Milton Friedman, the renowned American economist, had posited that: “inflation is taxation without legislation”. He was awarded the Nobel Prize in economic sciences for his research on consumption analysis, monetary history and theory, and the complexity of stabilization policy in 1976.
Nigeria's headline inflation rate in December 2024 rose to 34.80% from 34.60% [in November 2024], marking a 0.57% increase month-on-month, and a 20% increase year on year [December 2023 – 28.9%]. This trend is unabated despite the targeted policy measures of the Government. While some of the drivers of the rising inflation are obvious, the other causes are institutional and complex in nature – including high energy costs, impact of the devaluation of the local currency, and impact of ‘ways and means'.
High inflation rates significantly impact the cost of living for the average citizen. Basic goods and services become more expensive, disproportionately affecting low-income households. A high inflation environment erodes purchasing power, meaning that people can only buy less with the same amount of money. The high inflationary environment can stifle economic growth by creating uncertainty in the marketplace, discouraging investment and savings.
For many Nigerians, this has translated to difficult choices between essentials like food, housing, and healthcare. Milton Friedman's assertion that "inflation is a form of tax" resonates in the current Nigerian context. When inflation rises, the real value of money decreases, effectively reducing the purchasing power of citizens. This loss of value can be viewed as a tax on consumers, as they must spend more to maintain their standard of living.
Some economic theorists have canvassed for a combination of monetary and fiscal policies to tackle rising inflation. While efforts by the monetary authority have been visible [including consistent increase of the MPR] but not yielded the desired outcome, more actions are expected from the fiscal authorities.
The Government is considering some fiscal changes, especially changes with respect to taxes and levies. In response to economic pressures, the Nigerian government has bemoaned the relatively low tax-to-GDP ratio of 10.86%. The Government asserts that this cripples its ability to service its debt and invest in the critical infrastructure required to unlock the latent potential in the Nigerian economy. Consequently, the Nigerian Government is intent on markedly improving the tax to GDP ratio. It envisages that this will be achieved in the medium to long term by employing technological solutions to improve collection, and ensuring it widens the tax net. For instance, the Government intends to enact a National Tax Bill [Nigeria Tax Bill, 2024], which seeks to streamline the number of taxes payable at the level of the Federal Government, reduce the rates for some taxes, revamp existing tax incentives, introduce new taxes/levies (such as an excise duty on telecommunication services, betting, gaming, gambling and lotteries) and increase the rate for some taxes, like the Value Added Tax (VAT) – from 7.5% to 10% in 2025 and ultimately 15% by 2030.
Although, the Bill also proposes a corresponding reduction in Companies Income Tax (CIT), one should appreciate that CIT is chargeable on the profit of a company while the VAT and excise levies are borne by the consumers, i.e. it is directly borne by the populace. A reduction in CIT will be favourable to companies but individual consumers will have to pay more in VAT and excise levies.
This proposed increases have reignited discussions about the interplay between inflation and taxation, drawing attention to Milton Friedman's assertion that inflation is, in effect, a form of tax. This connotes that the planned hike in tax rates during a period of high inflation in Nigeria, would amount to double tax increment; informally through inflation, and formally through the tax increases.
The taxes, including VAT and excise levies aim to address budget deficits and fund critical infrastructure and social programs. However, the timing of such increase raises concerns, particularly in an environment already strained by inflation. The potential consequences of the VAT and excise increase can be adverse. Some of these consequences are highlighted below:
- Potential decrease in corporate profits and investment: Higher VAT rate and excise levies, coupled with inflation, would lead to reduced consumer spending. When individuals have less disposable income, businesses would generally experience lower sales, impacting overall economic growth.
- Increased Cost of Living: For many Nigerians, the combination of rising prices and higher VAT and excise mean a significant increase in the cost of living. The proposed VAT increase could compound this effect. Higher taxes in an inflationary environment leads to reduced disposable income for consumers. As prices continue to rise, households face a dual burden: paying more for goods and services while also contributing a larger share of their income to the VAT pool. This could likely lead to increased poverty levels and greater economic disparity.
- Public Discontent: This is perhaps the most dangerous consequence, because the social implications of increased VAT during a period of high inflation can lead to public unrest. Citizens may feel that their financial struggles are being exacerbated by government policies, potentially leading to a loss of trust in leadership, and a potential breakdown of law and order.
It must be noted however, that the Nigerian Governors' Forum has recommended that the VAT rate be maintained at 7.5%. The Forum has significant political influence in Nigeria and has stymied similar tax and regulatory reforms in the past. Notwithstanding, as at the time of publishing this article, it remains to be seen whether the Forum's recommendation will be adopted this time around.
Conclusion
The interplay between inflation and tax in Nigeria presents a complex economic challenge. While increasing taxes (such as the VAT) may be necessary for government revenue, doing so during a period of high inflation could further strain households and stifle economic growth. As Milton Friedman aptly noted, inflation can act as a hidden tax, diminishing the purchasing power of the populace.
To navigate this precarious situation, the Nigerian government must adopt a holistic approach that addresses inflation through sound monetary and fiscal policies, while also being mindful of the impacts of taxation on citizens' livelihoods. Balancing fiscal responsibility with the economic realities faced by Nigerians is crucial to fostering a more stable and prosperous economy.
The opinion expressed in this article is solely personal and does not represent the views of any organization or association to which the authors belong.
