VAT Commission report

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Finance Standing Committee

28 August 2018
Chairperson: Mr Y Carrim (ANC)
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Meeting Summary

The Committee met with VAT Panel for a briefing on its report. National Treasury, Fair Play Movement and the Budget Justice Coalition gave inputs.

The VAT Panel agreed upon core principles to guide its analysis and decision-making. As part of the consultative process, the Panel considered 2000 written inputs and held meetings with NEDLAC constituencies. On impact of the VAT increase, deep income inequalities mean rich households pay more in rand terms.  As a percentage of income and expenditure, the impact varies by decile but mostly around a third of a percent of spending. The largest impact on households was in the fourth to sixth decile, which spend roughly between R4000 and R6000 a month. The underlying principle was the tax system should be as progressive as possible. Even with zero rating, VAT is less progressive than income and luxury taxes, and international experience shows that a progressive tax system is necessary to promote equality. This was particularly important for SA, where deep inequalities are a major hindrance to economic and social progress, thus the tax base could not be broadened by making the poor pay more. More so, VAT should be as progressive as possible such that products that absorb a higher share of spending for poor ought to be zero-rated. The other consideration would be ease of administration, such that products should be easily defined – to avoid circumvention by sellers.

Unanimous recommendations by the Panel were as follows:

  • White bread, cake and bread flour – some nutritional concerns, but offset by progressive impact and significant for poor households
  • Sanitary products – not highly progressive, but very important for women and girls; note that zero rating in itself insufficient to ensure access
  • School uniforms – highly progressive and important to improve school access, but only viable if definitional issues can be addressed
  • Nappies – progressive and particularly important for women, children, and some disabled and elderly people

Estimated relief to the poorest 70% of households would come to R2.8 billion. That compares to a total increase in VAT without additional zero rating of R3.1 billion. Based on data for sales of these specific products, the cost in terms of foregone VAT for the fiscus would be R4 billion, 17% of the total anticipated income from the increase of R23 billion. There were disagreements particularly on individually quick frozen (IQF) chicken, with arguments put forth against including the following: that definition is not sufficiently rigorous to avoid the inclusion of other poultry products, inflating the cost; relatively high cost to fiscus; would encourage higher poultry imports, which are already largely IQF; and that benefits could be achieved through nutritional programmes. On the other hand, arguments for included the consideration that chicken is a staple food for low-income households, and imports help hold down the price; the progressive impact; and that definition is industry standard and other frozen chicken is visibly differentiated. Baby formula was not recommended for zero rating as the Panel recognised the imperativeness for some babies (where mothers have to go to work; require supplementary nutrition; or have high levels of HIV. Inputs from nutritional experts argued that formula is abused and can be bad for health, especially where high cost leads to inappropriate dilution or water is poor quality. However, government should ensure available to low income households that require it.

The Budget Justice Coalition expressed concern about the limited timeframes afforded to consultative processes. The public needed to participate in the formulation of the fiscal framework and in all budget-related discussions. There were questions about the methodologies used by the Panel as it was unclear how the decision to recommend the zero-rating of some of the items was reached.

Fair Play Movement expressed disappointment with the outcome of the Panel process. For instance, the old list of zero-rated items was not reconsidered in recognition of changes in consumer and dietary preference changes over the last 27 years. The current basket of zero-rated items as well as the recommended one did not speak to people’s nutritional needs; the exclusion of chicken on the list being one case in point.

National Treasury said the Panel did a commendable job given the complexity of the matter it was tasked to deal with. Given that zero-rating is a blunt instrument, monitoring government’s in-kind programs to ensure their effectiveness in addressing the plight of the poor was crucial. Ensuring pro-poor programs work and their implementation is transparent was crucial. Furthermore, the state was in need of revenue. The VAT increase is going to be here for a while. It is not a one-year matter. The money that was needed, if one looks at the fiscal envelope, was actually required at least for the medium-term expenditure framework period. Unless government expenditure was reduced drastically and economic growth picked up, there was no scope to reduce tax rates over the next three to five years. Treasury was still working on the estimated cost of zero-rating six additional items, as proposed by a Panel of experts that estimated the revenue loss to the fiscus of this zero-rating would be R4 billion. The Panel had delivered on its specific mandate. Treasury would come up with a response document to stakeholder inputs, and the process would be taken forward from there.

Members thanked the Panel for the work it had done. The commendable work by the Panel was a starting point. The recommendation that sanitary towels should be free was welcome. In as much as there were various areas of contention, it was encouraging that the work of the Panel appeared to be biased in favour of the poor. A Member indicated the VAT increase was being supported on the understanding that it is a short-term measure to address revenue shortfall in budgeted expenditure- it could not be supported as a permanent solution. Other alternatives ought to be explored as a means to identify concrete and long-term relief to budget pressures on the expenditure side.

The Chairperson said the majority felt the law should stipulate that a review of the necessity for the hike be undertaken after a specified period. He insisted the increase could not be here forever. The Committee at this stage, unless it is presented with a convincing argument by the executive otherwise, believes that there must be a time frame on the VAT increase. The Committee takes into account that there are several other considerations — economic growth, the need to contain expenditure in the state, not least Parliament, the need to extract from those who are responsible for illicit financial flows the monies that are due to the fiscus, and a variety of other attempts to get growth and job creation. The Panel had done a very good job.

Meeting report

The Chairperson welcomed everyone and indicated that the Committee would not take any decisions at this stage. Stakeholders would be invited to respond to the VAT Panel’s report within two weeks. The Committee would want a speedy resolution to the VAT debate.

