VAT ratings a zero-sum game
The one percentage point increase in value-added tax (VAT) that Finance Minister Malusi Gigaba announced in the budget on Wednesday has gone down very well in the market. But it isn’t going down well at all with the opposition or the labour movement or community groups. And the ANC itself is ambivalent: its parliamentary caucus, according to finance committee chairman Yunus Carrim, did not support the increase and is concerned the poor will be hit hard. Its secretary-general, Ace Magashule, has said the government should consider adding more items to the list of zero-rated items to cushion the poor from the effect of the higher rate.
Faced with a gaping fiscal hole and the threat of being roundly junked by the ratings agencies, Gigaba had to offer a revenue measure that could be relied on to bring in large sums of revenue. A VAT increase was the only real option, and there was even serious thought of a two percentage point hike rather than the one percentage point hike.
That 85% of the VAT take comes from just 30% of households is little comfort to poor and middle-class people, reflecting simply how unequal SA is. The effect even of a one percentage point increase on poor households will be significant, especially combined with the hike in the fuel levy, which tends to affect the price of all items in the consumer basket, including zero-rated ones such as bread.
But would it help, as many in politics, labour and community organisations believe, to add to the list of zero-rated items? There are 19 zero-rated foodstuffs, including brown bread, fresh fruit and vegetables, tinned pilchards, milk and lentils, but excluding meat, chicken and fish. Other items such as fuel, paraffin and education are not subject to VAT.
The 19 foodstuffs are a nice list of what proponents of healthy living might like the poor to eat. But arguably they are quite a poor reflection of what poor households actually eat.
White bread and fizzy drinks are not on the list, even though they feature in many poor households’ baskets, as does chicken, while fresh fruit is much more likely to appear in rich households’ baskets than in those of the poor. Zero-rated kiwi fruit was one food of the rich that was cited as an example. It’s one that reflects precisely the problem of adding more to the zero-rating list, which is that in relative terms the benefit goes much more to higher-income households than it does to lower-income ones, raising the question of how well targeted such zero ratings are.
The trouble is, as always in economics, that there are tradeoffs. SA has long been able to keep its VAT rate low by international and emerging-market standards because it has such an efficient VAT system, and that is mainly because SA has kept it simple. SA has a single rate, while some countries have different ones for luxuries and staples, and it applies to almost everything. The result, as the IMF found in a recent study, is that the gap in SA between the VAT that should be paid and what is actually paid is very low by global standards.
The risk is that the more complicated the system becomes, and the more exemptions and differential ratings are introduced, the more difficult it becomes to administer well and the greater the chances of noncompliance. The existing zero ratings already come at significant cost to the public purse: if much of that will benefit the rich, not the poor, it wastes public resources that could be better spent.
Raising social grants to compensate poor households for the effect of raising VAT is what the government has opted for this time, but other targeted interventions could and should be considered, such as food vouchers or boosting school nutrition programmes. If poor people can’t even afford food, VAT zero rating will do nothing for them. If research shows zero-rating a product is a poor way to assist the poor, then those opposing a VAT hike, and policy makers in general, should rather focus on innovative ways to achieve that end.
FRESH FRUIT IS MUCH MORE LIKELY TO APPEAR IN RICH HOUSEHOLDS’ BASKETS