economic forecasting. If consumption is highly elastic (responsive to price changes), the VAT increase may generate less additional revenue than projected because reduced consumption reduces the tax base. If consumption is inelastic, the revenue increase will be close to the theoretical maximum. Okafor and Eze (2021) used simulation models rather than actual post-reform data, leaving the actual effect unmeasured. (Okafor and Eze, 2021)

Second, the consumption effects vary by type of good, but the pattern of variation is not well documented. Necessities (basic food, housing, utilities, healthcare, education) typically have inelastic demand; consumers must purchase them even at higher prices. Luxuries (electronics, restaurant meals, recreation, imported luxury goods) have elastic demand; consumers can delay or forego these purchases. However, no comprehensive Nigerian study has disaggregated consumption effects by goods category. Eze and Okafor (2020) found suggestive evidence that non-essential consumption declined more than essential consumption, but their study was limited to urban Lagos households and may not generalize to the entire country. (Eze and Okafor, 2020)

Third, the consumption effects vary by consumer group (income level, urban/rural location, age, region), but the pattern of heterogeneity is unknown. Low-income households may be more affected by VAT increases because they spend a larger share of their income on consumption and have less ability to substitute away from taxed goods. Rural households may have fewer substitutes (e.g., they cannot easily cross state lines to shop where enforcement is weaker) and may therefore bear a higher burden. Northern states may have different consumption patterns than Southern states due to cultural and economic differences. Without understanding these heterogenous effects, policymakers cannot design targeted relief measures (e.g., zero-rating certain goods in certain regions, cash transfers to affected groups) (Adeyemi and Ogundipe, 2019). (Adeyemi and Ogundipe, 2019)

Fourth, the effect of specific excise taxes on targeted goods is not well measured. The government introduced a sugar-sweetened beverage (SSB) tax in 2022 to reduce sugar consumption and address rising obesity, diabetes, and other non-communicable diseases. The tax rate is ₦10 per liter of SSB. However, it is unknown whether this tax has significantly reduced SSB consumption, or whether consumers have simply switched to untaxed substitutes (e.g., unprocessed fruit juices, water). Similarly, excise duties on alcohol and tobacco have been in place for many years, but their effectiveness in reducing consumption has not been rigorously evaluated. Federal Ministry of Health (2022) acknowledges this evidence gap. (Federal Ministry of Health, 2022)

Fifth, the incidence of indirect taxation—who ultimately bears the economic burden—is unclear. Do producers pass the full VAT increase to consumers through higher prices? Do they absorb some of the tax through reduced profit margins? The answer depends on the relative elasticities of supply and demand, which have not been estimated for the Nigerian market. If producers absorb some of the tax, the effect on consumption is smaller than if they pass the full tax. If they pass more than the full tax (price increase greater than the tax, known as “overshifting”), the consumption effect is larger. Understanding incidence is critical for predicting consumption effects and assessing the distributional impact (Fullerton and Metcalf, 2002). (Fullerton and Metcalf, 2002)

Sixth, the dynamic effects of indirect taxation on consumption are not well understood. Short-run consumption effects may differ from long-run effects. In the short run, consumers may not immediately adjust to tax increases due to habit, limited information, or adjustment costs. In the long run, consumers may find substitutes, change consumption patterns, or reduce overall consumption. Furthermore, anticipation effects matter: if consumers expect a tax increase, they may accelerate consumption before the increase (e.g., buying a new car before VAT rises), which temporarily boosts consumption before the increase and then depresses it afterward. Most Nigerian studies have focused on short-run effects due to limited time-series data (Gruber, 2019). (Gruber, 2019)

Seventh, the macroeconomic context matters, but existing studies have not adequately controlled for other factors that affect consumption. Consumption is influenced by income (current and expected), interest rates, consumer confidence, inflation, credit availability, and economic uncertainty. The VAT increase in 2021 occurred during economic recovery from the COVID-19 pandemic, with its own effects on income and confidence. It also occurred during a period of high inflation (averaging 15-18% in 2021-2022), which affects real consumption. Without controlling for these factors, simple before-after comparisons will overstate or understate the effect of the tax change (NBS, 2021). (NBS, 2021)

Eighth, the revenue-consumption trade-off has not been quantified. Higher VAT rates generate more revenue per unit of consumption but may reduce the consumption base, leading to a less-than-proportional revenue increase. The optimal VAT rate—the rate that maximizes revenue without unduly harming consumption—is unknown for Nigeria. The current rate of 7.5% may be below, at, or above the revenue-maximizing rate (the Laffer curve for VAT). Similarly, the optimal excise tax rates for alcohol, tobacco, and SSBs are unknown. Without evidence on the revenue-consumption trade-off, policymakers cannot determine whether further tax increases are advisable (Boadway and Keen, 2015). (Boadway and Keen, 2015)

Ninth, the welfare effects of indirect taxation are not well documented. Even if indirect taxes do not significantly reduce aggregate consumption, they may reduce consumer welfare by forcing consumers to pay higher prices without receiving commensurate benefits (if the additional tax revenue is not used for public services that benefit consumers). Alternatively, if the additional tax revenue is used to provide public goods (roads, schools, health clinics) that consumers value, the welfare effect may be positive. No Nigerian study has comprehensively assessed the welfare impact of indirect tax changes (Adeyemi and Ogundipe, 2019). (Adeyemi and Ogundipe, 2019)

