The South African economy has been going in a strong direction since the appointment of Cyril Ramaphosa as the new president of the country. Despite the short recession and the bleak predictions of 2017, the South African economy pulled out some surprises and obtained a higher GDP growth rate for the year than what was expected. However, in the February Budget speech, the Minister of Finance Malusi Gigaba announced that taxes will have to be increased and spending will have to be cut. This is because the country is facing a tax revenue shortfall of R50.8 billion for the year 2017/18.
The tax revenue is not only due to poor economic cycle but also due to the administration and governance issue at the tax authority. For this reason, the VAT rate has been increased to 15% as of the 1st of April 2018. This increase comes with many risks, such as continued weak economic growth, high unemployment, wasteful expenditure, uncertainty about public sector wage increases and the impact of fee free education.
I am going to analyse the effect of this VAT hike, by focusing on its impact on individuals, aggregate expenditure and the economy at large.
Low economic growth has limited the Finance Minister Malusi Gigaba’s options because of the effect that raising tax income will have on both the economy and individuals, more particularly individuals with low or no income. I am going to examine this effect, focusing mainly on the economy and poor individuals.
Impact of tax increase on the economy
According to Finance Minister Malusi Gigaba (2018) the increase in tax was unavoidable if South Africa was to maintain integrity of its public finance. The National Treasury (2018) added on to say that personal income tax rate increase would have had greater negative consequences for growth and investment than a VAT increase.
A VAT increase can discourage work, saving and investment. It can also cause a hike in inflation, which will hit customer’s pockets the hardest (Koronteng, 2018). Higher Value Added Tax rates may lead to higher rates of inflation, as the cost of goods and services rises. Businesses may also take advantage of the rising VAT by increasing their prices. This increase in inflation will lead to an increase in the standard of living.
An increase in VAT will affect small, labour-intensive businesses more than capital-intensive businesses, because small labour-intensive businesses have a higher ratio of value added to selling prices than capital-intensive business (Magloff, 2017)
Although South Africa’s economic growth outlook has improved, growth remains down and the GDP is only expected to expand by 1.5% in 2018, compared to Treasury’s projection of 1.1%.
Impact of tax increase on the poor
The wealthiest 30 percent of households contribute 85 percent of VAT but this claim is irrelevant in judging the effect of the new taxation on the poor or who it will hit the hardest. A study done by the World Bank in 2015 showed that poor South Africans paid more indirect tax, including VAT, fuel levy and excise tax than the rich South Africans. South Africa’s VAT system includes 19 basic foodstuffs; samp, maize meal and rice that are zero rated and to limit the impact of the increase in VAT on the poor, this system will stay in place. However, the poor and the working class spend more than the protected 19 items, which does not include key items like electricity.
Economist from the University of Johannesburg, Prof Nicholas Ngepane (2018) said that there needs to be better research on how the poor spend their money, but inflationary increases associated with the increase in VAT will likely outweigh the benefits of zero-rated products. Therefore, inflation for the poorest South Africans is higher than general consumer price index.
The Minister of Finance, Malusi Gigaba said that vulnerable households will compensated through above average increase in social grant. An extra R26 billion has been allocated to social grant to alleviate the negative effects on the poor.
With the combination of tax increases and the very slight increase in social grants, there’s a greater danger that there is a real destruction of poor people’s spending power and will potentially worsen poverty (Isaacs, 2018).
But here is no doubt that an increase in VAT could have a very big effect on the poor and could increase both inequality and poverty.
Impact on aggregate expenditure
The reason why VAT has been increased to 15 percent is because the government wants more money to cover its ever increasing expenditure. According to SARS (2014), VAT is a significant source of revenue for the government and businesses are required to register and to charge and collect VAT. However, in South Africa VAT is a broad-based tax on consumption instead of a selective tax on certain goods and services in the economy.
By increasing VAT, the government is injecting new money into the economy. This means that taxation has an inverse relationship with consumption, so an increase in VAT will shift the C (consumption) downwards with the expected impacts on equilibrium GDP. Therefore, aggregate expenditure decreases by a fraction of the change in taxation.
THE SOUTH AFRICAN STATUS QUO
South African Economic Outlook
On the 23rd of March, Moody’s confirmed South Africa’s BBB rating and upgraded its outlook from high to stable. This decision prevented a credit downgrade to sub-investment grade, which would have put a considerable pressure on the country’s high debt burden.
The assurance that a credit rating is unlikely allows for a sustained recovery in business and consumer confidence, giving President Cyril Ramaphosa’s administration room to implement market-friendly policies to bring investment into an economy that is slowly gaining power. In February 2018, the manufacturing output expanded for the 5th consecutive month and in the growth in retail sales was increased by the stronger currency.
