Smart tax on alcohol will counter bootleggers
As finance minister Tito Mboweni prepares to deliver his budget, he is faced with various challenges, including GDP that contracted by 8%, rising unemployment and government debt, and a demand to finance a Covid-19 vaccine initiative while stimulating the economy into a positive growth path.
One of the contributing factors to this economic conundrum for the government of SA is the total ban of alcohol sales three times in a single financial year — leading to a R36.3bn loss in sales revenue and a R29.3bn loss in direct tax contribution (including excise tax). In addition, 200,000 of the 1-million jobs supported by the industry value chain are believed to have been lost as a result.
Justifiable or not, SA took a more extreme approach in limiting alcohol sales compared with other similar-sized markets in Africa and globally. Of the many countries competing for the estimated $350bn (R5-trillion) global wine market, SA was the only wine-producing country that prohibited production and export of its wines and other alcoholic beverages for five weeks of its initial prohibition.
The second ban of sales in July and August led to concerns emerging among spirits exporters in Europe about trade imbalances between the EU and SA. SA wines continued to be exported to the EU under the quota arrangement while SA was not absorbing imports because of extended prohibition of both off- and on-consumption sales.
It is important to recognise that export bans, prolonged closures and excessive taxation of alcohol above the rate of inflation will slow SA’s recovery, threaten further job losses and cost the Treasury vital revenue — revenue the government needs to fight the pandemic. In particular, it is worth noting the impact of the two bans on sales of alcohol in SA last year. These actions were designed to protect health, but they had the unwanted effect of stimulating the supply of alcohol on the illicit market to meet a new surge in demand.
The Organisation for Economic Co-operation and Development (OECD) reported that not only was there a drop in excise tax following the ban, but 470 stores were looted and there were reported to have been substantial increases in the smuggling of alcohol into the country.
Such an increase in illicit trade is difficult to counter. Consumers who were satisfied with the price and quality of the illicit product are especially unlikely to return to buying legitimate products if the excise tax rise is perceived as excessive.
The February 2021 budget offers an opportunity to return alcohol taxation to a level that will be more acceptable to consumers and thus improve South Africans’ health by reducing the incentive to consume illicit alcohol.
Limiting any increase in tax to levels below inflation — for instance, to half of inflation — would offer several benefits. First, it would help post-Covid economic recovery and jobs. From the Treasury’s perspective, it would return to the policy of excise increases targeted to, rather than above, inflation. This could attract consumers back to the legal market and deter further illicit consumption, which improves both the health of South Africans and Treasury’s revenues.
SA’s legal alcohol industry contributes significantly to the economy, accounting for 3.4% of GDP and 5.6% of government revenue. It supports employment (direct, indirect, induced) of about 500,000 people, with an employment multiplier of 8.84 for the industry.
Following increases in excise duty in 2019, and of between 4.4% and 7.5% again in 2020, the Treasury noted in the 2020 budget statement that the “excise burdens for most types of alcoholic beverages ... currently exceed the targeted level as a result of above-inflation increases and price fluctuations”. Because inflation is now lower as the economy has slowed, the 2020 rise in excise duty led to increases effectively above the rate of inflation and thus above the policy target.
Overall household consumption in SA declined more than 15% from April to June 2020, an amount almost four times higher than during the global financial crisis of 2008-2009.
As income falls, one would naturally expect alcohol consumption to fall, because it is highly sensitive to disposable income. Add to this the dramatic impact on sales with 14 weeks of alcohol bans (including a partial export ban) in 2020, with sales of beer falling 23.1%, spirits 21.9%, and wine 21.0%. These figures negatively impact employment (-1.0%) and GDP (-1.2%). The impact of the third prohibition is expected to be severe, and it will exacerbate the GDP and tax losses from the first two alcohol bans significantly.
Alcohol taxation can help plug the revenue gap, but not if rates are excessive and/or increases are steep, both of which deter legal consumption and thus cost the Treasury revenue. As personal income has fallen, the risk of consumers buying alcohol in the unsafe and untaxed illicit market has grown. Appropriate levels of excise duty not only move purchases to the legal market but also help spur SA’s overall economic recovery because the highly efficient legal alcohol industry has higher job multipliers than the national average.
At a time of great uncertainty about SA’s economy, it is always good to return to basics. As the SA Revenue Service notes: “The primary function [of excise duties] is to ensure a constant stream of revenue for the state, with a secondary function of discouraging consumption of certain harmful products; ie. harmful to human health or to the environment.” In SA’s current situation, both considerations imply a reduced rate of alcohol excise tax increase in this year’s budget.
Following that policy of returning to the target, consumption of legal, duty-paid products will recover more quickly, while discouraging consumption of harmful illicit (and thus untaxed) alcohol. Implementing such smart tax policy at this critical juncture in the pandemic will help drive growth and employment in the eventual economic recovery.
The focus of Mboweni’s budget should be on policies that aid SA’s economic recovery and recovery from the pandemic. Excessive rates of taxation on alcohol will do neither. Instead, they will stimulate illicit trade.