VAT hike will hit the poor hardest as their spending power is eroded
The regressive tax increase will worsen poverty and increase inequality — and there are viable alternatives, writes Gilad Isaacs
The value-added tax (VAT) hike announced in the budget speech threatens to erode the spending power of poor and lower-income households, worsening poverty and increasing inequality.
VAT, charged on most goods and services at a rate of 14%, is levied irrespective of how much the consumer earns, making it a regressive tax.
Taxes on goods (VAT plus excise duty) hit the poor hardest. The lowest-earning 10% spend 13.8% of their disposable income on these taxes compared to 12.6% of the highest-earning 10% in the country.
The Davis Tax Committee has conceded that raising the VAT rate would increase inequality. It would also make basic goods more expensive and necessitate a proportional increase in social grants and wages to maintain the buying power of the poor.
The statistical model used by the Treasury to support a VAT increase rests on highly improbable assumptions.
While VAT is successful if considered solely from the perspective of revenue-raising, ignoring its potential negative effect on the poor and the other available options, taxes that hit the poor hardest, make consumption of basic goods more expensive and increase inequality should not be entertained.
Overall, taxation in this country is mildly progressive, meaning the wealthier pay a higher share of overall taxes. But given the extreme levels of inequality in SA, the system is not progressive enough. And taxes paid by households are less progressive than in comparative developing countries.
The share of revenue from personal income tax (PIT) fell from 43% in 1999 to 30% in 2007. This was despite strong growth in the number of PIT taxpayers and significant wage growth among earners in the higher-income bracket.
This was largely due to falling PIT rates, strong corporate profits and the consistently high share of VAT. The tax rate for the highest earners fell from 45% in 1990 to 41% in 2016 (in the two decades prior to democracy it averaged 51%).
A South African Revenue Service (SARS) study shows that the share of tax paid by those earning above R1m has fallen between 2006 and 2015 — and fallen more than their share of overall taxable income, which means their relative contribution has declined.
The share of corporate income tax (CIT) in the overall tax mix rose prior to 2007-8 on the back of strong corporate profits and better tax collection, and subsequently fell amid slower economic growth.
While corporate profits boomed, the CIT rate was decreased from 50% in 1990 to 28% in 2016-17. According to the World Bank’s Doing Business Index, SA’s effective corporate tax rate (total tax and contribution rate) is well below other emerging-market peers and the fifth lowest in Africa.
VAT has contributed 24%-27% of tax revenue and been held constant at 14% since 1993. Despite wealth inequality in SA being extreme — the top 10% of South Africans hold at least 90%-95% of its wealth, while the top 1% holds 50% or more of its wealth — taxation on wealth or income from wealth is low.
This includes direct tax on assets such as property, income from holding assets (such as capital gains) and inheritance.
Capital gains tax, for example, raised only R17bn in 2016-17, a mere 1.5% of tax revenue. Because not all capital gains are taxed, in 2017 individuals paid a rate of 16% on capital gains, and companies 22%.
Tax on inheritance — estate duty — is levied at only 20% and raises revenue worth 0.05% of GDP, compared with the Organisation for Economic Co-operation and Development average of 0.2%.
SA has no annual "net wealth tax" that would tax the total value of wealth held in a given year. Considering large amounts of wealth were accumulated under apartheid, that this wealth is passed between generations, and that black earners have less assets to begin with and must support more dependents, low taxes on wealth are indefensible and perpetuate inequality.
The ability of SARS to raise the requisite revenue has been undermined by state capture. Judge Dennis Davis notes "erosion of the integrity of SARS" and previous SARS managers point to loss of expertise. Specialist units pursuing tax evasion have been gutted, while there is an indication that companies and individuals associated with state capture are not tax compliant.
At the same time, capital flight and tax evasion and avoidance are endemic, though the exact cost is difficult to pinpoint; various estimates suggest it runs into many billions of rands. One estimate calculates that illicit financial flows from SA constitute 5%-9% of all trade, and little tax will be paid on such funds.
Instead of uniformly raising VAT, the list of zero-rated items (products upon which VAT is not charged) should be expanded, targeting goods generally bought by low-income earners, such as bread, poultry, flour, candles, soap, basic medicines, pay-as-you-go airtime and education-related items.
This will also benefit higher earners but the share of disposable income spent on these goods by the poor is higher. Even taking into account the benefit to wealthier households and the potential capture of some gains by retailers, this will have positive distributional outcomes (and generally no less so than other pro-poor government policies, except social grants, which are highly redistributive). It will also assist in ensuring basic needs of poorer households are met.
Instituting a land tax, particularly on unused land, and increasingly property taxes, particularly on nonresidents and those owning multiple homes, would also help close the gap
A higher VAT rate (for example, 20%) should be levied on luxury goods. These include goods bought only by the rich, such as yachts, as well as upper segments of other goods markets, for example, fancy cars, expensive fridges, and so on.
The selection of items should not place goods that poorer households save for beyond their reach.
Given the existing tax administration systems this can be feasibly implemented. And given that a higher share of luxury items are imported, this should not unduly dampen domestic demand and could modestly assist the balance of payments.
These changes could be made in a tax-neutral manner. The revenue gap could be closed through repairing the administrative capacity of SARS, including its ability to tackle tax avoidance and evasion by corporates and the wealthy.
This requires a change in executive management and various administrative measures, as well as governance reforms aimed at greater independence.
The gap could also be closed by raising personal income tax, particularly on the highest earners. For example, in 2015 an effective tax rate of 40% on those earning between R500,000 and R1m and 45% on those earning above R1m would have raised additional revenue of R5.4bn and R5.3bn respectively (though some seepage is likely to occur).
Increasing corporate income tax would also assist. In 2015, effective tax rates of 30%, 32% and 35% would have raised an additional R13bn, R26bn and R45bn respectively (though this is likely to be somewhat less due to avoidance and/or a fall in taxable profit).
An annual net wealth tax could also be instituted. International comparisons suggest this could raise anywhere between R22bn and R154bn, though this degree of uncertainty is a result of a lack of adequate data.
Instituting a land tax, particularly on unused land, and increasingly property taxes, particularly on nonresidents and those owning multiple homes, would also help close the gap.
Increasing other taxes on property, or income from property, such as capital gains tax, estate duty and securities transaction tax, would assist. For example, levying capital gains tax in line with a top marginal tax bracket of 45% could raise an additional R4bn.
In a country plagued with high levels of poverty and inequality, every instrument must be brought to bear on solving these challenges. The tax system is one tool.
A detailed process of engagement with all social partners should be undertaken to find an appropriate means of raising the required revenue. A unilateral increase on the least progressive tax component — VAT — will harm the poor and lower-income earners.
• Isaacs is director of the Corporate Strategy and Industrial Development research programme, School of Economic and Business Sciences at the University of the Witwatersrand.