The recent increase in Value-Added Tax (VAT) from 14% to 15% came into effect in April 2018. The hike is expected to raise R22.9 billion in additional revenue in 2018/19. As the first VAT increase since 1993, the move has been understandably controversial.

Impact on inflation

Linda Sing, adjunct faculty, strategy, economics and innovation at GIBS, notes that inflation has crept up month-on-month from 3.8% in March to 4.4% in April, which can in part be attributed to the VAT increase, coupled with increasing fuel levies and the sugar tax.

Dr. Adrian Saville, professor at GIBS and chief executive at Cannon Asset Managers, explains that inflation refers to a process whereby there is a general increase in prices across a broad basket of goods and services over long periods. “By this definition, the increase in the VAT rate constitutes a price increase, but is not ‘inflation’. That said, the reality is that this once-off VAT rate increase is likely to have served as an agitator or catalyst that provokes a set of knock-on price increases as the April rate increase passes through the system and nudges prices higher over a drawn-out period, rather than a naïve case of ‘once and done’ on 1 April 2018,” he says.

Sing believes that the VAT increase will continue to contribute towards higher inflation in the short to medium term. “In the long term, we’ll adjust our spending, but that then impacts aggregate demand, which puts pressure on things like unemployment and income inequality. It doesn’t help that there are external factors impacting us too, like the investor flight away from emerging markets, which we’ve seen globally, which impacts on the exchange rate and makes everything more expensive. It just exacerbates the whole inflation problem.”

Impact on business
Saville notes that arguably the biggest immediate effect of the VAT increase on businesses was in the administrative impact of ensuring prices were adjusted for the 1 April VAT rate increase.

“The administrative challenge has taken a range of forms, including the need to re-issue invoices on transactions that were not completed; resolving VAT receipts that were lost to the company through early invoicing and late payment; and having to get product and service prices adjusted with very little lead time or warning, and no experience of having to deal with VAT rate adjustments since 1993, when the VAT rate was last increased from 10% to 14%,” he says.

“Some businesses could be out of pocket if they contracted just before the increase,” says Sing. “You were contracting at 14%, but you’re buying at 15%, so you might miss out on that 1% on an existing contract.”

Impact on low-income households
Government countered accusations that the VAT increase would disproportionately affect low-income households by citing a list of zero-rated items, along with an “above-inflation increase in social grants”.

However, Sing notes that increasing inflation always disproportionately impacts the poor and that low-income households don’t only buy zero-rated goods. “Things like electricity, cleaning products or clothing are not VAT-exempt. Some research suggests that VAT-exempt items and services represent a low proportion of what poor people buy.”

She adds that while social grants may also have increased, it’s not obvious whether these increases were sufficient to take into account not only the VAT hike, but increased fuel prices and the sugar tax too. “To be honest, I don’t think our current research truly understands the way poorer households shop and their buying behaviours. That would be great research to have to understand the real impacts of the increase in VAT.”

Finance Minister Nhlanhla Nene, in his Budget address, noted Treasury had established a panel to review VAT-exempt products and to consider how best government could mitigate the impact of the VAT increase on poor and indigent households.

The panel’s terms of reference were later amended to allow the panel more flexibility to make proposals that might be taken into account in the 2019 Budget. The panel may also receive and consider submissions on the zero-rating of non-food items.

However, writing for the Daily Maverick, Dr. Seán M. Muller, senior lecturer at the School of Economics and Econometrics and research associate at the Public and Environmental Economics Research Centre (PEERC) at the College of Business and Economics, notes that there are two major problems with expanding the number of zero-rated goods. The first is that government loses out on revenue on these goods that it currently gets from high-income households and the second is that the removal of VAT may benefit producers more than consumers.

“The danger of ill-considered zero-rating is that in some circumstances it could simply transfer government revenue to firms, worsening the distributional effects of the VAT increase rather than mitigating them,” Muller writes. “While the National Treasury has pointed this out in the past in response to proposals to zero-rate books, it is a danger that is continually omitted in commentary on the subject.”

...there is no viable way to fully protect the poor from the VAT increase.

His view is that, despite government commitments to the contrary, there is no viable way to fully protect the poor from the VAT increase.

Sing agrees, adding that zero-rated goods are a form of government subsidy and that all such subsidies tend to favour the wealthy. They can also impact public finances. For example, if electricity were to become zero-rated, Eskom’s funding would be severely affected. For an entity that is already in financial difficulty, that could be catastrophic. A further problem is that the increased pressure on consumers is making it even less affordable for them to save.

Looking ahead
Sing does not believe that there is much more fiscal leeway for government to provide any more of a “social safety net”, unless it does something “silly” like implementing price caps, which would cause market disruptions in terms of demand and supply.

“Our social safety net at the moment is as much as we can afford,” she says. While she notes that initiatives like the NHI could in theory help to mitigate healthcare costs, it’s another thing that requires spending and it’s unclear how it will be funded.

“The danger is perceived pressure on consumers,” she says. “I’d imagine that people with wealth are looking at uncertainty around land reform and arguments for higher wealth taxes, and then the possibility of medical aids being effected with the introduction of national health insurance (NHI). I guess it’s a question of how much relatively privileged South Africans will be able to bear. It’s a fine line we need to walk.”

She adds that the VAT increase also needs to go hand-in-hand with better governance and use of resources. “We can’t keep on hearing how the public should fund the fiscal gap, and then the Auditor General’s report comes out and shows we’ve lost billions through the municipalities.”

Saville is less inclined to venture an opinion on the longer-term effects of the VAT increase. “We need to see how it materialises in the form of inflationary pressures and establish the impacts on different income groups and different consumer groups,” he says. “As much as we might want to speculate, I think the reality is we have to wait and see.”

Box: Key takeaways

·       Hidden VAT surprises for consumers: Saville says there are many places consumers don’t easily see price increases. “For instance, where spend is a very small component of the total basket – such as ATM fees. Another way in which the VAT increase passes into the consumer basket, but is disguised, takes the form of items such as a car financing,” he says. “The car price will have moved 1% higher on 1 April 2018, and the cost of financing the car will have similarly increased. Even if the impact is modest, it unquestionably represents a higher cost of financing.”

·       Passing on the increase: Sing says the biggest issue for businesses is whether they can pass on the 1% VAT increase to consumers, which will depend on the type of the product, the industry and business model. “I’m not quite sure how sustainable it is to just keep squeezing backwards along the value chain. For example, retailers have already been pressuring manufacturers to reduce costs for the last decade since the global financial crisis.”

·       Economics goes beyond fundamentals. Sing notes that it will be important to tap into Ramaphoria to manage and leverage public sentiment. “Things like economic growth prospects are critically dependent on investor and market sentiment and are ultimately self-fulfilling prophecies,” she says.

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