Increase the safest way to get SA out of the quagmire
Despite a slightly lower revenue shortfall compared with the R50.8bn estimated at the medium-term budget policy statement, the shortfall remains large at R48.2bn.
A significant portion of the shortfall is attributed to lower personal income tax collection. The unexpected announcement of fee-free education, which will cost the state about R56bn over the medium term, together with a rising debt-to-GDP ratio of 53.3%, left the Treasury with very little choice but to cut expenditure and increase taxes, including value-added tax (VAT).
The main taxes include a one percentage point increase in VAT to 15%, effective on April 1. Of the R36bn that the Treasury hopes to raise through taxes to reduce the budget deficit and fund fee-free higher education, R22.9bn will come from the increase in VAT.
Other increases include a jump in the general fuel levy of about 22c/l and a 30c/l rise in the Road Accident Fund levy, an increase in excise duties for luxury goods, a rise in estate duty to be levied at 25% for estates above R30m, increases in the plastic bag levy and motor vehicle emissions tax.
The increase in VAT was a bold but necessary move.
The three main contributors to gross tax revenues are personal income tax (37%), VAT (25.3%) and corporate income tax (17.9%). So why did the Treasury not opt for an increase in personal income tax?
There have been successive increases in personal income tax and a top income tax bracket of 45% was added for those earning above R1.5m.
Less than 14% of South Africans contribute towards personal income tax, so a further increase in this tax would put a strain on the small tax base. The revenue shortfall is so large that an increase in personal income tax would not have yielded the revenue required to stabilise the public finances.
Many have argued that corporate income tax should have been increased. An increase in corporate income tax contributes more as a share of GDP in SA than in most other countries. Globally, corporate income tax has been declining and if SA went against the global trend, this would affect its competitiveness.
Corporate tax in SA is 28% and when compared with the country’s main trading partners such as the US (which has reduced its rate from 35% to 21%), the UK (reduced from 30% to 19%) and China, where it is 25%, SA is an outlier.
SA certainly does not want to provide an incentive for companies to shift profits abroad. Taxing the rich or corporates will reduce the aggregate investment to GDP ratio, which could affect economic growth.
Studies have also shown that an increase in corporate income tax does not fall entirely on shareholders. Instead, companies tend to respond to higher corporate taxes by passing on the burden to consumers through increasing prices, lowering wages or retrenching workers.
It is obvious that the Treasury’s hand was forced by the large revenue shortfall. Before this recent increase, VAT had only been increased once — in 1993 to 14% from 10% in October 1991.
Since then, there have been amendments to the items that are zero-rated for VAT as part of a comprehensive macroeconomic policy framework aimed at alleviating poverty and lowering income inequality.
It has been argued that since low-income earners consume a higher proportion of their income than high-income earners, VAT is regressive.
During periods of sluggish growth in household incomes, an increase in VAT reduces real income. Given that low-income groups have a higher marginal propensity to consume, poor households are more affected by a consumption tax than any other income group.
Notwithstanding the elasticity of demand and supply, an increase in VAT is generally expected to increase prices of consumption goods and services as suppliers ordinarily shift the tax to consumers. However, the relationship of taxation between suppliers and consumers is a little more complex. It depends on demand patterns, income distribution and market structures.
There has been much debate about how the Treasury will plug revenue shortfall, with some arguing for more increases in indirect taxes instead of VAT.
VAT in combination with other taxes need not be regressive if exemptions are given and zero-rated items mainly consumed by the poor are extended. There are 19 basic food items currently zero-rated or exempted from VAT and more products such as sanitary towels may need to be added. However, to further support the poor, there is an above-inflation increase in social grants.
A one percentage point increase from 14% to 15% is an increase of 7.1% in the VAT rate. This means nonexempt goods will increase by 0.877%. A food basket of R8,000 of nonexempt and non-zero-rated goods, for instance, will increase by R70.18 due to the increase in VAT to 15%.
While the most important objective of taxation is to raise the required revenues to meet expenditure needs, an increase in VAT in combination with welfare support should mitigate an increase in income inequality. VAT will increase the cost of living for all households, but the burden to the poor has been softened.
The wide revenue shortfall is the Treasury’s Gordian knot, but the choice of increasing VAT may be sufficient to stave off a ratings downgrade by Moody’s ratings agency. It is the only major ratings agency that rates SA above sub-investment grade, or junk status.
A downgrade by Moody’s would result in significant amounts of outflows. The rand will weaken, inflation will increase, food and fuel pries will spike and the South African Reserve Bank will be forced to hike rates.
The already fragile GDP growth will contract and unemployment will rise. The impact of a ratings downgrade will be significantly more injurious to the poor than an increase in VAT.