[ANALYSIS] To zero-rate, or not to zero-rate: the complex VAT debate
This article first appeared on The Conversation.
The one percentage point increase in South Africa’s Value Added Tax (VAT) rate, which was implemented in April this year, has raised important questions about how the tax system can and should address inequality. In response to the increase, Nhlanhla Nene, the minister of finance, appointed an expert panel to look into ways that zero-rating can better tackle inequality. The panel made recommendations about additional items which should be zero-rated.
It’s important that the recommendations of the panel be considered within the framework of a larger conversation about tax policy in South Africa. This is particularly true because the tax system is key to addressing the extremely high levels of inequality in South Africa.
To be both fair and to address inequality, tax systems need to do two things. First, they should treat people with the same income and circumstances in the same way. Secondly, they should treat people with different incomes and different circumstances appropriately differently – rich people should both pay a greater amount of taxes and also a larger portion of their income in taxes.
But South Africans should also be realistic about what tax policies can achieve. Zero-rating isn’t a panacea: it should be accompanied by policies that help poor people access essential products. In addition, its unintended consequences should be noted: by providing relief for the poor, it also provides a large amount of relief for the rich. The rich consume far more than the poor, and thus benefit in absolute terms to a far greater degree than the poor.
THE EXAMPLE OF SANITARY PADS
The panel’s recommendation about sanitary products is a good example of the limitations of VAT in addressing inequality.
The panel agreed that it was important to include sanitary products on the zero-rated list. But addressing the issue only through tax policy effectively subsidises the consumption of women from higher-income households, but does very little to address the fact that most poor women are simply unable to afford sanitary pads, whether they are zero-rated or not.
The panel therefore argued that it was imperative that free sanitary pads should be given to women and girls who can’t afford to buy them. It found that women in the poorest 70% of households are able to meet only 8% of their needs for sanitary products. Zero-rating won’t help them much.
If South Africa is to address the problem of access to sanitary pads, zero-rating has to be accompanied by policies that make sanitary pads available, free of charge, to those who cannot afford to purchase them.
THE CASE OF BOOKS
A number of submissions to the panel argued for zero-rating books to promote access to reading material. But unlike sanitary pads, the case for zero-rating books is not a strong one.
Books are very expensive and bought almost entirely by the richest 10% of households. Zero-rating books would be symbolically good, but it would, in effect only subsidise the consumption of high-income households and do very little to actually promote a culture of reading among low-income households. Better provision of books in schools and access to libraries are likely to have a much bigger impact.
This highlights that targeted expenditure programmes can ensure that the relief reaches those who need it most. This is not to say that one or the other of these options must prevail. But tax collection tools should always be weighed against expenditure policy options.
It’s also important to be aware that changes in tax policies often generate changes in economic behaviour. That’s why there are “sin” taxes on products like alcohol and tobacco. The assumption is that a higher tax will result in reduced consumption. Zero-rating may change economic behaviour which could result in unintended consequences.
Take the example of zero-rating frozen chicken pieces. The argument for zero-rating them is that poor people buy chicken in pieces, so exempting them from VAT will make them more affordable.
But high-cost chicken (including organic or free range) consumed mainly by the rich could also be sold in pieces. The fact that they also enjoyed the benefits of zero-rating would allow wealthy consumers to benefit. This highlights the related issue of demarcation – how can we define items for zero-rating in a way that is efficient and practicable?
The zero-rating of school uniforms is the best example of this challenge. School uniforms consist, say, of white shirts, grey skirts and trousers, black shoes, and blazers or jackets. But these items are also consumed by wealthy people many of whom wear white shirts and black shoes with their business attire. What distinguishes a business shirt from a school shirt, and how do we ensure only the latter is VAT exempt? If we are unable to do this in an effective manner, the benefit of the zero-rating will be enjoyed both by the intended group – parents of school children - but also by the wealthy.
Another problem is that those who have economic power are often able to pass on the costs of a tax to others. For example, if company taxes are increased, a firm that has a monopoly may be able to pass on the full costs of the tax to consumers by increasing the price of the goods.
In the case of zero-rating, the problem is reversed – how do we ensure that any benefit from zero-rating is passed on to the consumer and not captured by producers, wholesalers and retailers? In markets where producers or retailers are in a powerful position, we can’t assume that the zero-rating benefit will be passed on to the consumer.
SIMPLICITY IS KEY
Issues of administrative ease and efficiency are very important for tax policy. Issues of demarcation must be easy to define and implement at the risk or passing an administrative and therefore financial burden onto both business and the receiver of revenue. In addition, the more complex a tax system is, the more the incentive there is for evasion and the greater the resources needed for enforcement and collection.
Our argument is that while issues of zero-rating are very important, it’s vital to understand them in the context of the larger tax policy universe. This includes how revenue is allocated, how consumers respond to changes, and the importance of being realistic and pragmatic about implementation.
Imraan Valodia, Dean of Commerce, Law and Management, University of the Witwatersrand.
David Francis, Research Manager at the Southern Centre for Inequality Studies, University of the Witwatersrand.