OP-ED

New report supports expanding VAT zero-rating

By Gilad Isaacs 10 August 2018

Soybeans on sale are displayed in a grain wholesale market in Beijing, China, 31 July 2018. Soybean prices have plummeted in recent months after US President Donald J. Trump announced tariffs on 50 billion US dollars of Chinese goods. China is the world's largest buyer of soybeans, importing 12.4 billion US dollars worth of the legumes from the US in 2017. EPA-EFE/WU HONG

As households feel the pinch from the increase to VAT and rising fuel prices, an expert panel set up by National Treasury has been investigating how to cushion the blow from the VAT increase.

A new report by the Institute for Economic Justice (IEJ), entitled Mitigating the impact of the VAT increase: can zero-rating help? shows that exempting a limited number of carefully chosen additional goods and services from VAT (zero-rating) is one viable route. This is an important finding as the VAT increase reduces the disposable incomes of all South Africans, including those of poor and low-income households.

Increasing VAT also makes the tax mix more regressive by increasing the tax contribution of poor and low-income households. Further, it has the potential to dampen domestic demand and growth, and increase inequality.

For these reasons civil society organisations, Parliament’s finance committees, the ANC and trade unions have called for measures, beyond the current list of zero-rated items, to be put in place to support poor and low-income households.

Currently, a range of items including 19 basic food items are VAT exempt.

In line with other existing research, the IEJ report shows that the benefits from zero-rating, in the form of savings from not paying VAT, accrue disproportionately to poor and low-income households.

The report also shows that similar benefits can be derived from zero-rating other items. These findings are made through analysing the spending patterns of the population.

Testing zero-rating

Naturally, we want to ensure that poor and low-income households are the beneficiaries of zero-rating and that zero-rating is not predominately a tax break for wealthier households. To assess this we compare how much of the goods or service is consumed by poor and low-income households. The primary test is whether the poorest 70% of the population account for 70% or more of all expenditure on that item, and hence would accrue 70% or more of the benefits.

This threshold is chosen because 55% of South Africans are poor and because the lowest spending/earning 70% earn below the income-tax threshold. The Parliamentary finance committees strongly argued “that the list of zero-rated items needs to be expanded taking into account the needs of the poor and low-income earners”.

Other tests complement this primary test.

Importantly, the report analyses where benefits accrue more to women, single mothers and female pensioners, thereby assessing benefits to more vulnerable groups.

The report also considers that some items may not pass the statistical tests, but are important to zero-rate anyway as the realisation of constitutionally enshrined socio-economic rights relies on access to these items. Greater access to school uniforms would support the right to education, cheaper sanitary pads would enhance equity and the rights to dignity and education, and various foodstuffs and medicines have significant health implications, including for children.

Finally, the report shows that removing zero-rating from the existing items would make VAT more regressive, whereas extending zero-rating to the proposed items would make it less regressive.

Current zero-rated items

The accompanying table (Table 1) shows 17 currently zero-rated items. The extent to which they are “well targeted” is a question before the Treasury’s expert panel.

Rice, brown bread, mealie meal, samp, dried beans, canned pilchards, powered milk, sour milk, cooking fat, edible oils and paraffin all pass the primary test – the poorest 70% of households derive 70% of more of the benefits of zero-rating.

Table 1

Consumption of existing zero-rated items by the lowest spending 70% of the population

Consumption item

Rand expenditure, mn 2018

Percentage of total expenditure

Benefit women more?

Rice

5851

73%

YES

Brown bread

10593

76%

YES

Mealie meal/Maize flour

12871

84%

YES

Mealie rice

32

41%

YES

Samp

546

84%

YES

Beans dried

930

84%

YES

Lentils dried

22

51%

NO

Canned pilchards

2168

75%

YES

Vegetables

14679

58%

YES

Powdered milk

443

74%

YES

Sour milk/maas

1725

78%

YES

Milk

4932

47%

YES

Cooking fat (vegetable)

12

91%

YES

Edible oils (e.g. cooking oils)

4129

77%

YES

Fruits

2099

32%

NO

Eggs

3365

60%

YES

Paraffin

1239

88%

NO

Source: Statistics South Africa, Living Conditions Survey 2014/15, own calculations

By this test, some items, such as milk and fruit, are not “well targeted”. However, the IEJ report argues that after taking a closer look, all items (barring mealie rice) should remain zero-rated.