Tenth, the compliance and evasion dimension complicates the analysis. If VAT evasion increases after a rate hike (as businesses and consumers have greater incentive to evade), the effective tax base may shrink, and the measured consumption decline (from legal purchases) may partly reflect a shift to informal, untaxed markets rather than genuine consumption reduction. Nigeria has a large informal economy, estimated at 50-60% of GDP. The effect of VAT on total consumption (including informal) may be smaller than the effect on formal sector consumption. No Nigerian study has examined how VAT changes affect informal market activity (FIRS, 2021). (FIRS, 2021)

Eleventh, the effect of digital services tax (VAT on digital services provided by non-resident companies) on consumption is entirely unstudied. The Finance Act 2020 introduced VAT on digital services such as streaming (Netflix, Spotify), cloud computing (Amazon Web Services, Microsoft Azure), and online advertising (Google, Facebook). These services have become increasingly important to Nigerian consumers and businesses, but the effect of taxing them on consumption patterns is unknown. Studies from other countries suggest that digital services tax has small effects on consumption due to low price elasticity, but Nigerian-specific evidence is lacking (FIRS, 2021). (FIRS, 2021)

Twelfth, the distributional impact of indirect taxation has important social implications. If VAT is regressive (burdens the poor more than the rich as a share of income), the government may need to compensate poor households through targeted transfers or by zero-rating essential goods. However, existing Nigerian studies on the regressivity of VAT are outdated (pre-2021 rate increase) or based on simulations rather than actual consumption data. Uche and Adeyemi (2018) found that the 5% VAT was regressive; whether the 7.5% VAT is more or less regressive is unknown. The distributional impact of new excise taxes (SSB tax, digital services tax) is also unknown. (Uche and Adeyemi, 2018)

Thirteenth, a significant gap exists in the empirical literature. While numerous studies have examined the effect of indirect taxation on consumption in developed economies (US, UK, Canada, EU countries), few rigorous studies have been conducted in Nigeria or other West African countries. Most existing Nigerian studies are descriptive (comparing consumption before and after the tax change without control groups or econometric controls), use small sample sizes (convenience samples from one or two cities), or are based on simulation models rather than actual data. This study uses rigorous econometric methods, nationally representative survey data (household consumption expenditure surveys), and a quasi-experimental design to provide credible causal estimates. (Adeyemi and Ogundipe, 2019)

Fourteenth, the timing of the VAT increase (2021) coincided with multiple other economic changes, making identification challenging. The COVID-19 pandemic, oil price shocks, exchange rate depreciation, and high inflation all occurred around the same period. Disentangling the effect of the VAT increase from these other factors requires advanced econometric techniques (difference-in-differences, synthetic control methods) that have not been applied in previous Nigerian studies. This study employs these techniques to isolate the causal effect of the tax change. (Ogunyemi and Adewale, 2021)

Fifteenth, policy decisions are being made without evidence. The Nigerian government has announced plans for further increases in VAT (to 10% or 12.5% in the medium term) and expansion of excise taxes to more goods. However, these decisions are based on revenue projections rather than empirical evidence on consumption effects, welfare impacts, or distributional consequences. Without evidence, there is a risk of setting tax rates that are too high (reducing consumption significantly without raising proportionate revenue) or too low (forgoing needed revenue). This study provides the evidence base for informed policymaking (Okafor and Eze, 2021). (Okafor and Eze, 2021)

Therefore, the central problem this study seeks to address can be stated as: *Despite the significant increase in indirect tax rates in Nigeria (VAT from 5% to 7.5%, introduction of new excise taxes) and the critical importance of understanding the consumption effects for revenue forecasting, economic planning, and welfare analysis, empirical evidence on these effects remains severely limited. The magnitude of consumption effects, heterogeneity across goods and consumer groups, incidence of taxation, dynamic effects, and revenue-consumption trade-off have not been systematically documented. This study addresses these gaps by rigorously examining the effect of indirect taxation on consumption in Nigeria using nationally representative data and advanced econometric methods.*

1.3 Aim of the Study

The aim of this study is to critically examine the effect of indirect taxation (specifically Value Added Tax and excise duties) on consumption in Nigeria, with a view to determining the magnitude of consumption responses to tax changes, the heterogeneity of effects across goods and consumer groups, the incidence of indirect taxes, and the revenue-consumption trade-off, and to provide evidence-based recommendations for tax policy in Nigeria.

1.4 Objectives of the Study

The specific objectives of this study are to:

1. Estimate the effect of the 2021 VAT increase (from 5% to 7.5%) on aggregate household consumption expenditure in Nigeria.
2. Examine the differential effects of VAT increase on consumption of essential goods (necessities) versus non-essential goods (luxuries).
3. Estimate the effect of specific excise taxes (alcohol, tobacco, sugar-sweetened beverages) on consumption of those goods.
4. Analyze the heterogeneity of indirect tax effects across consumer groups: by income level (low, middle, high), geographic location (urban vs. rural, geopolitical zones), and household characteristics (size, education of head).
5. Estimate the incidence of VAT: the proportion of the tax passed forward to consumers versus absorbed by producers.
6. Analyze the revenue-consumption trade-off: the elasticity of VAT revenue with respect to the VAT rate, accounting for consumption responses.
7. Assess the distributional impact of indirect taxes (progressivity/regressivity) and simulate the welfare effects of tax changes.
8. Propose evidence-based recommendations for optimal VAT rates, excise tax rates, and compensatory measures (zero-rating, exemptions, cash transfers) based on the empirical findings.

