In an unprecedented move, the national Budget Speech scheduled for 19 February 2025 has been delayed. This was a direct result of disagreements within the Government of National Unity, which did not agree on the proposed VAT rate increase from 15% to 17%.

Although VAT is an indirect tax by design, in a simple economic framework, any increase in VAT will raise the costs of goods and services for the average consumer, with the poor facing the most significant burden.

Before we get into the details, it’s helpful to understand the history of VAT in South Africa and why the increase was considered.

VAT was imposed in 1991 at a statutory rate of 10%, which was increased to 14% in 1993 and again to 15% in 2018. Its primary purpose is to generate revenue for the state while distributing the tax burden across the economy. During the 2023/24 tax year, SARS collected revenues of over R1.7 trillion, of which 25% came from VAT. VAT is the third largest contributor to SARS revenue after personal and company income tax.

Reasons for the Proposed Increase

The proposed increase to 17% is primarily driven by the need to boost revenue to support higher government spending on essential services such as health, education, and infrastructure. But it is far more profound than this: increasing VAT and, ultimately, tax revenues would assist in alleviating the pressure of our fiscal deficit and better managing our debt-to-GDP ratio.

The Treasury argues that a VAT increase is more difficult to avoid compared to other taxes, making it a more reliable source of revenue. This could be because VAT is consumption-based, has a broad base, and is less prone to evasion and avoidance. This would result in approximately R60 billion additional VAT next year. Currently, South Africa’s national debt is approximately R4.5 trillion. So, an increase in VAT of 2% would close the debt deficit by 1.3% (all else equal). This seems to be a very small amount, considering the impact on consumers.

Impact on Consumers

The proposed VAT increase from 15% to 17% will significantly impact consumers, particularly those in lower-income brackets. Here are some key points to consider:

1. Higher Prices for Goods and Services: The most immediate effect of the VAT increase will be higher prices for a wide range of goods and services. Since VAT is a consumption tax, it is added to the cost of most items that consumers purchase. This means that everyday essentials such as food, clothing, and household items will become more expensive (apart from zero-rated and exempt items).
2. Increased Cost of Living: As the prices of goods and services rise, the overall cost of living will increase. This can be particularly challenging for low-income households, which spend much of their income on basic necessities. The increase in VAT will put additional strain on their already tight budgets.
3. Inflationary Pressure: The VAT increase will likely contribute to inflationary pressure in the economy. As businesses pass on the higher tax to consumers, the general price level of goods and services will rise. This can lead to a cycle of rising prices, which can further erode the purchasing power of consumers.
4. Impact on Disposable Income: With higher prices, consumers will have less disposable income to spend on non-essential items. This can lead to reduced consumption and potentially slow down economic growth. For many households, the VAT increase will mean having to make difficult choices about how to allocate their limited resources.
5. Mitigation Measures: To offset the impact on vulnerable households, the government plans to provide grants and relief measures. These may include increasing social grants, expanding the list of zero-rated and exempt items, and providing targeted subsidies. However, the effectiveness of these measures in fully mitigating the impact remains to be seen.
6. Behavioural Changes: The VAT increase may also lead to changes in consumer behaviour. With higher prices, consumers might reduce their spending on discretionary items, seek cheaper alternatives, or delay certain purchases. This shift in behaviour can have broader implications for businesses and the overall economy.
7. Increased Consumer Debt: This is a double-edged sword. Consumer debt may rise as people try to afford the increased cost of living, and the ability to service this debt may become more challenging, especially if interest rates are high. This can lead to increased financial stress and potential defaults.
8. Economic Inequality: The VAT increase could exacerbate economic inequality. While higher-income households may be able to absorb the additional costs more easily, lower-income households will feel the impact more acutely. This could widen the gap between different segments of the population and increase social tensions.

Final Thoughts

While the VAT increase is intended to boost government revenue and address fiscal challenges, it will significantly impact consumers, particularly those who are already struggling financially. The government must carefully balance the need for additional revenue with the potential economic and social consequences of the VAT hike.

In conclusion, while the VAT increase may be a necessary step to address fiscal challenges and boost government revenue, it is crucial for the government to consider and address the potential economic and social consequences carefully. Balancing the need for additional revenue with the impact on consumers, particularly those already struggling financially, will be key to ensuring that the VAT hike does not lead to greater economic disparity and social tension. The government must implement effective mitigation measures and closely monitor the situation to support those most affected by the increase.