In a democratic system taxation is a critical part of the social contract between the state and its citizens. The tax system can help address poverty, inequality and unemployment in South Africa.
With renewed discussions on value-added tax (VAT) policy, it is useful to revisit past tax reforms to assess their impact. One of the most significant adjustments in recent years was the 2018 VAT increase from 14% to 15%. The decision, made in response to fiscal constraints, aligned South Africa with some neighbouring countries such as Namibia and Zimbabwe but raised concerns about its disproportionate burden on lower-income households.
VAT is a tax added to the purchase price of goods and services and has once again received scrutiny as policymakers debate potential revenue-raising measures. Though our current 15% rate remains lower than Mozambique’s standard rate of 16%, the question persists: how much of the burden falls on those who can least afford it?
To help mitigate the effect of the 2018 VAT increase on poorer households, the government introduced an above-inflation increase in existing social grants and later expanded the list of VAT zero-rated items. However, since people with higher incomes tend to consume more in absolute terms, they benefited more from zero-rating than lower-income households. As VAT policy discussions resurface, there is an opportunity to assess whether these compensatory measures were sufficient or if alternative approaches should be considered.
The increase in VAT from 14% to 15% caused a slight rise in poverty and inequality overall, but that was reversed by increases in benefit amounts
Using SAMOD, a South African tax-benefit microsimulation model, we can examine the long-term distributional impact of VAT changes and explore the potential impact of new fiscal policy decisions on the poorest households. By testing different tax-benefit scenarios, we can compare options for mitigating VAT’s regressive effects.
The increase in VAT from 14% to 15% caused a slight rise in poverty and inequality overall, but that was reversed by the subsequent increases in benefit amounts which took effect in October 2018. However, the effect of the increase in VAT was distributed unequally across the population with the people worst affected being those in the poorest post-fiscal income decile. For this group, post-fiscal income — that is, per capita household income after accounting for taxes, including VAT, and grants — fell more than 6% as a result of the tax increase. The increase in benefit amounts that took place in October 2018 did not wholly offset this negative impact because not all households in the poorest 10% qualify to receive benefits.
Building on these findings, a number of hypothetical reform scenarios were explored to identify options that might achieve redress for the poorest households. To generate revenue for the redress, the zero-rating of VAT was abolished and the revenue generated by doing so (just under R20bn) was ploughed back into the benefit system.
Options were explored for new means-tested benefits (programmes that require participants to meet certain qualification criteria) for which young people and older people of working age might qualify. Some of the hypothetical schemes used the same means test as is used for South Africa’s child support grant, for which 80% of all children in South Africa are eligible.
The overall cost and effects on poverty and inequality of new social grants, targeting either young people (18-25 years) or older people (26-59 years) of working age, are similar. However, with reference to the poorest 10%, the impact of the reform aimed at older people of working age is much greater — increasing the post-fiscal income of the first decile by about 30% — than the impact of the reform aimed at younger people which increases post-fiscal income for the poorest decile by about 16% only. This is despite the benefit for those aged 18-25 years being paid at almost twice the value of the benefit for those aged 26-59 years.
The findings suggested that while both approaches had poverty-reducing effects, the largest impact was seen in policies supporting older working-age individuals, with post-fiscal income increasing by 30% for the poorest decile. The study was conducted before the social relief of distress grant had been made available to adults of working age in extreme poverty, in response to the Covid-19 pandemic and ongoing unemployment challenges.
Given the renewed VAT debate, these findings highlight the importance of carefully evaluating revenue alternatives that balance fiscal needs with equity considerations, within the current policy context.
Two further strands of analysis were pursued:
- First, two universal benefits were tested and it was demonstrated that these would have a greater poverty-reducing effect overall than means-tested benefits, though at a greater cost.
- Second, a scenario was tested whereby the VAT hike was simply reversed, zero-rating was eliminated and the revenue generated was applied to an existing benefit (the child support grant). Though this also reduced poverty overall, it did not improve post-fiscal income for the poorest 10%.
The above analysis supports the widely held concern that a VAT hike disproportionately and negatively affects the poorest households. This is commonly found to be true at the global level for taxes on consumption. Second, it provides a positive message about the impact of the October 2018 benefit hike, overall, as the total impact of the benefit increase on poverty cancelled out the total impact of the VAT hike. However, these effects were not distributed equally across the bottom half of households, so the poorest households continue to be negatively affected.
Tax-benefit microsimulation provides an opportunity to test out the first-order effects of an almost infinite number of reform scenarios to explore options for redress. In these tests, new benefits aimed at those who at the time fell outside the benefit system most effectively reversed the negative impact of the VAT hike.
As South Africa again considers revenue-raising options, the lessons remain highly relevant. VAT increases, while effective in generating revenue, come with trade-offs — especially if compensatory measures fail to fully protect those most affected. Before moving forward with another increase, policymakers should assess the potential impact on low-income households as well as considering alternative revenue sources or targeted relief mechanisms to avoid deepening inequality.
• Wright is the co-executive director of Southern African Social Policy Research Insights (SASPRI), a UK-based not-for-profit, and a research affiliate at the Centre for Microsimulation and Policy Analysis, University of Essex
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