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VAT hikes lesser evil to raise tax revenue

Wednesday, 08 July 2015   (0 Comments)
Posted by: Author: Linda Ensor
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Author: Linda Ensor (BDlive) 

A HIKE in the value-added tax (VAT) rate would be less distorting for the macroeconomy should the government need additional funds in future, than a rise in personal or corporate tax rates, the Davis Tax Committee has concluded.

The committee’s interim report on VAT, which was submitted to Finance Minister Nhlanhla Nene in December, was released on Tuesday for public comment.

Trade unions and civil society organisations are likely to oppose suggestions that the VAT rate be increased because of the effect of this on the poor.

The state would need significantly more tax revenue if and when it implements its national health insurance plan. The report said that if the VAT rate — currently 14% — were raised for this or any other reason, the poor would have to be compensated, possibly by increases in social grants or with a better school nutrition programme.

The government has forecast VAT revenue of R284bn this year, which is 27% of total estimated revenue of R1-trillion.

The committee argued against any further zero-rating of food and against multiple rates of VAT, for example for luxury goods, saying this would increase the complexity and administrative burden of the tax. It also urged the Treasury to consider how to apply VAT to the financial services sector to mitigate the current cascading of the tax.

Financial institutions incur nonrecoverable VAT, which is an incentive for them to self-supply services or infrastructure to avoid the additional VAT resulting from outsourced services.

The committee also recommended the adoption of internationally accepted, explicit place-of-supply rules so cross-border traders understood where to account for VAT. Specific rules should also be devised for telecommunication services.

The committee conceded that an increase in the rate of VAT would be somewhat inflationary in the short run as prices of consumer goods would rise overnight. However, it believed this would be more efficient than increasing direct taxes, which in the long term would damp growth, reduce tax revenue and limit the ability of the state to reduce inequality through the expenditure side of the budget.

"An increase in personal or corporate tax rates would be much less inflationary," the report said.

However, such increases would have a more severe effect on real gross domestic product and employment than a hike in the VAT rate. "It is thus clear that from a purely macroeconomic standpoint, an increase in VAT is less distortionary than an increase in direct taxes," the committee’s report said.

The very slight negative effect of a VAT hike on inequality could be offset by state spending. The committee said inequality would decline if personal or corporate income taxes were increased as this would affect higher-income households most.

A Treasury exercise found that a three percentage point rate hike in VAT would generate R45bn. Rises of 6.1 percentage points in personal income tax and 5.2 percentage points in corporate income tax would be necessary to generate the same amount. An International Monetary Fund study found SA’s VAT system quite efficient.

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