In the debate around a possible increase in the value-added tax (VAT) rate in South Africa, left wing trade unions are likely to point to the Organisation for Economic Co-operation and Development’s recent survey.
The survey suggests the South African government could raise revenue in ways that would not have an impact on impoverished households. VAT is a tax that hits the poor. The survey proposes alternative measures including the broadening of personal and corporate income tax bases by reducing deductions, credits and allowances.
The current tax exemption for a significant amount of interest earned by individuals could be reduced or abolished since it is only the affluent who have interest earning investments. The survey also recommends that taxes on property, such as municipal taxes on land and buildings, could be increased.
The OECD is an international organisation of 34 countries that cooperate on issues of democracy and economic development. Its stance on tax policy puts it in the same camp as the Congress of South African Trade Unions, South Africa’s left wing trade union federation, which has campaigned for increased taxes for the rich.
Ordinary people are feeling the pinch
The macro-economic arguments in favour of an increase are unlikely to divert the attention of the person in the street away from the fact that that any such increase will translate into an immediate hike in the price of many goods and services.
Household budgets that are already stretched to breaking point will now have to find more rands for the same shopping list or find ways to economise.
In the background to the debate on a possible VAT increase is the looming cost of the envisaged national health insurance scheme and the estimated R1 trillion cost of the proposed programme for South Africa to enhance its electricity generation through multiple nuclear-powered power stations.
Cosatu has already said it will oppose any increase in VAT. And people have become weary and cynical after recent increases in electricity tariffs, hikes in taxi fares and seemingly never ending newspaper headlines about government waste, corruption, and dubious multi-million rand golden handshakes to state employees.
The person in the street may ask whether clamping down on waste and corruption is not a better alternative to an increase in VAT.
Why a VAT increase is attractive
South Africa first introduced VAT in 1991 at a rate of 10%. This was hiked to 14% in 1994, a watershed moment as the country became democratic.
According to Treasury estimates, an extra R45 billion in tax could be raised by increasing VAT to 17%, whereas to raise the same amount by way of income tax would require personal tax rates to rise by over 6%.
VAT is also attractive because the cost of collection is low. In contrast, income tax requires a huge and expensive bureaucracy to administer and enforce. A significant proportion of the money collected is consumed by the cost of collection.
Moreover, VAT is far less vulnerable to tax evasion than income tax. There is no way, short of shoplifting, for a supermarket customer to duck the VAT that’s included in what must be paid at the check-out till.
In 2013/14 VAT in South Africa is estimated to have yielded R237 billion and is estimated to yield R267 billion in 2014/15. VAT is second only to personal income tax in the amount of revenue raised for the state.
Many essential food items are zero-rated for VAT. A narrow range of services are exempt from VAT, including educational services and public road and rail transportation.
Currently, the list of zero-rated food includes brown bread, maize meal, rice, dried beans, lentils, tinned pilchards, milk, vegetables, fruit, eggs and paraffin. These are all staple items in the shopping list of low-income consumers.
A simple versus a differentiated approach
The optimal way of increasing state revenues is via economic growth and job creation, which leads to an increase in gross domestic product, the flow-through effect of which is to boost tax collections.
In the short term, significant economic growth seems unlikely. Current economic growth in South Africa is sluggish with gross domestic product increasing at only about 2% per annum. Unemployment remains stubbornly high.
Fairness suggests that VAT should be imposed at differential rates; the more luxurious the goods or services, the higher should be the rate.
But experience has shown that VAT, imposed at a single rate, is easier to administer than VAT systems which impose the tax at numerous different rates. In South Africa VAT is imposed at only two rates, namely 14% and zero per cent and is payable only by vendors who have registered.
South Africa has thus opted for simplicity in the VAT system rather than the greater fairness of imposing VAT at several differential rates.
International experience in the difficulty of taxing services has led many developing countries to impose VAT on only a limited range of services. South Africa, however, imposes it on services with only a few exceptions.
A hard sell for government
A committee appointed to review the country’s tax regime has recommended in its interim report that the government increases VAT. It does, however, state that it is firmly opposed to any additions to the current list of zero-rated items.
At this point in time an increase in the VAT rate is far from a done deal. Even if an increase in the VAT rate makes sense from an economic point of view, the political cost to the government of alienating significant numbers of voters may, in the end, tip the balance the other way.
Public acceptance of an increase in the VAT rate will hinge on whether the deeply-rooted perception can be changed that VAT hits the poor harder than the rich.
At grass roots level, this seems self-evidently true. Where a food item is subject to VAT, a poor consumer will feel greater pain in paying the tax than will an affluent shopper because the tax is a higher proportion of the poorer person’s income. That economists argue this is to some extent a perception, rather than reality, is unlikely to change peoples' minds.