New VAT plan for South Africa

The National Treasury is considering a smaller VAT hike as part of a set of proposals that could enable it to fund an estimated R60 billion shortfall in South Africa’s Budget. 

However, this proposal has met fierce opposition from parties within the Government of National Unity (GNU) and business and civil society organisations. 

Many of those opposed to the VAT hike have called on the government to find ways to cut spending to reduce the R60 billion shortfall rather than burden South Africans further with tax increases.

While an increase in VAT is politically unpopular, it is among the easiest taxes to administer and adjust. 

Crucially, it is also broad-based, meaning it should not exacerbate South Africa’s extremely narrow personal income tax base. 

The draft Budget intended to be presented on 19 February pencilled in a real increase in spending of 0.9%, or R173 billon, a year over the medium term. 

This increase in spending would have been mainly financed by the two percentage point increase in VAT. To help the poor, the Treasury proposed expanding the list of tax-exempt foods.

After stiff opposition from GNU members, the Budget Speech was postponed to 12 March. The Cabinet will present the Treasury with a set of options to manage the R60 billion shortfall. 

One of these proposals is a smaller VAT hike of around one percentage point coupled with spending cuts or tax hikes in other areas, such as fuel levies or sales taxes. 

The Treasury is believed to favour an increase in VAT and/or other taxes as it will provide a long-term solution to the shortfall. 

Other proposals, such as a pause on pension fund contributions for public servants, have been opposed by Treasury as it will only provide short-term relief. It could give it space to review government spending further. 

“Tax increases are never ideal, but we must keep an eye on the bigger goal of fiscal consolidation,” Old Mutual chief economist Johann Els said at an internal economic briefing.

In a fragile economy, it’s crucial to strengthen public finances in a way that appeals to investors and credit rating agencies. 

“This might not be pleasant in the short term but may be necessary for South Africa’s long-term economic prospects,” he said.

“If the government chooses not to raise VAT, we could see severe spending cuts jeopardising critical areas like health, education, or social grants. One has to decide which route is ultimately the least damaging.”

Els emphasised that a higher VAT rate spreads the tax burden widely, unlike targeted hikes in personal or corporate income tax. 

From an investment perspective, demonstrating fiscal discipline could trigger positive reactions, such as improved credit ratings, enhanced foreign inflows, and, eventually, greater economic stability.

VAT hikes present significant problems, particularly in a weak economy with a consumer under immense pressure. 

The first challenge is that such a hike may not generate the revenue expected. This was the case when the government raised VAT to 15% in 2016. 

Nedbank chief economist Nicky Weimar explained that this VAT increase was ill-timed, with consumer spending growth slowing along with the broader economy. 

As a result, the VAT increase did not result in greater tax revenue for the government, as consumers spent less. 

VAT is a consumption tax levied on goods and services at each stage of the supply chain. Ultimately, the end consumer bears the cost.

If this consumer is under pressure and is not spending, VAT collections are unlikely to grow. 

Weimar explained that this time, the outcome may be different as the timing of the increase is better, with consumer spending growing as interest rates and inflation come down. 

However, this does not account for the potentially disastrous impact a VAT hike would have on households still under immense, albeit reduced, pressure. 

John Manyike, head of financial education at Old Mutual, said that any increase in VAT needs to be carefully scrutinised for its impact on household finances. 

“Millions of South Africans live in poverty or are reliant on social grants as their primary source of income. Even a relatively small adjustment in VAT can shrink disposable income significantly,” Manyike said. 

This is especially true for those who spend most of their money on essential items such as transportation and food. 

While zero-rated goods offer some relief, a 2% hike will still filter into everyday costs, putting more pressure on those already struggling.

Instead of increasing South Africans’ tax burden, Manyike suggested that the Treasury focus on systemic spending issues such as wasteful expenditures, poor service delivery at the municipal level, and weak accountability. 

Manyike said that higher taxes could be seen as a stopgap unless accompanied by more decisive reforms and prudent expenditure management. 

“Increasing VAT may bring short-term relief to the public purse, but it doesn’t solve the underlying problems of fruitless expenditure or corruption.”

“We need to see stricter controls, better financial governance at local and national government level and a concerted effort to ensure taxpayer money is spent responsibly. Without that, consumers can feel like they’re being asked to pay more just to finance the same inefficiencies.”