VAT burden on the poor bothers governments
29 May 2014
Posted by: Author: Amanda Visser
Author: Amanda Visser (BDlive)
The effect of value added tax (VAT) on inequality remains a concern for countries around the world, as it hits poorer households harder than richer ones.
The regressive nature of VAT was highlighted during the second meeting of the Organisation for Economic Co-operation and Development’s (OECD’s) Global Forum on VAT in Tokyo last month. OECD deputy secretary-general Rintaro Tamaki said it was widely accepted that VAT could be regressive as it could place a disproportionate burden on poorer households who spend a large part of their income on necessities.
South Africa’s income tax system is progressive — the higher the income the higher the tax. Many countries, including South Africa, try to alleviate the regressive burden of VAT by implementing reduced or zero rates of VAT on certain products.
"It its widely known, however, that reduced rates of VAT are a very costly means of alleviating the regressive effects of VAT. This is because all consumers, not only low-income consumers, benefit from the lower rates," Mr Tamaki says.
The state forfeits the VAT income on zero-rated products, yet richer people are bigger beneficiaries of such a "subsidy", it is being argued.
In South Africa, paraffin was zero-rated in the late 1990s with an estimated loss of R150m a year to the fiscus. It was estimated that poorer households spent at least 20% of their income on fuel for cooking, lighting and heating. However, this relief was not effective, as few suppliers reduced paraffin prices when the product was zero-rated.
The largest single category of expenditure for the poor is food, it was noted in a study on women and tax by Terence Smith, aided by Debbie Budlender and Imraan Valodia, in about 2000.
According to the 1995 Income and Expenditure Survey, households in the bottom expenditure quintile spend up to 51% of their total average expenditure on food, while households in the top quintile spend 12%.
The VAT system was designed about 60 years ago by the French, says PwC VAT leader Charles de Wet.
The European VAT system was characterised by complexities due to different rates and numerous exemptions.
The "new age" VAT systems, such as those in New Zealand, Australia, South Africa and some African countries, are more "purist" in nature, with fewer exemptions and differential rates.
In South Africa, there are only a zero rate and the standard 14%.
There has been pressure on European countries to get rid of lower or zero rates, yet not one has been successful in doing it, Mr de Wet says.
Research by the OECD shows that a more effective and less costly way to provide assistance to poorer households is to target relief through the use of direct cash transfers, either through income tax or benefit (social grants) systems.
Michael Keen, deputy director of the fiscal affairs department of the International Monetary Fund, said in a presentation at the Tokyo meeting that reduced rates were a "badly targeted" way of helping the poor.
The poor spend a large proportion of their income on food (which have lower rates), but the rich spend "absolutely" greater amounts and therefore benefit disproportionately, he says.
Rate reductions are so poorly targeted at the poor that state spending (in the form of cash transfers or social grants) does not have to be much better targeted in order to benefit the poor, he says.
The challenge is to ensure that the people who need relief, get it, says Gerhard Badenhorst, a tax executive at law firm Edward Nathan Sonnenbergs in Johannesburg.
If there is a good distribution system it will be more effective to have fewer zero-rated goods and to channel the tax generated from the increase in the VAT rate to poor households.
Many activists have been advocating that educational books be zero-rated in order to promote literacy.
However, would it not be better to continue charging VAT on books, but to ring-fence the income and distribute it to schools with a lesser income, Mr Badenhorst asks.
"I do not think we will ever be without zero-rated products. However, the ideal circumstances will be a standard rate on all services and products (with) income generated this way redirected at poorer households."
Mr Badenhorst suggests keeping the current zero-rated products and services, but to reduce them selectively over time and use the new income to assist poorer households.
The government’s reaction to the Katz commission’s tax report during the 1990s was to accept the principle that there would be no move towards targeted relief as an alternative to zero-rating basic necessities — until there was certainty over the "effective delivery structures, with widespread acceptance".
"This is clearly not the case at present," the joint standing committee on finance said at the time (1996). This still seems to be the case in South Africa today.
PSG investment economist Dawie Klopper says governmental payment systems are no stranger to inefficiency, corruption and bribery.
Any new system to administer such cash transfers could easily turn out to be as costly as the current system for administering the controversial Gauteng e-toll payment system.
"The VAT system is well established and managed. It would be unwise to fiddle with something that is working well," Mr Klopper says.
This article first appeared on bdlive.co.za.