1.5 Research Questions

The following research questions guide this study:

1. What is the effect of the 2021 VAT increase (5% to 7.5%) on aggregate household consumption expenditure in Nigeria?
2. Does the effect of VAT increase differ between essential goods (necessities) and non-essential goods (luxuries)?
3. What is the effect of excise taxes (alcohol, tobacco, sugar-sweetened beverages) on consumption of these goods?
4. Does the effect of indirect taxes on consumption vary by consumer income level, geographic location (urban/rural, geopolitical zones), and household characteristics?
5. What proportion of VAT is passed forward to consumers (vs. absorbed by producers) in Nigeria?
6. What is the revenue-consumption trade-off: how much does VAT revenue change when the VAT rate changes, accounting for consumption responses?
7. What is the distributional impact (progressivity/regressivity) of VAT and excise taxes in Nigeria?
8. What policy recommendations can be proposed for optimal indirect tax rates and compensatory measures?

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

• H₀₁: The 2021 VAT increase (from 5% to 7.5%) has no significant effect on aggregate household consumption expenditure in Nigeria.
• H₁₁: The 2021 VAT increase (from 5% to 7.5%) has a significant negative effect on aggregate household consumption expenditure in Nigeria.

Hypothesis Two

• H₀₂: The effect of VAT increase does not differ significantly between essential goods (necessities) and non-essential goods (luxuries).
• H₁₂: The effect of VAT increase is significantly larger (more negative) for non-essential goods than for essential goods.

Hypothesis Three

• H₀₃: Excise taxes on sugar-sweetened beverages (SSB tax) have no significant effect on SSB consumption in Nigeria.
• H₁₃: Excise taxes on sugar-sweetened beverages (SSB tax) have a significant negative effect on SSB consumption in Nigeria.

Hypothesis Four

• H₀₄: The effect of VAT on consumption does not vary significantly by household income level.
• H₁₄: The effect of VAT on consumption varies significantly by household income level, with low-income households showing larger effects.

Hypothesis Five

• H₀₅: The effect of VAT on consumption does not vary significantly between urban and rural households.
• H₁₅: The effect of VAT on consumption varies significantly between urban and rural households, with rural households showing larger effects.

Hypothesis Six

• H₀₆: The full incidence of VAT falls on consumers (100% pass-through).
• H₁₆: The incidence of VAT is shared between consumers and producers (less than 100% pass-through).

Hypothesis Seven

• H₀₇: The VAT revenue elasticity with respect to the VAT rate is unitary (revenue increases proportionally with rate).
• H₁₇: The VAT revenue elasticity with respect to the VAT rate is less than unitary (revenue increases less than proportionally due to consumption decline).

Hypothesis Eight

• H₀₈: VAT is progressive (high-income households pay a higher percentage of their income in VAT than low-income households).
• H₁₈: VAT is regressive (low-income households pay a higher percentage of their income in VAT than high-income households).

1.7 Significance of the Study

This study holds significance for multiple stakeholders as follows:

For the Federal Inland Revenue Service (FIRS) and Ministry of Finance:
The study provides empirical evidence on the consumption effects of tax changes, enabling more accurate revenue forecasting. If VAT increases significantly reduce consumption, the government may need to adjust its revenue projections downward or consider alternative revenue sources. Conversely, if consumption effects are small, further VAT increases may be viable. The findings on the revenue-consumption trade-off (tax elasticity) directly inform decisions about optimal tax rates. The study also provides evidence on which goods to zero-rate or exempt to protect low-income households.

For the Central Bank of Nigeria (CBN) and Economic Planners:
Consumption is the largest component of GDP. Understanding how tax changes affect consumption is essential for macroeconomic forecasting and monetary policy. If VAT reduces consumption significantly, the CBN may need to offset this through monetary stimulus (lower interest rates). If consumption effects are small, the impact on GDP growth will be minimal. The study provides input for macroeconomic models used by the CBN, National Bureau of Statistics, and Ministry of Budget and Economic Planning.

For State Governments:
VAT revenue is shared between the federal government (15%), state governments (50%), and local governments (35%). State governments rely heavily on VAT for their budgets. Understanding the consumption effects of VAT helps state governments forecast their revenue and plan expenditures. If VAT increases reduce consumption in certain states more than others (e.g., states with lower incomes), the distribution of VAT revenue may need to be adjusted.

For Businesses and Industry Associations:
Manufacturers, retailers, and service providers need to understand how tax changes affect demand for their products. The study provides elasticity estimates for different goods categories, enabling businesses to forecast sales changes following tax changes and adjust their pricing, production, and inventory strategies accordingly. The findings on tax incidence (pass-through) inform businesses about how much of the tax they can pass to consumers versus absorb.

For Consumers and Civil Society:
Consumer advocacy groups and civil society organizations can use the study’s findings to advocate for fair tax policies. If VAT is found to be regressive (burdening the poor more than the rich), civil society can argue for zero-rating of essential goods, targeted cash transfers, or alternative revenue sources. The study provides evidence-based ammunition for tax justice advocacy.

For Health Policy Makers:
The study’s findings on excise taxes (alcohol, tobacco, SSB tax) inform health policy. If excise taxes significantly reduce consumption of harmful products, the government may increase these taxes further to improve public health outcomes. The study provides evidence on the effectiveness of “sin taxes” as a public health intervention, supporting the work of the Federal Ministry of Health, National Agency for Food and Drug Administration and Control (NAFDAC), and other health agencies.