South Africa’s Economic Growth
South Africa’s economic outlook has improved since February when Cyril Ramaphosa became president. The South African economy grew by 1.3% in 2017, exceeding the National Treasury’s expectation of the 1.0% growth that was announced during the February 2018 National Budget Speech. The economy contracted in the first quarter of 2017. It then saw sustained growth for the rest of the year, with the 4th quarter experiencing the highest growth rate in 2017, with the economy expanding by 3.1% quarter–on-quarter.
The strengthening in the economic activity in 2017 was partly due to the agricultural industry returning from a very bad drought. The agricultural production increased by 17.7% in 2017 compared to the year 2016. The finance and mining industries contributed positively to GDP growth in 2017.
According to a recent article by Stats SA, the mining’s growth was led by increased production of manganese ore, chrome and iron ore. The increase in the demand for minerals used in the production of steel contributed to these increases.
The following graphs summarise how South Africa’s industries performed in 2017 and South Africa’s annual GDP growth. The agriculture industry contributed the most with 17.7%, mining was second with 4.6%. the industries that contributed the least are the trade, construction and manufacturing industries, with negative contributions of 0.6%, 0.3% and 0.2% respectively
Source: Gross domestic product (GDP), 4th quarter 2017
Source: Gross domestic product (GDP), 4th quarter 2017
According to BankservAfrica’s Economic Transaction Index, BETI (2018), the South African economy continued to grow regardless of the various tax increases that came into effect on the 1st of April 2018. Consumer confidence was at its strongest in the first quarter of 2018, which shows that the economy is growing despite the increase in value added tax rate.
Retaining the economic status quo which left over half of South Africans living in poverty will threaten the country’s peace and stability.
The increase in VAT by 1% has not only had an impact on aggregate expenditure and individuals, but also on the inflation and the unemployment of the country.
Economic growth is expected to pick up moderately in 2018/2019 as stronger activity in trading partners encourages exports. Investment will support growth in 2019 on the expectation that business confidence increases and policy uncertainty fades.
Unemployment is a major social challenge with youth unemployment among the highest on the African continent. Despite the continuously high unemployment, private consumption will go up as wages increases and food prices stabilise.
South Africa’s consumer price index increased four percent year-on-year in February 2018, mitigating from 4.4% increase in January and below the market expectations of a 4.2% gain. It was the latest inflation rate since March 2015. However, the fall in inflation makes room for a relatively expansionary monetary policy to support the activity.
The inflation rate over one year to February 2018 stood at 4 percent, which is at the lowest end of the inflation target, the lowest since January 2016. Under normal circumstances, an increase in inflation would raise the question of whether or not the Reserve Bank will ease the monetary policy by decreasing interest rates. But given the VAT increase, these are not normal circumstances. An increase in VAT by one percent point could result in an increase in the inflation rate to 5%. With the inflation rate approaching the upper limit of the inflation target, interest rates are likely to be increased.
Unemployment is a major social challenge with youth unemployment among the highest on the African continent. An increase in unemployed youth, who are becoming frustrated and keep increasing poverty levels that add to frustration, the levels of stability our country and the ability of business to do business in a calm atmosphere will be compromised (Dlamini-Zuma, 2018). Currently South Africa’s unemployment rate is sitting at 26.7 percent, which is a decrease of 1 percent from the previous period’s unemployment rate of 27.7 percent. However, a deeper analysis of the numbers shows that large sections of the population are suffering from chronic joblessness and this includes the fact that about 39% of all unemployed South Africans have never worked before and 60.3% of people struggle to find their first job.
With such scary figures it raises the question of how will these figures be affected by the one point increase in value added tax. The increase in taxation is likely to increase the amount of people living in poverty and if jobs are not created, the unemployment rate could increase, and people will turn to illegal doings in order to survive, this will likely result in the destruction of businesses and another downfall in the country’s financial stability, political and security stability.
The graph above represents the unemployment rate of South Africa since January 2015 until January 2018. Our unemployment rate might have declined it is still high compared to that of January 2016. This is a problem that the government needs to pay attention to, especially with the recent tax hike.
Progressive or regressive
The main argument against an increase in VAT is that this type of tax is regressive. A regressive tax is one where a proportion of an individual’s income expanded on that tax falls as their income increases. The reason for this is that, the lower income earners spend a greater portion of their income on goods and services and save less; they also spend a higher share of their wages on VAT than higher income earners.
