On The Value Added Tax (VAT) Controversy and Fiscal Federalism in Nigeria

VAT Value Added tax okechukwu edward okeke

By Professor Okechukwu Edward OKEKE

The judgement of the Federal High Coourt in Port Harcourt on this matter was not a policy decision by the judge. It was simply a declaration that there are no constitutional provisions that empower the federal government to collect Value Added Tax (VAT). In other words, the ruling invalidates the Value Added Tax Act of 2004 (which was amended in the Finance Act of 2019). The ruling does not say, either, that the Constitution permits the state governments to collect VAT without the backing of a federal law. So there is a gap which the Rivers State government has filled with its Rivers State Value Added Tax Law of 2021.

Justice Pam does not have and did not try to assume the power to make a decision on fiscal federalism or restructuring. It is reasonable to assume, therefore, that he was following the law as he understood it. Unless the higher courts rule that Justice Pam was wrong, it is only the National Assembly, and the National and State Assemblies if it requires a constitutional amendment, which can now make laws to reallocate revenue-collection powers among the three levels of government.

The Federal High Court judgement and the follow up action by the Rivers State government have made the age-old debate on restructuring topical once again. In particular, the debate has focused on fiscal federalism, with supporters of the Rivers State government seeing the judgement and the state’s VAT law as being consistent with the principles of fiscal federalism. Indeed, Nyesom Wike, the Governor of Rivers State, is being portrayed as a hero in the struggle for fiscal federalism.

In most of the reports and social media posts on the subject, the definition of fiscal federalism is not given. But it can easily be inferred from the reports and posts that its proponents believe that fiscal federalism means that, in a true federal system (“true federalism”), each state would control its resources (assume ownership and taxing powers over resources in its territory) and pay taxes to the federal government to enable it run a few common services (notably defence, external affairs, currency and banking).

It is necessary to point out that this popular view about fiscal federalism is wrong. As Simon Kolawole has pointed out, “fiscal federalism does not mean resources control. To the contrary, it is a theory about fiscally balancing the federation so that poorer parts don’t suffer” (see his 3 July op-ed, “We keep missing the point” in TheCable and ThisDay). Indeed, fiscal federalism entails that the federal government would have vast sources of revenue such that it can transfer revenue to lower levels of government. In the words of a report on the subject, “Federal governments use this power to enforce national rules and standards”. In other words, the federal government uses measures called “fiscal transfers” and “equalization transfers” in the literature on fiscal federalism, to redistribute revenue to favour poor states. This point is elaborated by Naim Kapucu in Encyclopaedia Brittanica:

“The theory of fiscal federalism assumes that a federal system of government can be efficient and effective at solving problems governments face today, such as just distribution of income, efficient and effective allocation of resources, and economic stability. Economic stability and just distribution of income can be done by federal government because of its flexibility in dealing with these problems. Because states and localities are not equal in their income, federal government intervention needed”.

The main takeaway from the theory of fiscal federalism is that federal governments try to minimize revenue gaps among the lower levels of government. This is done by redistribution – taking from the rich and giving to the poor. Thus, what Nigeria has been practising, since the adoption of the federal system of government in 1954, has been fiscal federalism. It is also done in other federations like ours, where governments are elected and where there is a free press. Canada, Germany, Australia, India and the United States are notable examples. I concede the practice of fiscal federalism, especially in the allocation of oil revenues, mainly between the late 1970s (when derivation was heavily reduced in the revenue allocation formula) and 2000 (when the implementation of the 13% allocation to oil-producing states started and NDDC was established) has been unfair to the states from where the bulk of federally collected revenues are derived. The unfairness has been enabled by the fact the fiscally weak states are numerically larger and politically stronger than the revenue rich states. The challenge is to deal with the abuses, rather than abandon the principle and practice of redistribution. In a manner of speaking, to be a federal state is to be a redistributive state. Advocates of restructuring contend that redistribution makes states lazy. This may be true, but the reality is that, even if all states maximize their internal revenue generation efforts, there will still be gaps, probably wide gaps, between states. So long as there are gaps, there will be attempts to redistribute revenue to help the poor, within reasonable and politically tolerable limits.

I would like to add here, as something of a footnote, that another way federal governments redistribute wealth is by taking over some of the functions previously performed by lower levels of government. This enables the federal government to treat individual citizens in rich and poor states equally. If, for instance, the federal government of a country establishes federal universities, it gives citizens in rich and poor states the same quality of education at the same costs, thus enabling more citizens of fiscally poor states to attend university. This is also done in Nigeria and other federations. Another “footnote” is that the debate over the extent of federal powers to tax and spend vis-à-vis the lower tiers of government is also a controversial issue in other federations. In Nigeria, the main antagonists are, on the one hand, oil-rich states and Lagos in the south and, on the other hand, the territorially larger and more populous states in the north. The former generally oppose redistribution while the former support it. In the democracies of the West, the main antagonists are, on the one hand, left-of-centre politicians, and, on the other hand, right-of-centre politicians. The former want a greater role for the federal government (uniformity and more redistribution); the latter generally oppose the expansion of federal power (states’ right, less uniformity, and less redistribution).

Concerning VAT, it is reasonable to broaden our views on the matter by considering what other countries do. The position of the Federal Inland Revenue Service (FIRS) is that VAT is a federal tax in other jurisdictions. The little research I have done on the subject shows that it is indeed so. For this reason, the United States is listed among countries that do not collect VAT. A few states in the country, just a few, collect sales tax (which is a value-added tax). However, because the federal government does not collect VAT, the country is classified as non-VAT country. In some federations, notably Brazil, India and Canada, federal law permits both the federal and state governments to collect VAT, with the laws specifying the items that each level of government is permitted to tax.

Apart from being an important source of the money that is used for fiscal equalization (redistribution), VAT is usually a federal tax because it involves the taxing of imports and exports (a federal subject); because the federal government is responsible for the regulation of inter-state commerce; because there is a concern in most countries to ensure that tax rates are uniform; and because it is believed that decentralization increases the tax burden on buyers (through what is called the cascading effect).

Because of the interests at stake in Nigeria, the struggle over VAT will linger. In deciding what to do, our lawmakers and courts should, among other things, consider both universal best practices and the need to reduce political tension in the country. To appease the states where the bulk of the revenue from VAT is collected and at the same time find the resources for redistribution, the country should, in my view, adopt a dual VAT regime. To deal with concerns about impediments to inter-state commerce, increase in the tax burden, and probable lack of uniformity, a federal law would be needed—one that would permit FIRS to collect VAT on certain items and the states on other items.

Okechukwu Edward Okeke is a professor of History at Federal University Otuoke, Nigeria. He can be reached via [email protected]’edu.ng or [email protected]

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