  • Eggs and vegetables are not too far off from meeting the primary test and “basic” vegetables (tomatoes, cabbage, potatoes etc.) do pass the primary test; more expensive vegetables do not. The exclusion of canned vegetables, consumed more by poorer households, also skews the outcome.
  • Differentiating between categories of vegetables, by removing zero-rating from more expensive vegetables, could be administratively tricky and would place more expensive vegetables even further out of the reach of poorer households. As vegetables are essential to healthy diets, containing their cost is important and zero-rating should be maintained (and expanded to canned vegetables).
  • The cases of milk, eggs and fruit also raise health considerations. Removing the zero-rating of these items would increase the cost of relatively cheap sources of protein, iron and vitamins, which is also important in the diets of children. Dried lentils and mealie rice appear poorly targeted. However, lentils are a relatively cheap source of healthy protein.

Extending zero-rating

This established, the report turns it attention to considering what other items should be zero-rated.

Twenty-three categories of goods and services emerge as ideal candidates for zero-rating (some categories contain more than one item). These are obtained by applying the same tests as for currently zero-rated items and by removing unhealthy items (such as sugar) or impractical ones (such as “dung bought” or specific types of spices). These items are listed in the second table.

Table 2

Candidates for further zero-rating

ITEM

Pass primary test?

Benefits poor and low-income women more?

Socio-economic considerations

VAT forgone (R mn)

Cake and bread flour

YES

YES

 

491

Sorghum meal/powder and mabella

YES

YES

 

68

Poultry (incl heads and feet)

CLOSE BUT NO

NO

YES

3 982

Mopane worms

YES

YES

 

3

Other canned fish

YES

YES

 

27

Whiteners (Cremora; Ellis Brown)

YES

YES

 

137

Amageu

YES

NO

 

26

Baby food

SOME, NOT ALL

YES

YES

395

Powder soup

YES

YES

 

187

Instant yeast

YES

NO

 

19

Soya product (excluding soy milk)

YES

YES

 

19

Tea

YES

YES

 

197

Infants and children’s clothing and footwear (include school uniforms)

SOME, NOT ALL

YES

YES

4 108

Candles and matches

YES

YES

 

116

Coal (including anthracite)

YES

YES

 

11

Hotplates

YES

YES

 

43

Soap

NO

NO

YES

1 525

Medicine and medical services in public institutions

SOME, NOT ALL

SOME, NOT ALL

YES

309

Calls (including airtime for cellular phones)

NO

NO

YES

4 180

Textbooks and stationery

NO

NO

YES

355

Disposable nappies

YES

YES

YES

685

Sanitary towels and tampons

NO

YES

YES

100

Agricultural own production

MOST, NOT ALL

SOME, NOT ALL

 

53

Source: Statistics South Africa, Living Conditions Survey 2014/15, own calculations

Zero-rating most of these items would disproportionately benefit poor and low-income households. This includes: cake and bread flour; sorghum meal/powder and mabela; mopane worms; other canned fish; whiteners (Cremora; Ellis Brown); mageu; powdered soup; instant yeast; soya product (excluding soy milk); tea; candles and matches; coal (including anthracite); hotplates; and disposable nappies. For most of these, women benefit disproportionately.

Poultry is included because it is a major source of animal protein for poor and low-income households.

Not all forms of baby food, infants’ and children’s clothing and footwear, and textbooks and stationery, pass the primary test. However, zero-rating these items would disproportionately assist women and advance the rights of babies and children to food, dignity and education. Similarly, making sanitary towels and tampons more accessible is a national imperative, both to ensure the dignity and health of women, and because of the benefit to school enrolment.

Ensuring cheaper access to soap and medicines and medical services (limited to those in public institutions) would advance the rights to health, sanitation and dignity.

Airtime costs are also included in the list, on the understanding that a strong case can be made that access to communication and the internet is essential to participation in society, education and the labour market.

For almost all items, their inclusion in the basket of zero-rated items would make the tax mix more progressive.

The context

Zero-rating would, of course, come at the cost of foregone VAT revenue, as shown in the table.

However, this cost, as well as the decision to impose zero-rating in the first place, should be seen in context. That context is a fall in personal income tax rates (in 1997 someone earning R1-million in 2018 rand paid an effective tax rate of 41%, by 2018 this had fallen to 31%), a decrease in the corporate income tax rate from 50% in 1990 to its 28% level today, and the significant under taxation of wealth and income derived from wealth.

The IEJ report shows that more than half of the costs of zero-rating the above items (R9.6-billion out of R17-billion) could be made up through imposing a VAT rate of 25% on a basket of luxury goods consumed by the rich. Previous submissions to Parliament show scope to significantly boost revenue from increasing corporate and income tax rates as well as imposing a net wealth tax and other taxes upon wealth.

Zero-rating is not a silver bullet and a range of interventions that assist poor and low income households – including increasing social grants, reducing transport cost and ensuring greater access to social services – must be explored. What the IEJ report shows is that zero-rating is one viable means to achieve this. DM

Dr Gilad Isaacs is an economist at Wits University and co-director of the Institute for Economic Justice.

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