VAT may well be Gordhan's biggest political headache - analyst

Johannesburg – Increasing the VAT rate by one percentage point could raise R20bn in tax revenue, but Finance Minister Pravin Gordhan may be reluctant to raise this tax given the political resistance to it, said an analyst.

Speaking at a pre-budget briefing on Tuesday, PwC’s tax policy leader Kyle Mandy explained that a decision about the VAT rate is still “up in the air”. An increase in VAT would have to be accompanied by reforms to alleviate pressure on poor households which would likely suffer the most.

“Political difficulties remain, particularly in so far as the likes of resistance by Cosatu (Congress of South African Trade Unions) is concerned - they would be vehemently opposed to it.”

He added that “internal politics” of the ANC would limit the minister in increasing the VAT rate. It would be “detrimental politically” for him to do so, said Mandy.

The only way a VAT increase would be politically feasible would be if it were accompanied by significant alleviation of its effect on the poor. But there are limited instruments for Gordhan to use in this regard.

READ: Budget 2017: Experts share tax predictions

He could use the social grant system to alleviate the impact on social grant recipients by simply increasing the social grants. Gordhan could also increase the extent of goods and services included in the zero-rate basket. “The difficulty with that is that again it is highly politicised and poorly targeted, because wealthier tax payers would benefit more than poorer tax payers in terms of zero-rated goods and services.”

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He added that this would not be the most efficient system to provide relief.

Gordhan could also try provide relief in terms of the personal income tax system; again the working poor and unemployed would not benefit from this. 

Globally, there has been a shift towards increasing the rates of indirect taxes and decreasing the rates of direct taxes, said Mandy.

South Africa’s VAT rate at 14% is quite low compared to the rate in the rest of Africa at 16%, and the highest rate in Europe is at 27%. The last time the rate was raised was in 1993, up from 10%, added indirect tax partner Lesley O’Connell.

Treasury may have to increase the fuel levy given the limitations of VAT, explained Mandy. The fuel levy is the only mechanism apart from VAT that could make a significant contribution to revenue, with a minimal negative impact on the economy rather than direct taxes related to personal income and corporate income, he said.

An increase in the fuel levy to 50c could raise R10bn.

Why direct taxes yield more revenue

Consumption taxes or indirect taxes such as VAT are voluntary. “If you don’t spend money then you don’t pay tax,” said Mandy. Imposing a consumption tax reduces the buying power of the consumer. It only impacts the consumption side of the economy.

Direct taxes however impact the discretionary income of an individual. People have an option to spend this, which is subject to consumption tax.

Alternatively they can save it, which also has an impact on the economy. The South African economy has reduced savings levels, which have a significant impact on economic growth in the medium to long term. In the corporate environment, taxes impact decisions to invest which also impacts economic growth. 

This is why direct taxes are more distortionate from an economic growth point of view, said Mandy. 

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