Does higher VAT really hurt poorer people more?
If so, maybe it’s time to hike corporate income tax
When the Davis tax committee called for public submissions on a proposed wealth tax last year, it received well over 300 submissions. By contrast when it called for submissions on Value Added Tax a couple of years ago, just 22 arrived.
It’s a measure, perhaps, of the extent to which VAT had fallen off everyone’s radar screens over the past quarter century since the VAT rate was last increased. But the budget proposal to raise the VAT rate by one percentage point has evoked huge controversy and much of that it relates to questions of income and wealth inequality – the same questions which calls for a wealth tax try to target.
If the Davis committee were to repeat its VAT investigation now, chances are it would elicit much more public interest. A great deal of energy and research is now at last going into the tax, which contributes a full quarter of government revenue, and it’s raising some intriguing questions about how best to tax and target to ensure fiscal policy reduces rather than increases inequality.
Some of that thinking was on show this week in a seminar on VAT at the Wits University school of economic and business science this week, where there were some unexpected areas of agreement between two academics on broadly opposite sides of the argument.One was on the key issue of whether VAT is indeed a regressive tax, which hurts the poor more than the rich. The perception that it is has been one of the big reasons the VAT rate has been politically untouchable until now, and it was a key concern raised in recent parliamentary hearings on the VAT increase.
The true fact is, however, that VAT isn’t regressive, says Wits commerce, law and management dean Imraan Valodia, who was one of the panelists at this week’s seminar and who with David Francis has done the analysis, based on income distribution and VAT data, that refutes the regressivity argument. They have found that the poorest households spend a lower proportion of their income on VAT than the richest do, and they calculate the richest 10% of income earners will pay R13.6-billion of the R22.9-billion in extra revenue that the government expects to raise with the one percentage point hike in the VAT rate, with the top three income bands paying more than 85% of the increase. Valodia suggests in fact that the government should look at increasing the VAT rate by even more, but route the extra revenue back to poor households through pro-poor spending or a tax credit system.Unexpectedly at the Wits debate, the other panelist, head of the Wits centre for the study of industrial development Gilad Isaacs, agreed with Valodia that VAT is not in fact regressive. Isaacs, who led a submission to parliament by a group of civil society organisations that opposed the VAT hike, had previously argued that VAT was regressive. He does argue, however – and here Valodia agrees with him – that the whole set of indirect taxes taken together in South Africa is regressive, hurting poor households relatively more than rich ones. That is because excise taxes on tobacco and alcohol are regressive because poor households, sadly, consume more of these goods. So too are fuel taxes. And while Isaacs concedes that VAT itself is not regressive, he argues that the effect of hiking the VAT rate, rather than using personal or corporate income tax hikes, will be to make the tax system as a whole less progressive – not good in a country with South Africa’s high levels of inequality.
A more interesting debate that’s being fleshed out now is around whether the list of items that are zero rated for VAT should be expanded beyond the current 19 basic foods plus paraffin and so on. Treasury is to convene a panel of independent experts to investigate the potential to expand that list.
It is zero rating that makes VAT less regressive, but it’s not always optimally targeted to benefit the poor rather than the rich: Isaacs and the community organisations argue the list should expand to include items poor households typically consume such as white flour, canned beans, margarine, chicken , candles, soap – and polony. Whether Enterprise polony would still be on that list given the listeriosis crisis is not clear.Intriguingly, though, the evidence shown by Valodia and Treasury is that zero ratings such as fruit, milk, eggs and lentils proportionally benefit high income earners much more than low income earners, though the zero rating on dried beans, samp, paraffin, mealie meal, sour milk and brown bread is well targeted to poor households. Valodia notes zero ratings are effectively a subsidy, so we need to be careful who it goes to.
One issue he and Isaacs agree on, for different reasons, is the need to hike the corporate income tax rate. That pits them against Treasury, which argued against increasing CIT at a time when other countries are cutting it. Isaacs wants a more progressive mix of taxes. Valodia argues that hiking the CIT rate by two percentage points would yield an extra R13-billion and would help to build consensus on a VAT hike as well as demonstrating that the private sector is serious about equitable growth. The next frontier for debate about tax policy then, could well be CIT.