The pros and cons of a tricky tax
SA’s finance minister and raising VAT
South Africa’s finance minister, Enoch Godongwana cancelled the unveiling of the country’s 2025 budget as it was due to be released. The move is unprecedented in the country’s history.
The reason for the abrupt cancellation was the failure of the minister to get cabinet approval for the proposal to raise value-added tax (VAT) from 15% to 17%. VAT is the second biggest contributor to tax collection after personal income tax, followed by corporate taxes.
The strongest opposition to the idea came from parties that have joined the African National Congress in a government of national unity which was formed after the ruling party lost its majority in polls in June 2024.
To understand the finance minister’s efforts to raise VAT it’s helpful to revisit the revenue proposals of a year ago.
In the 2024 budget, all the additional revenue was to come from a “stealth tax” on personal income. Because personal income tax is levied at increasing rates as income rises, the tax burden rises as wages go up if tax thresholds are not adjusted for inflation.
In the Treasury’s estimates, R16.3 billion (U$889 million) was raised in 2024/25 by not making inflation-related adjustments to the personal income tax brackets and rebates. This meant that another 200 000 income-earners became taxpayers, and everyone’s effective tax rate was raised.
This has been a long-standing trend. Over the past decade, the tax threshold (for individuals under the age of 65) has declined from R115 000 (in today’s prices) to R95 750, bringing about 850 000 more people into the tax net.
Above the threshold, tax rates were raised by one percentage point in 2015 and the 45% rate was introduced in 2017.
Impressive results
As a strategy for raising personal income tax, the results have been impressive. Personal income tax has increased from 8% of GDP in 2014 to nearly 10%. In the nine months to December 2024, personal income tax increased by over 13% compared with the same period in 2023. Even after taking account of the revenue windfall from retirement fund withdrawals following recent reforms, this signals a substantial erosion of households’ disposable income.
But that is precisely the problem. Taxes collected on goods and services (mainly VAT and excise duties) increased by just 0.4% last year by comparison with 2023. Revenue from corporate income tax declined. The implication is clear: higher taxes on personal income are at least partially offset by reduced consumption and declines in revenue from other sources.
So the Treasury has taken the view, this year, that there should be relief given in the personal income tax and that additional revenue will have to come from taxes on consumption.
There are good reasons for this: personal income tax has contributed a rising share of the overall tax burden over the past decade, while households also face rising costs of electricity, housing and services. However, raising VAT also has its downsides: it generates revenue by raising prices relative to the costs of production, and effectively also reduces households’ spending power.
Additional revenue
The Treasury’s estimate is that an increase in VAT from 15% to 17% would raise an additional R60 billion (US$3.3 billion) in revenue. To offset the impact on low-income households, the schedule of basic foods that don’t attract VAT will be extended beyond the present list of 21 items to include various specified meat cuts and tinned and bottled vegetables. In addition, above-inflation adjustments to social grants are proposed.
The main argument against increasing the VAT rate is that it is regressive – it has a greater impact on lower-income households than on the rich. But a two percentage point VAT increase would also be a substantial shock to overall consumption spending. It would temporarily raise inflation and it would have a negative impact on business income and profitability.
The arguments for a higher VAT rate, rather than other tax increases, are in part about its broad base and comparative ease of collection.
Nonetheless, there are valid concerns from an administrative perspective. The Treasury argues that other countries have higher VAT rates than South Africa (Morocco, Turkey, Brazil and India, for example). But this is not in itself protection against the potential impact of a higher tax rate on non-compliance and tax fraud.
The upsides
There may be deeper economic considerations behind the Treasury’s tax proposal.
The most compelling arguments for VAT as a revenue source are in its basic design structure: what is taxed and what is not. There are two key features. The first is that it taxes imports and zero-rates exports. The second is that the VAT base excludes investment.
The import VAT is sometimes seen as an unfair form of trade protection. But it simply levels the consumption tax across foreign and domestic-produced goods. And it’s simpler than excise and sales taxes.
The important consideration for domestic production is that by comparison with alternative taxes on income, the VAT encourages exports.
The exclusion of investment from the VAT base caused some controversy when the tax was introduced in 1990. Some argued that this would bias economic development in favour of capital and against labour. But investment and employment are complements. To achieve higher rates of employment, South Africa needs far greater levels of investment. Since 2013, investment has fallen as a percentage of GDP from 19% to less than 15%: nowhere near enough to generate growth sufficient to bring down South Africa’s unemployment rate.
Because the VAT base is consumption, not investment, it supports expansion of the economy’s productive capacity.
Managing the fallout
But this doesn’t change the short-term impact on the cost of living that would result from a VAT rise. A higher tax burden will reduce demand and inhibit growth at first, before potentially contributing to fiscal stability and lower interest rates.
If the tax increase is to be avoided, then the spotlight will have to fall on the expenditure side of the budget. This is a far harder discussion than tax policy – there are a thousand options to consider, and there are vested interests wherever you look.
If Godongwana’s VAT rate increase is to be rejected, tough choices on the alternatives will have to be confronted. – The Conversation
* Andrew Robert Donaldson is a Senior Research Associate, Southern Africa Labour and Development Research Unit, University of Cape Town.
