A tough choice or a risk to economic recovery? – The Mail & Guardian

Increasing VAT will weaken consumer purchasing power in an environment where household debt remains high.

South Africa’s economy is still recovering from the post-Covid-19 downturn, yet the government has decided to increase VAT to boost revenue. This decision has sparked intense debate, with MPs suggesting that corporate or income tax increases would be a better alternative. But raising income tax is unfeasible given the fragile state of household finances, while higher corporate tax could lead to price hikes, as businesses tend to pass costs onto consumers when profit is threatened.

At a time when monetary policy tightening has already made borrowing more expensive, the middle class remains trapped under a rising debt burden. Although the South African Reserve Bank recently lowered the repo rate by 25 basis points, the reduction was marginal and does not significantly offset the aggressive interest rate hikes of 2022-23. Household debt remains alarmingly high, with the debt-to-disposable income ratio at 61.6% in the fourth quarter of 2023. Compounded by rising fuel prices, which have surged by over 12% year-on-year, increasing VAT in this environment will further weaken consumer purchasing power, dampening economic recovery efforts.

VAT is a regressive tax, meaning it disproportionately affects low- and middle-income households. Unlike corporate tax, which can be structured to target high-profit companies, VAT directly reduces consumer purchasing power, leading to lower spending and economic slowdown. In an environment where businesses are already struggling with weak demand, this move could further erode confidence and investment in key sectors.

In addition, businesses are likely to pass increased costs on to consumers, exacerbating inflation and making basic goods and services even more expensive. The expected revenue boost from VAT might not offset the broader economic consequences, as a slowing economy will generate less tax revenue over time. 

A recent study by the World Bank on VAT elasticity in emerging markets found that excessive reliance on VAT can reduce household consumption and slow GDP growth, particularly in economies with high inequality, such as South Africa.

The National Development Plan 2030 emphasises reducing inequality and ensuring economic growth benefits the majority, especially the poor and working class. However, increasing VAT contradicts this by disproportionately impacting low-income households and exacerbating economic inequality. 

Key goals undermined include:

• Poverty reduction: VAT hikes increase the cost of essential goods, making it harder for low-income households to afford necessities.
• Job creation: Reduced consumer spending could weaken demand in businesses, leading to job losses.
• Inclusive growth: Instead of progressive revenue solutions, this approach burdens consumers more than corporations.

The Economic Reconstruction and Recovery Plan seeks to stimulate demand and stabilise consumer spending. The VAT hike undermines this by discouraging household spending, negatively affecting businesses and job creation.

• Infrastructure investment: Weak consumer spending could slow economic activity, limiting tax revenues needed for infrastructure.
• Employment stimulus: Reduced consumer demand could slow hiring, especially in retail and services.
• SME support: Small businesses rely on consumer spending and higher VAT could shrink their customer base.

The VAT increase contradicts promises made in the State of the Nation address to lower the cost of living.

• Electricity costs: Households already face higher tariffs and VAT hikes add financial strain.
• Food prices: Although some items remain VAT-exempt, indirect cost increases make food more expensive.
• Household incomes: Higher VAT effectively reduces disposable income while wages remain stagnant.

Instead of increasing VAT, South Africa should explore alternative revenue mobilisation strategies and cut wasteful government spending. MPs have rightly suggested prioritising budget reallocation using policy frameworks such as the Medium-Term Development Plan Priorities. 

One of the most obvious cost-saving measures is addressing the bloated cabinet, which consumes significant public funds. With South Africa maintaining one of the largest cabinets in the world relative to GDP, rationalising government ministries and improving efficiency in public sector spending would reduce fiscal pressure without harming economic growth.

Furthermore, South Africa should leverage its international partnerships to mobilise funding from sources such as European development assistance, which is stepping in after cuts to USAid support. 

Africa has also invested in training and innovative financing expertise, particularly through collaborations with China and other global partners. It is time to put these resources to use in developing sustainable financing mechanisms. 

Furthermore, South Africa could explore broadening the tax base by closing loopholes in corporate taxation and enhancing tax compliance measures, rather than overburdening consumers.

Instead of increasing VAT, the country can learn from emerging and developing nations that have raised revenue through innovative means.

Sovereign wealth funds (Botswana, Norway, Singapore)

• Botswana’s Pula Fund: Uses diamond revenues to build reserves and stabilise fiscal policy. South Africa can leverage mineral wealth similarly.
• Norway’s oil fund: Invests petroleum revenues for long-term growth; a model this country could follow using mining profits.
• Singapore’s Temasek Holdings: State investments in high-return sectors generate revenue without raising taxes.

Sin tax and luxury goods tax (Thailand, Brazil, Mexico)

• Thailand and Brazil: Increased excise taxes on tobacco, alcohol and sugary drinks without burdening essential goods.
• Mexico: Taxes on high-sugar and processed foods both raise revenue and improve public health.

Public-private partnerships (PPPs) (Malaysia, Kenya, Rwanda)

• Malaysia: Successfully funds infrastructure through private-sector partnerships.
• Rwanda: Uses PPPs to develop energy and transport projects, reducing reliance on direct taxation.
• Kenya: Expands telecom-based revenue collection through mobile money taxation without impacting the poor.

Strengthening corporate tax compliance (India, Indonesia, Chile)

• India and Chile: Closed tax loopholes and improved collection efficiency, rather than raising consumer taxes.
• Indonesia: Implemented a digital economy tax, ensuring multinational corporations contribute fairly.

While increasing revenue is necessary, South Africa must ensure that tax policies do not stifle economic recovery. Relying on VAT hikes in a period of weak growth, high consumer debt and rising living costs could do more harm than good. Instead, the government should focus on:

• Cutting non-essential spending, including reducing the size of the executive and inefficiencies in government departments.
• Exploring alternative revenue sources through international partnerships and innovative financing strategies.
• Aligning fiscal policy with economic productivity, ensuring that revenue collection does not undermine growth and social well-being.

A well-balanced approach, one that strengthens fiscal sustainability without compromising economic recovery, is the only way forward.

Noluthando Qwelani holds an economics master’s and has worked in public service research for five years.