No guaranteed silver lining with VAT hike

Dr Sanele Gumede

Although it’s now over three decades since the democratic elections in South Africa, the country still battles with the triple challenge of unemployment, inequality and poverty. South Africa’s current weak economic growth and outlook present a very bleak future.

South Africa has immediate pressures on infrastructure investments and job creation. In his budget speech, Minister Enoch Godongwana argues that tax hikes will contribute immensely to the planned R232.6 billion funding of key programmes. Minister Godongwana stated that “the funding is for spending pressures for infrastructure investments, social protection, a higher-than-anticipated public-service wage agreement, and provisional allocations for critical frontline services.” The current strategic focus of the national treasury is on electricity, rail, water and transportation infrastructure projects. Such investments are projected to contribute immensely to the reduction of the cost of doing business in the country – which should also have a positive contribution to employment and the gross domestic product. Infrastructure investment has always been featured in a number of State of the Nation Addresses (SONA) and budget speeches preceding this one. However, the actual amount spent by the government on this does not reflect the radical nature of such.

As a percentage of total government expenditure, capital expenditure has significantly declined from 11.7% in the 2013/14 financial year to 7.4% in the 2023/24 financial year. Even with the medium-term outlook, capital expenditure is not projected even to reach 9% of the total government expenditure. The National Treasury has confirmed that “Infrastructure investment declined as a share of total expenditure, indicating a shift towards current consumption at the expense of future growth.” As such, desirable sustainable growth that will be able to alleviate the pressures of unemployment can be achieved if the government can be radical with infrastructure investments.

The majority of employment should come from the private sector rather than the government. As such, government should also focus on creating a fertile environment for private investments and entrepreneurship. While we see a decline in infrastructure expenditure, the situation is made worse by incomplete projects, at times, inefficiencies and fruitless expenditures/white elephants. Included in the current government expenditure is the need to finance the growth in the size of the government, owing to maintaining the GNU. The postponement of the budget tabling contributes to the continuous fruitless spending of the government. It may also be considered as part of the GNU costs.

In order to finance its planned increase in expenditure, the government projected that it would raise an additional R58 billion if the 2% increase of VAT from 15% to 17% went ahead. The revised proposal of 0.5% increase is expected to raise government revenue by R28 billion. This will be implemented from the first of May 2025. An interesting relationship that is noted here is that 3 quarters decline in VAT only reduced revenue by half. This is an indication the harm that tax hike has on the economy is exponential. As such, it should be avoided for developing economy that has ambitions to grow and develop. Tax hikes are not guaranteed to raise revenue as projected. Learning from the latest VAT hike (1% from 14% to 15% in 2018), revenue collected as a result was way lower than expected. A VAT hike discourages the very same local consumption expenditure (the single most important component of the gross domestic product) in which government is hoping to raise revenue from. This might also negatively affect businesses and further reduce unemployment levels. Nevertheless, more tax hikes are expected in the coming years. The Minister of Finance has tabled that a further 0.5 in VAT will be implemented from the 1st of April in 2026. Treasury have not raised company income tax and personal income tax, but decided not to adjust tax brackets medical tax credits for inflation as usual. The non-adjustment of tax brackets to take care of inflation reduce the effective power of salaries and wages.

One should note that, to date, the government has already received additional tax revenue of more than R11.6 billion. This is due to two-pot retirement reforms implemented from  September 1, 2024. More tax revenue is still expected as people continue to put their claims. Raising VAT has a significant impact, especially on the poor, because they have little to no room to readjust their expenditures. To mitigate the impact of the VAT increase, the government proposes to extend the current list of 21 zero-rated essential food items. “From 1 May 2025, zero rating will be extended to include edible offal of sheep, poultry, goats, swine and bovine animals; specific cuts such as heads, feet, bones and tongues; dairy liquid blend; and tinned or canned vegetables” (National Treasury, 2025). Treasury agrees that the unfortunate part about zero rating is that it is a “blunt tool to assist lower-income households, because there is no guarantee that there will be a reduction in prices.” Nevertheless, government is convinced that the proposed items are mostly consumed by the lowest income earners and poorest people in South Africa. And such an increase in the number of zero-rated items will lead to the forgone revenue of about R2 billion. 

A macroeconomic policy that seeks to raise taxes and keep a budget surplus is a contractionary fiscal policy. With this budget, it is clear that the government has adopted this policy. This policy is not ideal for developmental states. This policy sacrifices economic growth for a reduction in government debts. What we can clearly see from the 2025/26 budget is that South Africa is struggling to create an environment that would incentivise private investments. There is an element of over-reliance on government for the majority of South Africa’s investments. Allowing private sector participation would ease the burden on fiscus.

*Dr Sanele Gumede is an Academic Leader in the School of Accounting, Economics and Finance & Founding member of the Macroeconomics Research Unit at the University of KwaZulu-Natal (UKZN).

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