The reason for the abrupt cancellation was the failure of the minister to get cabinet approval for the proposal to raise value-added tax (VAT) from 15% to 17%. VAT is the second biggest contributor to tax collection after personal income tax, followed by corporate taxes.
The strongest opposition to the idea came from parties that have joined the African National Congress in a government of national unity which was formed after the ruling party lost its majority in polls in June 2024.
To understand the finance minister’s efforts to raise VAT it’s helpful to revisit the revenue proposals of a year ago.
In the 2024 budget, all the additional revenue was to come from a “stealth tax” on personal income. Because personal income tax is levied at increasing rates as income rises, the tax burden rises as wages go up if tax thresholds are not adjusted for inflation.
In the Treasury’s estimates, R16.3 billion (U$889 million) was raised in 2024/25 by not making inflation-related adjustments to the personal income tax brackets and rebates. This meant that another 200 000 income-earners became taxpayers, and everyone’s effective tax rate was raised.
This has been a long-standing trend. Over the past decade, the tax threshold (for individuals under the age of 65) has declined from R115 000 (in today’s prices) to R95 750, bringing about 850 000 more people into the tax net.
Above the threshold, tax rates were raised by one percentage point in 2015 and the 45% rate was introduced in 2017.
Impressive results
As a strategy for raising personal income tax, the results have been impressive. Personal income tax has increased from 8% of GDP in 2014 to nearly 10%. In the nine months to December 2024, personal income tax increased by over 13% compared with the same period in 2023. Even after taking account of the revenue windfall from retirement fund withdrawals following recent reforms, this signals a substantial erosion of households’ disposable income.
But that is precisely the problem. Taxes collected on goods and services (mainly VAT and excise duties) increased by just 0.4% last year by comparison with 2023. Revenue from corporate income tax declined. The implication is clear: higher taxes on personal income are at least partially offset by reduced consumption and declines in revenue from other sources.
So the Treasury has taken the view, this year, that there should be relief given in the personal income tax and that additional revenue will have to come from taxes on consumption.
There are good reasons for this: personal income tax has contributed a rising share of the overall tax burden over the past decade, while households also face rising costs of electricity, housing and services. However, raising VAT also has its downsides: it generates revenue by raising prices relative to the costs of production, and effectively also reduces households’ spending power.
Additional revenue
The Treasury’s estimate is that an increase in VAT from 15% to 17% would raise an additional R60 billion (US$3.3 billion) in revenue. To offset the impact on low-income households, the schedule of basic foods that don’t attract VAT will be extended beyond the present list of 21 items to include various specified meat cuts and tinned and bottled vegetables. In addition, above-inflation adjustments to social grants are proposed.
The main argument against increasing the VAT rate is that it is regressive – it has a greater impact on lower-income households than on the rich. But a two percentage point VAT increase would also be a substantial shock to overall consumption spending. It would temporarily raise inflation and it would have a negative impact on business income and profitability.
The arguments for a higher VAT rate, rather than other tax increases, are in part about its broad base and comparative ease of collection.
Nonetheless, there are valid concerns from an administrative perspective. The Treasury argues that other countries have higher VAT rates than South Africa (Morocco, Turkey, Brazil and India, for example). But this is not in itself protection against the potential impact of a higher tax rate on non-compliance and tax fraud.
The upsides
There may be deeper economic considerations behind the Treasury’s tax proposal.
The most compelling arguments for VAT as a revenue source are in its basic design structure: what is taxed and what is not. There are two key features. The first is that it taxes imports and zero-rates exports. The second is that the VAT base excludes investment.
The import VAT is sometimes seen as an unfair form of trade protection. But it simply levels the consumption tax across foreign and domestic-produced goods. And it’s simpler than excise and sales taxes.
The important consideration for domestic production is that by comparison with alternative taxes on income, the VAT encourages exports.
The exclusion of investment from the VAT base caused some controversy when the tax was introduced in 1990. Some argued that this would bias economic development in favour of capital and against labour. But investment and employment are complements. To achieve higher rates of employment, South Africa needs far greater levels of investment. Since 2013, investment has fallen as a percentage of GDP from 19% to less than 15%: nowhere near enough to generate growth sufficient to bring down South Africa’s unemployment rate.
Because the VAT base is consumption, not investment, it supports expansion of the economy’s productive capacity.
Managing the fallout
But this doesn’t change the short-term impact on the cost of living that would result from a VAT rise. A higher tax burden will reduce demand and inhibit growth at first, before potentially contributing to fiscal stability and lower interest rates.
If the tax increase is to be avoided, then the spotlight will have to fall on the expenditure side of the budget. This is a far harder discussion than tax policy – there are a thousand options to consider, and there are vested interests wherever you look.
If Godongwana’s VAT rate increase is to be rejected, tough choices on the alternatives will have to be confronted. – The Conversation
* Andrew Robert Donaldson is a Senior Research Associate, Southern Africa Labour and Development Research Unit, University of Cape Town.
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