Tax Reform: Addressing the elephant in the room

The administrators of the Tinubu administration are working hard to promote the relevance of the Tax Reform bill. But they keep ignoring the elephant in the room—the VAT-sharing principle. They have made many people believe that state and local governments will receive money they do not deserve or that it should have gone to someone […]

The administrators of the Tinubu administration are working hard to promote the relevance of the Tax Reform bill. But they keep ignoring the elephant in the room—the VAT-sharing principle. They have made many people believe that state and local governments will receive money they do not deserve or that it should have gone to someone else. It is on the contrary.  

The good news is that the critical players and special interest groups have refused to be fooled into accepting this Greek gift. The northern governors opposed the bill, too, and urged members of the National Assembly to reject it. Similarly, in its last meeting, the National Economic Council recommended withdrawing the bill from the National Assembly. This shows the consequences of the proposed bill, which will affect everyone in the country, not just the North.

The proposed sharing formula will reduce the share of federal government allocation from 15 to 10 per cent. The share of state governments will rise from 50 to 55 per cent, while the share of local governments will remain the same at 35 per cent. But that is not the issue.  

The issue is the proposed changes on what state governments should retain based on the derivation principle. Currently, states retain 20 per cent of the VAT they collect, while the population distributes 30 per cent, and 50 per cent is shared equally among all states. But the proposal increased the derivation allocation for states from 20 to 60 per cent. This makes collection location as important as revenue size, potentially favouring high-producing states.

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The administrators argue that implementing the derivation principle to share VAT revenue would be beneficial, but they overlook a better proposition: the destination principle. This is the engine block of the reform. As we know, you cannot drive a vehicle if the engine is defective.  

On one hand, the derivation principle allocates tax revenue based on where the tax is collected or “derived”. This means the state government collecting VAT will retain a portion of that revenue. This approach benefits registered companies in areas like Lagos, Rivers, Ogun and Abuja. They will get 60 per cent of the tax revenue regardless of where their commercial activity is conducted. On the other hand, the destination principle allocates tax revenue to the location where goods or services are ultimately consumed, regardless of where they are produced or sold. If a Sokoto man buys Dangote cement to build in Sokoto, his tax should be retained in Sokoto, not in Lagos, where the company is registered.

The committee’s Chairman, Taiwo Oyedele, has proposed more changes to the bill but failed to change the principle that got people talking about it. Oyedele still believes that: “A state that produces food shouldn’t lose out just because its products are VAT-exempt or consumed in other states.” This is a clear deviation of fairness for the taxpayer—the consumers – as producers have been compensated with various incentives. It is unclear whether this is deliberate.  

Whatever the reason, you have to give it to Tinubu for appointing these collections of administrators who do not follow basic policymaking principles. What will the FIRS chairman propose when major services companies get a favourable deal to relocate their operations offices to another state? This can happen for manufacturers, services, communication, banking and oil sectors.  

We must understand that VAT is structured to tax consumption, so it captures spending instead of production. We must also know that VAT differs from company or production tax. VAT does not affect the profit of shareholders or the salaries of workers in any company. VAT affects the final consumer price. So, the consumers pay this tax, not the producers. So, if our consumption tax revenue is shared to compensate taxpayers, then the consumer deserves to benefit from it.

So, in a country where producers are predominantly in the South while the consumer population is spread across the country, it is most equitable to allocate VAT—a consumption tax—to the areas where consumption took place, not where production was done.

The primary rationale is that the producer areas already gain other economic benefits through various channels tied to their role in production. These include producer subsidies, which support industry, corporate taxes, profit taxes, and other business levies that the region collects due to its hosting of productive activities. These revenues contribute to regional infrastructure, public services and job creation, bolstering the producer region’s economy.

Since the consumer states bear the cost of purchasing goods and services, which VAT directly targets, sending VAT revenue to them aligns with the financial impact on consumers and supports public finances where the demand-side burden exists.

Allocating VAT to the consumer areas will bring the expected balance in fiscal benefits. This will be a fairer and more sustainable way to distribute tax revenue. It will recognise the role of consumer spending in sustaining the economy. It will help address potential inequalities between economically distinct regions and a fairer tax system overall. However, doing this will depend on the agenda of the Tinubu administration.  

We must accept that it is not wrong for stakeholders to fight to get a fair share of what their taxpayers pay. After all, it is precisely what the governors are doing. Some may interpret it in another sense, but the principles of fairness, equity and destination tell us that taxes should be retained where they are paid, which is the state of consumption.