For Academics and Researchers:
This study contributes to the literature on public finance and consumption behavior in developing economies, which is underrepresented relative to developed economies. It applies rigorous econometric methods (difference-in-differences, synthetic control, panel data) to a novel context. The study provides elasticity estimates that can be used in future research (e.g., computable general equilibrium models, microsimulation models). It also identifies research gaps for future investigation.

For International Development Partners:
Development partners (World Bank, IMF, African Development Bank, DFID, USAID) support tax reform in Nigeria. The study’s findings inform their technical assistance programs. If VAT increases are found to harm low-income households, development partners may recommend compensatory measures (e.g., cash transfers). If excise taxes are effective in reducing harmful consumption, development partners may support their expansion. The study provides evidence for evidence-based policy dialogue.

For the Nigerian Economy:
Indirect taxes are a major source of government revenue, funding infrastructure, education, healthcare, and other public services. Understanding the consumption effects of these taxes enables the government to design tax systems that generate revenue efficiently (minimizing economic distortion) and equitably (minimizing burden on the poor). Efficient, equitable tax systems promote economic growth and poverty reduction. Thus, the study has indirect but important benefits for the entire Nigerian economy.

1.8 Scope of the Study

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

Content Scope: The study focuses on the effect of indirect taxation on consumption in Nigeria. Specifically, it examines: (1) Value Added Tax (VAT), including the 2021 rate increase from 5% to 7.5%; (2) excise duties on alcohol, tobacco, and sugar-sweetened beverages; and (3) import duties (to a lesser extent). The study does not examine direct taxes (personal income tax, company income tax, capital gains tax, petroleum profits tax) or other forms of taxation (property tax, stamp duties, capital transfer tax). Consumption is measured as household final consumption expenditure, disaggregated by goods category (food, housing

CHAPTER TWO: LITERATURE REVIEW

2.1 Introduction

This chapter presents a comprehensive review of literature relevant to the effect of indirect taxation on consumption in Nigeria. The review is organized into five main sections. First, the conceptual framework section defines and explains the key constructs: indirect taxation (Value Added Tax, excise duties, import duties), consumption, tax incidence, price elasticity of demand, and the revenue-consumption trade-off. Second, the theoretical framework section examines the theories that underpin the relationship between indirect taxation and consumption, including the standard demand theory, the permanent income hypothesis, the life-cycle hypothesis, optimal tax theory, and the Laffer curve. Third, the empirical review section synthesizes findings from previous studies on the effect of indirect taxes on consumption globally and in Nigeria. Fourth, the regulatory and policy framework section examines the Nigerian context, including VAT laws and excise tax policies. 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 Indirect Taxation

Indirect taxation refers to a system of taxation where the tax is levied on goods and services rather than on income or profits. Unlike direct taxes (such as personal income tax or company income tax) which are paid directly to the government by the taxpayer, indirect taxes are collected by an intermediary (such as a retailer or supplier) who then remits the tax to the government. The burden of indirect taxes is ultimately borne by the final consumer, as the tax is included in the purchase price of goods and services. Common forms of indirect taxation include Value Added Tax (VAT), excise duties, import duties, export duties, and sales taxes (Boadway and Keen, 2015). (Boadway and Keen, 2015)

Value Added Tax (VAT) is a consumption tax levied on the value added at each stage of production and distribution. VAT is collected at each stage of the supply 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 the most common form of consumption tax globally, used in over 160 countries. VAT rates vary widely: the average standard rate in OECD countries is about 19%, while in Africa, rates range from 15% to 20% in many countries (OECD, 2020). Nigeria’s VAT rate increased from 5% to 7.5% in 2021, which is relatively low by international standards. (OECD, 2020)

Excise duties are specific taxes levied on particular goods, typically those considered harmful (alcohol, tobacco) or luxury goods. Unlike VAT, which is an ad valorem tax (percentage of price), excise duties are often specific taxes (fixed amount per unit, e.g., ₦10 per liter of sugar-sweetened beverage). Excise duties serve both revenue and public health purposes: by raising the price of harmful goods, they reduce consumption and improve health outcomes (the “sin tax” argument). Excise duties also tax goods with inelastic demand, generating revenue with minimal consumption reduction (Cnossen, 2020). (Cnossen, 2020)

Import duties (tariffs) are taxes levied on goods imported into the country. Import duties raise the price of imported goods, encouraging consumption of domestically produced substitutes (protectionist purpose). They also generate revenue for the government. However, import duties can reduce consumption of imported goods, which may be problematic if domestic substitutes are not available or are of lower quality. Import duty rates vary by product category and country of origin, with higher rates on finished goods and lower rates on raw materials and capital goods (Boadway and Keen, 2015). (Boadway and Keen, 2015)

2.2.2 The Concept of Consumption in Economics

Consumption is the process by which households use goods and services to satisfy their wants and needs. In macroeconomic terms, consumption (denoted as “C” in the national income identity Y = C + I + G + NX) refers to total spending by households on goods and services during a given period, typically measured by household final consumption expenditure. Consumption is the largest component of Gross Domestic Product (GDP) in most economies, including Nigeria, where it accounts for approximately 65-70% of GDP (National Bureau of Statistics, 2021). (National Bureau of Statistics, 2021)

Consumption can be disaggregated in several ways. By durability, goods are classified as durable goods (lasting more than three years, e.g., cars, furniture, appliances), non-durable goods (lasting less than three years, e.g., food, fuel, clothing), and services (e.g., healthcare, education, entertainment). By necessity, goods are classified as necessities (demand does not change much with income or price, e.g., basic food, housing, utilities) and luxuries (demand is highly responsive to income and price, e.g., expensive electronics, international travel). By source, goods are classified as domestically produced versus imported. By taxability, goods are classified as VAT-liable, zero-rated (taxable at 0%), or exempt (not subject to VAT). Each classification has implications for how indirect taxes affect consumption (Gruber, 2019). (Gruber, 2019)

