Big problems with Ramaphosa’s VAT plan

President Ramaphosa has repeatedly promoted significant changes to the list of VAT-exempt food items, with such a measure aiming to bring relief to South African households. 

However, several studies, including one by the National Treasury, show that zero-rating food items is ineffective in providing relief for poor South Africans. 

In his address to the National Council of Provinces last month, Ramaphosa reiterated the government’s plan to provide relief for South African households. 

“Among the measures to ensure that all South Africans have affordable access to sufficient food, the government is looking at whether the basket of food items exempted from VAT could be expanded to include more basic products.”

This list currently includes basic foods such as brown bread, maize meal, milk, rice, vegetables, and eggs. 

The last time the list was expanded was in 2018, following an extensive analysis of the impact of any expansion by the National Treasury. 

Director of Tax and Exchange Control at Cliffe Dekker Hofmeyr (CDH) Gerhard Badenhorst said the main aim is to provide relief to poor South Africans and potentially add protein to the list to address malnutrition. 

Badenhorst explained that VAT is an inherently regressive tax without any zero-rated items, as the amount paid by lower-income households as a share of disposable income is higher than that of richer households. 

When VAT was introduced on 30 September 1991 at a rate of 10%, only two food items were initially zero-rated – brown bread and maize meal. 

Subsequently, the number of zero-rated food items temporarily increased from 30 September 1991 to 31 March 1992 with the addition of another eight items. The zero-rating of these additional eight items was extended from 1 April 1992.

With effect from 7 April 1993, when the VAT rate was increased from 10% to 14%, the basket of zero-rated food items was expanded by nine more items to nineteen. 

Following the VAT rate increase from 14% to 15% on 1 April 2018, the zero-rated basket was expanded further by adding cake wheat flour and white bread wheat flour from 1 April 2019. Sanitary towels were also zero-rated, effective 1 April 2019.

Badenhorst said several global and South African studies have been conducted in the past decades to analyse the effect of zero-rating basic food items. 

The Katz Commission, which released its report in 1995, showed that zero-rating food items has only a modest benefit to the poor in rand terms and substantially benefits the rich. 

It also found that of the total revenue loss from zero-rating, a third of the benefits went to poorer households. 

The commission concluded that zero-rating food items may be considerably less beneficial to consumers than is commonly assumed.

It said this mechanism should not be considered in light of the erosion of the VAT base and its limited effect on poor households.

A 2015 study by the Organisation for Economic Cooperation and Development also found that zero-rating is a poor tool for supporting poor households. 

At best, rich households receive as much benefit as poor households, but they mostly tend to benefit much more than their lower-income counterparts. 

The study indicated that in some cases, the benefit to rich households is so large that the reduced VAT rate actually has a regressive effect in benefiting the rich much more in absolute terms.

A later study, focussed on South Africa, from the Davis Tax Committee argued that zero-rating does benefit poorer households. 

However, it also said that the benefit to the rich is far larger as they consume larger quantities of zero-rated goods. 

It noted that the poor benefit more from certain food items such as brown bread and maize meal, but the wealthy benefit substantially more from zero-rating of items such as milk and fruit and vegetables.

Accordingly, the wealthy not only benefit from the zero-rating of food, but they also benefit significantly more from some items than the poor. 

The Davis Tax Committee concluded that zero-rating is a very blunt instrument for pursuing equity objectives and strongly recommended that no further zero-rated food items be considered.

National Treasury conducted its own study in 2018 to review the zero-rating of some food items and potentially try expand the list to include chicken in some form. 

With regard to individually quick frozen (IQF) chicken products, Some panel members raised a concern that the definition was not sufficiently clear, which could give rise to abuse. 

Other concerns raised were the cost of foregone revenue, that zero-rating could encourage imports, and that the benefits would not be passed on to consumers. 

The panel stated that nutritional programmes would be more efficient to offset the higher cost for low-income households.