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Zeroing in on VAT change

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Johannesburg - The Davis Tax Committee chaired by Judge Dennis Davis is telling National Treasury what it likes to hear: VAT is good and zero VAT on basic foods is bad.

An interim report on the VAT system was released for public comment this week after it landed on Finance Minister Nhlanhla Nene’s desk in December. It makes the case for increasing VAT from the current 14% as being a much better option than raising personal or corporate taxes – if government wants to raise taxes at all.

This repeats verbatim Treasury’s argument over the years that the zero-rating of basic foods is a hopelessly blunt instrument while the anti-poor regressiveness of VAT is probably exaggerated.

The Davis committee calls this a “perceived” regressiveness.

The usual argument is that VAT hits the poor hardest because they consume their entire income while the rich do not. In effect, they pay 14% VAT on all their income while the rich do not, making VAT the only tax that hits the poor harder than the rich.

Overcoming this objection to VAT is key if Nene wants to buttress state coffers because the tax is considered to be the best state funding mechanism on just about every other score. It is easy to administer and does not hurt the economy the way other taxes do.

The tax committee had Treasury model the effects of raising an extra R45bn in tax using either VAT or income taxes. According to Treasury estimates, to achieve this would either require VAT to rise from 14% to 17% or for personal income tax to rise by 6.1%.

Its report adds that the figures are random and not meant to indicate a recommended VAT rate.

Davis’ resounding judgement is that VAT is the way to go if you don’t want to do too much damage to the economy, and it will lead to a “very small” increase in inequality. The judge’s report also has nothing nice to say about the zero-rating system that leaves a selection of “basic foods” with 0% VAT. Zero-rating is specifically meant to address the regressiveness of VAT.

Not adding anything to the zero-rated list is the only suggestion in the report that is a “strong” recommendation.

If a way could be found to compensate the poor consumer for the higher cost of food, the zero-ratings should be scrapped, adds the report.

VAT contributes about a quarter of all tax revenue – last year it was R267bn. About R19bn is lost to zero-rating basic foods, says the report.

The zero-VAT rating amounts to a “generalised subsidy which mostly favours the richest sectors of the population at a high cost for public finances”, it says.

This sounds similar to former finance minister Trevor Manuel’s view in 2008 when he said: “Evidence suggests that existing VAT zero-ratings and exemptions in almost all cases confer substantially more benefits on middle- and higher-income groups than on lower-income groups.”

This “subsidy” for the rich is particularly apparent with milk and fruit. They are zero-rated but are overwhelmingly consumed by higher-income groups.

The top 10% income group saves R208m a year thanks to not paying 14% VAT on milk, while the bottom 10% only save R32m, according to the tax report.

With fruit, the top 10% score R167m while the bottom 10% a mere R14 million.

Despite this problem being clearly limited to certain items, the Davis committee does not spend any time in its report on refining the zero-rated basket.

Professor Ada Jansen from Stellenbosch University’s economics department was the lead author on the paper the Davis committee used to demonstrate that VAT actually subsidises the rich.

But a 2013 research paper co-written by her argues that there is room to improve the zero-rating basket by excising the items that are mostly bought by the rich.

The last major tax inquiry similar to the Davis one, the Katz Commission of Inquiry into Taxation in 1995, recommended that the basket of zero-rated goods should be reviewed and adjusted on a continuous basis to maximise equity effects. But apart from the inclusion of paraffin in 2001, that never really happened.

Jansen’s case study looked at sales of fresh vegetables, such as mushrooms and lettuce. Both items are zero-rated, but almost exclusively consumed by the relatively wealthy.

On the other hand, tinned fruit is an anomaly excluded from the list but overwhelmingly bought by the poor.

The Davis proposals show this is probably even more true for milk and fruit.

Where 0% VAT unambiguously benefits the poor more than the rich is when it applied to maize meal and brown bread.

The latest report couches the inordinate subsidy for the rich in real money terms, but that might also be missing the point.

Jansen’s earlier research stated: “While it is obvious that higher-income groups gain more from zero-rating in absolute terms because they spend larger amounts, poorer households gain more in relative terms.”

Speaking to City Press this week, Jansen said the 2013 analysis was “not arguing that zero-rating is the best way to target the poor, but rather that, if it is retained, targeted items should be reviewed”.

The premise is that zero-rating is here to stay for “political economy” reasons.

The case for improving the basket to better target the poor is also helped by the fact that most tax relief over the past decade happened through personal income tax, which bypasses the people who mainly pay tax through VAT.

The reasoning around VAT goes to the heart of the South African tax system’s treatment of rich and poor and the debate about how “progressive” the system is and should be.

A report by the World Bank last year is proving very influential on the work of the Davis committee.

The World Bank argument is that South Africa’s inequality is already being addressed to a far greater degree than is commonly admitted.

It calculates that government spending on free public services – health and education in particular – can be considered “income” for the poor.

By that reckoning, South Africa’s famous world-leading Gini coefficient is actually a lot lower than critics say

What is VAT? 

South Africa introduced value-added tax (VAT) in 1991 at 10% and hiked it to 14% in 1994. 
Before then, there had been a general sales tax that tried to achieve more or less the same thing VAT does – to tax all domestic consumption. 

Currently, zero-rated items are brown bread, maize meal, samp, mealie rice, dried mealies, dried beans, lentils, tinned pilchards, milk, cultured milk, milk powder, dairy powder blend, rice, vegetables, fruit, vegetable oil, brown wheat meal, eggs and paraffin.




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