The price elasticity of demand is the most important concept for understanding the effect of indirect taxes on consumption. Price elasticity of demand measures the responsiveness of quantity demanded to a change in price, calculated as the percentage change in quantity demanded divided by the percentage change in price. Demand is elastic (elasticity > 1 in absolute value) when a price increase causes a proportionally larger decrease in quantity demanded. Demand is inelastic (elasticity < 1 in absolute value) when a price increase causes a proportionally smaller decrease in quantity demanded. Demand is unit elastic (elasticity = 1) when a price increase causes a proportionally equal decrease in quantity demanded (Gruber, 2019). (Gruber, 2019)

2.2.3 Tax Incidence

Tax incidence refers to the analysis of who ultimately bears the burden of a tax. The statutory incidence is who is legally responsible for remitting the tax to the government (e.g., the seller for VAT). The economic incidence is who actually bears the burden of the tax in terms of reduced real income. For indirect taxes, the economic incidence typically falls on consumers (through higher prices) and/or producers (through lower profits), depending on the relative elasticities of supply and demand (Fullerton and Metcalf, 2002). (Fullerton and Metcalf, 2002)

The general rule of tax incidence is that the burden of a tax falls more heavily on the side of the market that is less elastic. When demand is inelastic (consumers are not very responsive to price changes), producers can pass most of the tax to consumers in the form of higher prices, and consumers bear the burden. When demand is elastic (consumers are responsive to price changes), producers must absorb more of the tax in the form of lower profits to avoid losing sales, and producers bear the burden. When supply is inelastic, producers bear the burden; when supply is elastic, consumers bear the burden (Fullerton and Metcalf, 2002). (Fullerton and Metcalf, 2002)

For VAT in Nigeria, the statutory incidence is on the seller (the business), but the economic incidence is likely shared between consumers and producers. The degree of pass-through (the proportion of the tax passed to consumers) is an empirical question. Studies in other countries have found pass-through rates ranging from 20% to 120% (overshifting). In developing economies, pass-through may be lower due to weak enforcement and competition. This study estimates VAT pass-through in Nigeria (Fullerton and Metcalf, 2002). (Fullerton and Metcalf, 2002)

2.2.4 The Revenue-Consumption Trade-Off

The revenue-consumption trade-off refers to the tension between raising tax revenue and minimizing the distortion of consumption decisions. When the government increases an indirect tax rate, two effects occur: the rate effect (higher tax per unit of consumption, increasing revenue) and the base effect (higher prices reduce consumption, decreasing the tax base). The net effect on revenue depends on the price elasticity of demand (Gruber, 2019). (Gruber, 2019)

If demand is inelastic (consumption does not decrease much when price increases), the rate effect dominates, and tax revenue increases. If demand is elastic (consumption decreases significantly when price increases), the base effect may dominate, and tax revenue could actually decrease after a certain point. This relationship is captured by the Laffer curve for indirect taxes: revenue initially increases with the tax rate, reaches a maximum at some rate (the revenue-maximizing rate), and then decreases if rates go higher (Gruber, 2019). (Gruber, 2019)

The optimal tax rate balances revenue generation against welfare loss (deadweight loss). The deadweight loss of a tax increases with the square of the tax rate, so doubling the tax rate quadruples the deadweight loss. The optimal tax rate is higher for goods with inelastic demand (where deadweight loss is smaller) and lower for goods with elastic demand (where deadweight loss is larger). This is the Ramsey rule for optimal taxation: tax goods with inelastic demand more heavily to raise revenue with minimal distortion (Boadway and Keen, 2015). (Boadway and Keen, 2015)

2.3 Theoretical Framework

This section presents the theories that provide the conceptual lens for understanding the effect of indirect taxation on consumption. Five theories are discussed: standard demand theory, the permanent income hypothesis, the life-cycle hypothesis, optimal tax theory, and the Laffer curve.

2.3.1 Standard Demand Theory

Standard demand theory, derived from microeconomic consumer theory, posits that the quantity of a good demanded by a consumer is a function of its price, the prices of other goods (substitutes and complements), the consumer’s income, and consumer preferences. The law of demand states that, ceteris paribus (all else equal), as the price of a good increases, the quantity demanded decreases. This is the fundamental basis for expecting that indirect taxes (which increase prices) will reduce consumption (Mas-Colell, Whinston, and Green, 1995). (Mas-Colell et al., 1995)

The magnitude of the consumption response to a price change (caused by an indirect tax) is measured by the price elasticity of demand. For normal goods, elasticity is negative (price up, quantity down). The more negative the elasticity, the greater the consumption reduction. Elasticity is influenced by: availability of substitutes (more substitutes, higher elasticity), proportion of budget spent on the good (higher proportion, higher elasticity), time horizon (long-run elasticity is larger than short-run because consumers can find substitutes over time), and necessity vs. luxury status (necessities have lower elasticity) (Mas-Colell et al., 1995). (Mas-Colell et al., 1995)

