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The case for increasing VAT

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While concerns around global growth and pressure on the South African economy have eased recently, the local economy is still fragile.
Moody’s decision not to downgrade the country’s sovereign rating at this stage was a welcome surprise, but the risk of a downgrade to junk status by any, or both, of the other two major ratings agencies remains an ever-present threat.
However, South Africa can still avoid a ratings downgrade to junk status provided fiscal consolidation is strictly adhered to and confidence- and growth enhancing economic reforms are implemented without any further delay.
This is according to Old Mutual Investment Group chief economist, Rian le Roux, who also believes that the need for fiscal flexibility means that the case for raising VAT in the 2017 Budget should be revisited.
The global and local economic environment has been looking up recently, says le Roux, with global growth concerns easing slightly, the dollar drifting weaker, higher commodity prices easing pressure on Emerging Markets and bouncing markets.
“However, the medium to longer team outlook is still a problem, with the medium-term clouded by structural headwinds and Fed interest rate normalization,” says Le Roux.
He outlines the difficulties that SA has faced so far this year, pointing out the tightening of fiscal and monetary policy in the first quarter of the year, rising inflation, the drought and a very weak start to the year as far as real economic activity is concerned.
“The weak underlying growth momentum in the first quarter – we currently estimate that the economy pretty much stagnated in the January to March period – was borne out by the shocking employment numbers released earlier in the week.”
For the full 2016 calendar year, he expects GDP growth of only around 0,5%, improving moderately to little over 1% in 2017.
“We do not expect a full-blown recession this year, but with the economy at stall speed, the risk of such an outcome is clear,” le Roux explains.  “The weak economy, deeply depressed confidence, the serious employment situation and rising social pressures mean that  the speedy implementation of economic reforms have now become critical.”
On a more positive note, he says that there have been some encouraging developments recently too.
“Importantly, the rand finally seems to be benefiting certain industries, with tourist arrivals bouncing back strongly in the first few months of the year and there are increasing reports from manufacturers of a switch in domestic demand away from more expensive imports to cheaper locally produced goods.
“The strong recovery in the Bureau for Economic Research’s manufacturing PMI in April will hopefully feed through into an actual improvement in manufacturing output in due course, a key requirement for a broader economic recovery.  A further positive is the ongoing seemingly constructive engagements between government, business and labour,” he explains.  “While this is welcome, it needs to deliver better policy outcomes, greater labour stability and improved business confidence to have any meaningful positive macro-economic impact over the short- to medium term.”
Apart from the need for economic reforms, it is important to ensure that National Treasury’s planned fiscal consolidation stays on course, according to Le Roux.  Regarding the latter, he believes National Treasury needs greater fiscal flexibility and that such flexibility can only be provided by an increase in the value-added tax (VAT) rate.
“With corporate tax revenues under pressure from a weak economy and the income tax burden having risen sharply in recent years, raising the VAT rate should be put back on the public debating agenda.”
Le Roux points out that studies have shown that VAT is a very efficient tax in South Africa, but most importantly, that the overall impact is not regressive due to extensive zero-rating. “Various studies have found that zero-rating makes the overall VAT impact neutral in South Africa, with households across the income spectrum paying roughly the same proportion of income as VAT,” he says.
In addition, the inflation impact of a VAT hike is actually very small, the IMF has indicated that indirect tax revenues in South Africa are actually relatively low compared to its emerging market peers and a study done by National Treasury a few years ago showed that the damage to the real economy of raising personal or corporate income taxes is far greater than raising VAT to yield the same additional revenue stream in all three cases,” he adds.
Le Roux explains how additional revenue from a VAT increase will improve fiscal flexibility by pointing out that a 1% VAT hike will lead to about R21-billion in revenue collection, a part of which can be transferred back to lower income groups and the rest used to cement deficit reduction.
“VAT is the only tax that can generate considerable additional tax revenue without much damage to the economy, inflation or inequality,” he says. “In comparison a 1% ‘across the board’ income tax hike would only yield about R9-billion, while a 1% hike of the top marginal rate would yield only about R3-billion.”

  • Peter Lomax

    I sorry a Vat increase will not solve the inherent floor in the South Africa economy. All it does is raises the inflation of products and services. You said that the manufacturing looked up but this sector has shed 100 000 jobs in the last quarter.