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VAT rate increase still on the cards

07 March 2016   (0 Comments)
Posted by: Author: Maarten Mittner
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Author: Maarten Mittner (BDlive)

Although surprisingly, the value-added tax (VAT) rate was left unchanged in the budget presented last month, the door is open for a higher rate during the next three years.

"The budget certainly hints at a possible increase in the VAT rate at some point," says Investec economist Kamilla Kaplan.

Barclays Research analyst Peter Worthington says it had expected Finance Minister Pravin Gordhan to hike the VAT rate. "Instead, he chose to rely heavily on the fuel excise and sin taxes."

Concern about raising VAT in an environment of contracting economic growth seemed to have swayed the government to look at other alternatives. A higher VAT rate could shave off at least 0.2% in economic growth already close to a recession.

Inflation is also edging higher, which could be worsened by an increase in the VAT rate — a higher VAT rate is inflationary over the short term.

Mr Gordhan indicated in the budget review that there may be room to increase indirect taxes, such as VAT, but gave little indication of when this could occur.

"In our view, the timing of a VAT rise could still coincide with meeting the financing needs of a larger project, such as the National Health Insurance plan," says Momentum Investments analyst Herman van Papendorp.

Mr Gordhan said any proposals would need to be accompanied by measures to improve the pro-poor character of expenditure programmes, so that the fiscal system remained progressive.

At this stage, it is unclear what the pro-poor relief will entail. Extensive relief measures relating to VAT are already in place, with social spending to serve as a cushion for the poor also much higher than when VAT was introduced more than 20 years ago. VAT is a moderately regressive tax on income, which means lower income groups pay more VAT than those with higher incomes.

Zero-rated and exempt items reduce the potential tax the fiscus can collect, with the Treasury stating in the review that the government forfeited an estimated R49.5bn by not charging VAT on zero-rated and exempt items.

Top on the list of zero-rated items are the basic food items, with forfeited VAT totalling about R20.1bn, followed by petrol at R16.2bn, and municipal property rates of R10.2bn.

Other exempt items, mainly in transport and education, delivered R1bn less in tax revenue.

The Congress of South African Trade Unions has called for the zero-rating of more food items, and in other areas, such as health. This had been resisted by previous finance minister Trevor Manuel. The government has rather been following the worldwide trend in VAT, reducing zero-rating and exempt items and focusing on a relatively lower VAT rate.

Analysts say the government’s decision not to increase VAT this year points to a view that it would have been detrimental in the short term. Political factors are clearly at play.

Nomura analyst Peter Attard Montalto says the political incentive to sell a higher VAT rate was clearly not available at this time.

"There might well be a VAT increase in 2017 or 2018, but it is politically impossible to announce yet," he says.

Mr Gordhan increased additional revenue by R18.1bn this year, while a 1% increase in VAT is generally thought to increase government VAT revenue by about R15bn, if spending patterns largely remain the same.

However, the figures show that VAT revenue remains vulnerable to slowing economic growth, which is the case now. VAT revenue growth is closely linked to firmer economic growth. In 2010, VAT revenue dropped 4.1% following the global financial crisis, but increased by 24% in the following year on better gross domestic product growth. In 2014/2015, VAT revenue increased 9.9%, but again softened to 7.7% last year on softening growth.

In 2016, VAT revenue was budgeted to be R283.7bn, but came in 6.4% or R5.7bn lower at R278bn. VAT is budgeted to increase to R301bn in 2017, but could undershoot again if economic growth contracts further.

It could be indicative that the Treasury has pencilled in further overall tax revenue growth of R15bn annually over the next two years, which is the figure generally seen as the increased revenue resulting from a 1% VAT hike.

The scene seems set for a higher local VAT rate in the coming years, but that will be dependent on the growth and inflationary environment.

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