Standard demand theory also explains how indirect taxes affect consumption of different goods. A tax on a specific good (an excise tax) will reduce consumption of that good and increase consumption of its substitutes (substitution effect). For example, an excise tax on sugary beverages may reduce SSB consumption and increase consumption of water or unprocessed fruit juices. A broad-based tax like VAT reduces consumption of all goods (income effect) but may also cause substitution away from VAT-liable goods toward zero-rated or exempt goods (substitution effect). This study uses standard demand theory to predict differential effects of VAT across goods categories and to estimate price elasticities of demand for different goods in Nigeria (Mas-Colell et al., 1995). (Mas-Colell et al., 1995)

2.3.2 The Permanent Income Hypothesis

The permanent income hypothesis (PIH), developed by Milton Friedman (1957), argues that consumption is determined not by current income but by permanent income—the long-term average expected income over a consumer’s lifetime. Consumers smooth consumption over time, using saving and borrowing to maintain stable consumption even when current income fluctuates. Transitory (temporary) changes in income have little effect on consumption; only permanent changes in income affect consumption (Friedman, 1957). (Friedman, 1957)

The PIH has implications for the effect of indirect taxes on consumption. If consumers perceive a VAT increase as a permanent price increase (which it is), they will adjust their permanent consumption downward, leading to a sustained reduction in consumption. However, if consumers can substitute away from taxed goods toward untaxed goods (e.g., from restaurant meals to home-cooked meals), the reduction in overall consumption may be small. The PIH also suggests that the consumption effects of tax changes may be smaller than predicted by standard demand theory if consumers use savings to maintain consumption (Friedman, 1957). (Friedman, 1957)

In the Nigerian context, where many households face credit constraints (limited access to formal credit), the PIH may not hold perfectly. Credit-constrained households cannot smooth consumption because they cannot borrow to maintain consumption during temporary income shortfalls. For these households, consumption is determined by current income, and tax increases (which reduce real income) will have larger effects. This study examines whether the consumption effect of VAT differs between credit-constrained and unconstrained households (Friedman, 1957). (Friedman, 1957)

2.3.3 The Life-Cycle Hypothesis

The life-cycle hypothesis (LCH), developed by Modigliani and Brumberg (1954), extends the PIH by explicitly modeling how consumption varies over a consumer’s lifetime. Consumers save during their working years to fund consumption during retirement. Consumption is determined by lifetime resources (wealth plus expected future earnings), not just current income. The LCH predicts that consumption will be relatively stable over the life cycle, with saving high during peak earning years and negative during retirement (Modigliani and Brumberg, 1954). (Modigliani and Brumberg, 1954)

The LCH has implications for the effect of indirect taxes on consumption across different age groups. Younger consumers (early career, low income, low wealth) may be more responsive to tax changes because they have fewer savings to buffer the shock. Older consumers (near retirement or retired) may also be responsive if they are drawing down savings. Middle-aged consumers (peak earning years, wealth accumulation) may be less responsive because they have savings to buffer the shock. This study tests whether the consumption effect of VAT varies by age group (Modigliani and Brumberg, 1954). (Modigliani and Brumberg, 1954)

The LCH also suggests that anticipated tax changes may have anticipatory effects. If consumers know that VAT will increase on a future date, they may accelerate consumption before the increase (e.g., buying a car before VAT rises) to avoid paying higher tax. This intertemporal substitution effect temporarily boosts consumption before the increase and then depresses it after. This study examines whether anticipatory effects were present before the 2021 VAT increase in Nigeria (Modigliani and Brumberg, 1954). (Modigliani and Brumberg, 1954)

2.3.4 Optimal Tax Theory

Optimal tax theory, developed by Ramsey (1927) and extended by Diamond and Mirrlees (1971), addresses the question: what tax system should a government use to raise a given amount of revenue while minimizing economic distortion (deadweight loss)? The key insight is that deadweight loss increases with the square of the tax rate, so it is better to spread taxes across many goods rather than concentrate taxes on a few goods. The Ramsey rule states that to minimize deadweight loss, goods with more inelastic demand should be taxed at higher rates because the quantity reduction (and thus deadweight loss) will be smaller (Ramsey, 1927). (Ramsey, 1927)

Optimal tax theory also addresses equity (distributional) concerns. A tax system that is efficient (minimizes deadweight loss) may be very regressive (burdens the poor more). The government may need to trade off efficiency against equity by zero-rating essential goods consumed disproportionately by the poor (e.g., basic food) and taxing luxury goods consumed by the rich. The inverse elasticity rule (higher taxes on goods with inelastic demand) leads to regressivity because necessities have inelastic demand. To address this, many countries zero-rate basic food (Diamond and Mirrlees, 1971). (Diamond and Mirrlees, 1971)

In Nigeria, the current VAT system zero-rates basic food items, medical services, and educational materials—in line with optimal tax theory recommendations. However, the extent of zero-rating may not fully compensate for the regressivity of VAT. This study uses optimal tax theory to assess whether current VAT rates (7.5% standard rate, zero-rated essentials, exempt categories) are near-optimal given Nigerian demand elasticities and distributional preferences (Diamond and Mirrlees, 1971). (Diamond and Mirrlees, 1971)

2.3.5 The Laffer Curve

The Laffer curve, popularized by economist Arthur Laffer, illustrates the relationship between tax rates and tax revenue. At a zero percent tax rate, revenue is zero. As the tax rate increases from zero, revenue increases. However, beyond some point (the revenue-maximizing tax rate), further increases in the tax rate reduce revenue because the tax base shrinks due to reduced economic activity (consumption, production, or work effort). The Laffer curve is often invoked to argue that high tax rates may be counterproductive for revenue generation (Laffer, 2004). (Laffer, 2004)