While this is true in developed countries, in South Africa the situation is a bit refined. A February 2015 study by Ingrid Woolard, published in the World Bank paper, titled the distribution impact of fiscal policy in South Africa, shows that VAT would be regressive in the absence of zero-rated food items, which make VAT slightly progressive. This means that South Africa has extensive zero-rating of basic goods and this has a big impact on whether or not VAT is regressive (Woolard, 2015).
After much research, I came to understand that an increase in VAT is regressive, because an increase of 1 percent means that if income remains the same, lower income earners will have less money to spend on their essential standard-rated expenses every month because an additional 1% of their disposable income will be spent on tax. So the increase in VAT is regressive because everyone pays the same rate, even though not everyone is equally able to afford the taxes.
Personally, I agree and support the Minister of Finance’s decision to increase Value Added Tax by one percent. I agree with this decision because a VAT increase had been predicted by economists for years but the government managed to avoid it and it has now reached a point where it is unavoidable. The country has slow and low economic growth and the revenue shortfall is likely to make our economic growth even slower so an increase in VAT is needed to align South Africa’s tax structure with its growth objectives. It is no secret that South African government and officials are corrupt and that now ordinary citizens of South Africa are being called upon by the increase in VAT to fill the gaps in government finances which are partly due to maladministration and corruption, especially in state owned enterprises. A significant portion of the revenue shortfall is also due to lower income tax collection and the unexpected announcement of free education, which will cost the state close to R56 billion together with the increasing debt to GDP ratio left the treasury with little choice but to reduce expenditure and increase taxes, including VAT. The state needs to generate revenue to cover all these expenses, new and old and according to an Investec senior economist, “the least economically damaging means of increasing tax revenue would be increasing the VAT rate” (Kaplan, 2018). So although arguments against the increase in VAT may arise, there’s no denying that it is a decision that had to be taken.
Oxfam (2017) released its latest Commitment to Reducing Inequality Index, which ranks government based on what they do to tackle the gap between the rich and the poor. According to this index, South Africa is ranks 21. This is because of the country’s tax system. The indicators used to measure this are; progressivity of tax structure, incidence of tax on Gini coefficient and the current tax collection.
The key message in this financial period’s budget speech is that South Africa’s public finances are in a very bad shape and we have to find more revenue. The budget suggests that we make sacrifices to get the economy on a stable growth path. It also asks that all citizens pay more and all income groups to share the burden.
Citizen can offset this VAT increase and some of the ways in which they can do this are:
Rank their money
Citizens must pay important bills like bonds, insurance, water and rates on time every month. This way they will be able to identify how much money they have left for the rest of the month.
Citizens must have a budget and stick to it
It is important that citizens do not let their expenses derail them from the budget. To achieve this, they will need to identify their necessities and only buy items that fall under their necessities list.
Avoid purchasing things on account
It is important for us to remember that the money that is spent when buying on account is credit and it is not money that belongs to us.
South Africa’s low economic growth has been dragging down unemployment which negatively impacts the youth the most. The Organisation for Economic Co-operation and Development (OECD) conducted an economic survey for South Africa, which shows that our poverty rate makes up a 3rd of the population and is higher than those of other emerging countries.
To help counteract this negative impact, proposed solutions are:
Having limited annual wage increases in the public sector and civil servants should be positioned to priority areas. Public spending should be spent more effectively to “free up” resources for infrastructure and education.
To implement the national minimum wage to help reduce inequalities.
Apprenticeship and internship programmes must be created to improve youth employment.
The increase in VAT has a big impact on the economy too and to help lessen the effect of this increase on the economy, I would recommend the following:
The government needs to restore its relationship with the mining industry and provide it with greater policy certainty in order to persuade them to take on more workers, that way unemployment will also be tackled.
The government needs to repair investor confidence, improve institutional stability, restore credibility of the criminal-justice system and demonstrate that they have the political will to turn the country’s finances around.
The government needs to make Black Economic Empowerment more functional and sustainable and ensure communities and workers derive greater benefit.
Good governance and efficient use of resources could help mitigate further increases in taxation in the long term.
Financial and none-financial support for small businesses and start-ups must be reviewed.
The Davis Tax Committee (2018) admits that increasing the VAT rate would increase inequality and would make basic goods more expensive and demand a proportional increase in social grants and wages in order to maintain buying power of the poor and workers. There is also a very good chance that this hike in VAT will cause civil unrest, this could be because very few people understand that South Africa has been forced into this VAT increase by the announcement of free higher education, without any consultation (Rossouw, 2018).
As much as an increase in VAT will harm the poor and lower income earners the most, it is important to note that in a country such as South Africa where there are high levels of poverty and inequality, every instrument must be brought to bear on solving the challenges facing the country and the tax system is one tool. The increase in VAT might have been a bold move but it was a necessary move.