In South Africa, value-added tax (“VAT”) is a critical component of the government’s revenue collection, contributing significantly to the national budget. Since its implementation, there have been several adjustments to the VAT rate, with the most recent proposed increase revoked before coming into effect this year.

What is VAT exactly?

VAT is a tax applied at each stage of the production and distribution process. We as consumers, encounter this tax when we purchase goods and services, making it a significant part of our everyday expenses.

Higher VAT, higher prices

The immediate effect of a VAT increase is often an increase in prices. Businesses typically pass on the cost of a VAT increase to their consumers, resulting in higher prices for both essential and non-essential goods. This increase in the cost of living impacts household budgets, particularly for low- and middle-income families who may already struggle with financial constraints.

While VAT is not applied to a select list of basic food items and certain services (essential goods and services like education and healthcare), an increase in VAT still impacts the cost of many essential goods due to the ripple effect in the supply chains.

With the cost of essential items rising, consumers are often forced to cut back on discretionary spending. This means less money is spent on leisure activities, luxury items and even local services. This can negatively affect businesses and contribute to economic stagnation.

Hitting the poorest hardest?

The long-term consequences of higher VAT, as consumers adapt to higher prices, could undermine the financial stability of middle class and working class households:

• The increase in the prices of goods and services due to higher VAT will decrease the disposable income of a household, which can affect savings and investment. Households may find it increasingly difficult to set aside funds for savings or emergencies, leading to financial insecurity.
• A higher VAT rate can contribute to broader inflationary pressures in the economy. As businesses adjust their pricing strategies, the cost of living may stay high, eroding purchasing power over time. This can trigger a cycle of wage demands, putting further pressure on businesses and the economy.
• VAT is generally considered a regressive tax because it takes a larger percentage of income from lower-income households than wealthier ones. In consequence, higher-income households can absorb the cost more easily, while lower-income families face a heavier financial burden. As a result, a VAT hike will worsen the inequalities that already exist.

Fiscal policy and everyday life

In conclusion, a VAT increase (even if only by 0.5%) would have significantly impacted consumers, impacting household budgets, disposable income and overall economic conditions. While the government aims to balance revenue generation with social welfare, the challenges posed by such tax increases highlights the delicate interplay between fiscal policy and the lives of everyday citizens. Addressing the effects of a VAT increase requires ongoing attention and action to ensure that economic growth does not come at the expense of basic living standards for vulnerable citizens.

Being tax efficient is an important part of great financial management. In this blog, a group of South African tax experts at AJM Tax share their tips and explanations on tax issues. Learn everything you need to know about tax, from deductions you never knew about to retirement savings and capital gains. The first Tuesday of every month is Tax Tuesday.