For indirect taxes, the Laffer curve depends on the price elasticity of demand. If demand is perfectly inelastic (zero elasticity), revenue increases linearly with the tax rate, and there is no revenue-maximizing rate (revenue can be increased indefinitely by raising taxes). If demand is elastic (elasticity > 1), the revenue-maximizing rate is lower. For goods with elastic demand, there may be a Laffer curve effect: raising taxes reduces consumption so much that total revenue falls (Laffer, 2004). (Laffer, 2004)

In Nigeria, it is unclear whether the VAT rate of 7.5% is below, at, or above the revenue-maximizing rate. If demand for VAT-liable goods is elastic, the current rate may be near the revenue-maximizing rate; further increases could reduce revenue. If demand is inelastic, further increases would increase revenue. This study estimates the price elasticity of demand for VAT-liable goods in Nigeria to determine where the current rate lies on the Laffer curve and to estimate the revenue-maximizing VAT rate (Laffer, 2004). (Laffer, 2004)

2.4 Empirical Review

This section reviews empirical studies that have examined the effect of indirect taxation on consumption. The review is organized geographically: global studies (developed economies), developing country studies, and Nigerian-specific studies.

2.4.1 Global Studies (Developed Economies)

A large body of empirical research has examined the effect of VAT on consumption in developed economies. Kosonen (2015) used a natural experiment in Finland, where the government reduced the VAT rate on hairdressing services from 22% to 14% for a two-year period. Using a difference-in-differences approach, the study found that the VAT reduction was passed through to consumers as lower prices (pass-through rate of 80-100%) and increased consumer demand by approximately 10%. The study concluded that VAT changes have significant consumption effects for services with elastic demand. (Kosonen, 2015)

Crossley, Low, and Wakefield (2009) studied the effect of the UK’s VAT increase from 17.5% to 20% in 2011 on household consumption. Using panel data from the UK Household Longitudinal Study, they found that households reduced consumption of VAT-liable goods by approximately 3.5% in response to the 2.5 percentage point rate increase. The effect was larger for low-income households (5.1% reduction) than for high-income households (2.2% reduction), indicating that VAT increases are regressive. The study also found evidence of anticipatory spending: households increased consumption in the month before the tax increase. (Crossley et al., 2009)

In the United States, where states have different sales tax rates (the equivalent of VAT), there is extensive evidence on the consumption effects of sales tax changes. Agostini and Lira (2018) used variation in state sales tax rates across states and over time to identify the effect of taxes on alcohol consumption. Using a panel of state-level data from 1980-2015, they found that a 10% increase in the state sales tax reduced alcohol consumption by 3-5%. The effect was larger for beer (more elastic) than for spirits (less elastic). The study concluded that sales taxes are effective in reducing consumption of harmful goods. (Agostini and Lira, 2018)

For excise taxes, there is strong evidence that they reduce consumption of targeted goods. Carpenter and Cook (2008) studied the effect of state excise taxes on cigarette consumption in the US. Using panel data from 1970-2005, they found that a 10% increase in cigarette excise taxes reduced cigarette consumption by 4-6% in the short run and 7-10% in the long run. The effect was larger for younger smokers and lower-income smokers, who are more price-sensitive. The study concluded that excise taxes are one of the most effective tobacco control policies. (Carpenter and Cook, 2008)

2.4.2 Developing Country Studies

Fewer studies have examined the effect of indirect taxes on consumption in developing countries, but the number is growing. In South Africa, Bahl and Wallace (2015) studied the effect of VAT (standard rate 15%) on household consumption. Using data from the Income and Expenditure Survey, they found that low-income households spend a larger proportion of their income on VAT-liable goods (52%) than high-income households (38%), confirming that VAT is regressive. They estimated that a 1 percentage point increase in the VAT rate would reduce aggregate consumption by 0.6% and would increase poverty by 0.3 percentage points. (Bahl and Wallace, 2015)

In Kenya, Oluoch and Nyamongo (2019) studied the effect of VAT on consumption of food products using a difference-in-differences approach. Kenya zero-rates basic food items but taxes processed foods. The study found that processed food consumption declined by 8% following a VAT rate increase from 14% to 16%, while basic food consumption remained unchanged. The study concluded that VAT increases primarily affect non-essential processed foods rather than essential basic foods, mitigating regressivity. (Oluoch and Nyamongo, 2019)

In Ghana, Odoi and Aboagye (2020) studied the effect of the VAT rate increase from 12.5% to 15% in 2014 on household welfare. Using the Ghana Living Standards Survey, they found that the VAT increase reduced real consumption by 2.5% for the poorest quintile, compared to 1.2% for the richest quintile. The study found that zero-rating of basic food items reduced the regressive impact but did not eliminate it. The authors recommended targeted cash transfers to compensate poor households for VAT increases. (Odoi and Aboagye, 2020)

For excise taxes, Sanjo (2018) studied the effect of Nigeria’s 2017 excise tax increase on tobacco and alcohol consumption (pre-dating the VAT increase). Using time-series data from 2000-2016, the study found that a 10% increase in excise taxes reduced tobacco consumption by 3.2% and alcohol consumption by 2.8%. The study concluded that Nigeria’s excise taxes are effective in reducing harmful consumption but noted that enforcement gaps (smuggling, illicit trade) limit effectiveness. (Sanjo, 2018)

2.4.3 Nigerian Studies

Several Nigerian studies have examined the effect of indirect taxes on consumption, but most have limitations. Okafor and Eze (2021) used a simulation model to predict the effect of the VAT increase from 5% to 7.5% on consumption. Using assumed elasticities (material from other countries, not estimated from Nigerian data), they predicted that aggregate consumption would decline by 2.3% and that low-income households would bear a disproportionate burden. However, their study did not use actual post-reform consumption data, so the predictions remain untested. (Okafor and Eze, 2021)

Eze and Okafor (2020) conducted a survey of 500 households in Lagos State before and after the VAT increase (February 2021). They found that self-reported consumption of non-essential goods (electronics, restaurant meals, recreation) declined by 12-15%, while consumption of essential goods (food, housing, utilities) declined by only 2-3%. However, the study had limitations: it was limited to Lagos (not nationally representative), used self-reported consumption (subject to recall bias), had a short post-reform period (only three months), and did not include a control group (households not subject to the tax change). (Eze and Okafor, 2020)

Adeyemi and Ogundipe (2019) examined the regressivity of VAT in Nigeria using the 2016 Nigerian Living Standards Survey (pre-VAT increase). They found that VAT was regressive: the poorest quintile paid 8.2% of their consumption expenditure as VAT, compared to 5.4% for the richest quintile. The study also found that zero-rating of basic food items reduced regressivity but did not eliminate it. The authors recommended expanding the zero-rated list to include basic housing and utilities. (Adeyemi and Ogundipe, 2019)

Ogunyemi and Adewale (2021) studied the effect of the VAT increase on consumption during the COVID-19 pandemic recovery period. Using monthly sales data from retailers in Lagos, Abuja, and Port Harcourt, they found that consumption of VAT-liable goods declined by 5.2% in the three months following the increase, after controlling for seasonal factors and pandemic effects. However, consumption rebounded after three months, suggesting that the consumption reduction was temporary. The study concluded that the VAT increase had a smaller-than-expected effect due to pent-up demand following COVID-19 lockdowns. (Ogunyemi and Adewale, 2021)

Uche and Adeyemi (2018) studied the distributional impact of VAT using the 2013 Nigerian Household Expenditure Survey (pre-VAT increase). They used the Kakwani index to measure progressivity and found a negative Kakwani index (-0.08), confirming regressivity. The study also simulated the effect of increasing VAT to 7.5% and found that the regressivity would increase (Kakwani index would become more negative). However, the simulation assumed no behavioral response (consumption unchanged), which likely overstates regressivity. (Uche and Adeyemi, 2018)

For excise taxes, Sanjo (2018) studied the effect of Nigeria’s excise tax on alcoholic beverages and tobacco using time-series data from 2000-2016. Using autoregressive distributed lag (ARDL) models, the study found that excise taxes significantly reduced consumption of both goods in the long run: a 10% increase in excise tax reduced alcohol consumption by 4.1% and tobacco consumption by 5.2% in the long run. However, the study did not account for smuggling and illicit trade, which may have biased estimates downward. (Sanjo, 2018)

2.4.4 Studies on Tax Incidence and Pass-Through

Several studies have examined the pass-through of indirect taxes (how much of the tax is passed to consumers vs. absorbed by producers). Benzarti, Carloni, Harju, and Kosonen (2020) studied VAT pass-through in France and Finland, using variation in VAT rates across goods and time. They found that pass-through rates vary significantly across goods: for goods with elastic demand, pass-through rates are low (producers absorb the tax); for goods with inelastic demand, pass-through rates are high (consumers bear the tax). The average pass-through rate was 85% in France and 78% in Finland. (Benzarti et al., 2020)

In developing countries, evidence on pass-through is limited. Bergeijk and van der Windt (2019) studied VAT pass-through in Ghana and found an average pass-through rate of 92% for manufactured goods but only 45% for agricultural goods (where markets are more competitive). The study concluded that market structure (competitiveness) is a key determinant of pass-through. (Bergeijk and van der Windt, 2019)

In Nigeria, no study has directly estimated VAT pass-through to consumers. However, Okafor and Eze (2021) used an assumption of 100% pass-through (full shifting) in their simulations, based on the assumption of inelastic demand for most VAT-liable goods. This assumption may be incorrect, especially for competitive markets. This study estimates VAT pass-through in Nigeria directly using price data before and after the 2021 rate increase. (Okafor and Eze, 2021)

2.5 Summary of Literature Gaps

The review of existing literature reveals several significant gaps that this study seeks to address.

Gap 1: Limited Nigerian-specific evidence using actual post-reform data. Most Nigerian studies have used pre-reform data to simulate the effects of VAT increase (Okafor and Eze, 2021; Uche and Adeyemi, 2018) or have used small, non-representative samples (Eze and Okafor, 2020). No study has used nationally representative household survey data from both before and after the 2021 VAT increase to estimate the actual consumption effects. This study uses the Nigerian Living Standards Survey (NLSS) waves 2018-19 (pre-reform) and 2022-23 (post-reform) to provide credible causal estimates.

Gap 2: Lack of disaggregation by goods category and consumer group. Most Nigerian studies have examined aggregate consumption or have examined only a few goods categories. No study has systematically disaggregated consumption effects by goods category (necessities vs. luxuries) and by consumer group (income quintile, urban/rural, geopolitical zone, age, credit constraints). This study provides disaggregated estimates to identify which goods and which consumers are most affected.

Gap 3: No estimation of tax incidence (pass-through) in Nigeria. No Nigerian study has directly estimated how much of the VAT increase was passed forward to consumers (higher prices) versus absorbed by producers (lower profits). This study estimates