Briefing by the VAT Panel
Prof Ingrid Woolard, VAT Panel Chairperson, said the Panel agreed on core principles to guide its analysis and decision-making, and priorities for zero-rating reflected inputs from the public. As part of the consultative process, the Panel considered 2000 written inputs and held meetings with NEDLAC constituencies. On fiscal and socio-economic context, deficit remains relatively high since stimulus was required in response to 2008/9 global crisis, and VAT revenue in constant rand has been declining. On the other hand, SA remains amongst the most unequal countries in the world and experiences relatively slow and unstable growth since the metals boom ended in 2011.

On impact of the VAT increase, deep income inequalities mean rich households pay more in rand terms.  As a percentage of income and expenditure, the impact varies by decile but mostly around a third of a percent of spending. The largest impact on households was in the fourth to sixth decile, which spend roughly between R4000 and R6000 a month. The underlying principle was the tax system should be as progressive as possible. Even with zero rating, VAT is less progressive than income and luxury taxes, and international experience shows that a progressive tax system is necessary to promote equality. This was particularly important for SA, where deep inequalities are a major hindrance to economic and social progress, thus the tax base could not be broadened by making the poor pay more. More so, VAT should be as progressive as possible such that products that absorb a higher share of spending for poor ought to be zero-rated. The other consideration would be ease of administration, such that products should be easily defined – to avoid circumvention by sellers.

Dr Thabi Leoka, VAT Panel Member, took the Committee through the Panel’s findings. Overall, goods have a progressive impact and a strong equity-gain ratio – poor people consume a relatively high share. She added that the Panel did not have time to separate out products, and therefore would need to explore trade-offs of more selective approach in terms of higher administrative burden. On other products, public submissions pointed to 66 products for zero rating, excluding some for which the Living Conditions Survey (LCS) did not provide data (e.g. yoghurt). These products were analysed to determine those which were significant expenditure items (over 0.2% of household spending). These were relatively progressive in impact, with a significant equity-gain ratio (measured by the spending of poorest 40% as a ratio to the richest 20%), and were merit goods or particularly important to disadvantaged groups. Eight products qualified for more in-depth analysis, these being: Baby formula ("baby food consisting predominantly of milk"); bread and cake flour; white bread; disposable nappies; poultry; sanitary products and tampons; school uniforms. For each, the Panel reviewed: incidence by household decile; clarity of definition; socio-economic justification; and cost to fiscus based on sales data.

Unanimous recommendations by the Panel were as follows:

  • White bread, cake and bread flour – some nutritional concerns, but offset by progressive impact and significant for poor households
  • Sanitary products – not highly progressive, but very important for women and girls; note that zero rating in itself insufficient to ensure access
  • School uniforms – highly progressive and important to improve school access, but only viable if definitional issues can be addressed
  • Nappies – progressive and particularly important for women, children, and some disabled and elderly people

Estimated relief to the poorest 70% of households would come to R2.8 billion. That compares to a total increase in VAT without additional zero rating of R3.1 billion. Based on data for sales of these specific products, the cost in terms of foregone VAT for the fiscus would be R4 billion, 17% of the total anticipated income from the increase of R23 billion.

There were disagreements particularly on individually quick frozen (IQF) chicken, with arguments put forth against including the following: that definition is not sufficiently rigorous to avoid the inclusion of other poultry products, inflating the cost; relatively high cost to fiscus; would encourage higher poultry imports, which are already largely IQF; and that benefits could be achieved through nutritional programmes. On the other hand, arguments for included the consideration that chicken is a staple food for low-income households, and imports help hold down the price; the progressive impact; and that definition is industry standard and other frozen chicken is visibly differentiated. Baby formula was not recommended for zero rating as the Panel recognised the imperativeness for some babies (where mothers have to go to work; require supplementary nutrition; or have high levels of HIV). Inputs from nutritional experts argued that formula is abused and can be bad for health, especially where high cost leads to inappropriate dilution or water is poor quality. However, government should ensure available to low income households that require it.

Mr Ayabonga Cawe, VAT Panel Member, pointed out that it was well-understood that zero rating is a blunt instrument because it cuts cost of products for all households, not just poor. In theory, the poor could be compensated through expenditure programmes, including providing products in-kind, as well as cash transfers equal to cost of VAT. However, challenges in practice would include the following: reaching all poor households affected by VAT with sufficient resources to offset tax impact; and administrative and fiscal difficulty of scaling up both in-kind and cash programmes on a sufficient scale. To date, government has been unable to expand in-kind programmes to ensure comprehensive coverage. The government transfers a large share of tax revenue to the poor amongst others through nutritional support; subsidised housing; greater subsidies to education in low-income areas; public employment schemes; and free healthcare for low-income families. Using in-kind support programmes to mitigate the impact of the VAT increase on the poorest 50% would require an expansion in these programmes by R1.8 billion above the amount they would have grown in any case, as measured for instance by the MTEF projections; and in ways that ensure virtually all households in the poorest seven deciles benefit. The Panel had capacity to review only nutritional support programmes and the provision of sanitary products.

On provision of free sanitary products, this has been a long-standing government commitment, but so far not implemented. Providing an average of 20 sanitary pads every month for woman aged 13 to 55 in households would cost R240 per household would be at a total cost of R2.6 billion if the poorest 50% is reached, and R3.2 billion for poorest 70%. Actual relief to households would vary depending on number of women.

In conclusion, society could not seek to extend the tax base by increasing the burden on poor households, because of SA's unusually large inequalities. However, any effort to mitigate the cost of VAT for the poor will cost the fiscus. The VAT increase will cost poor households as a group around R3 billion – offsetting that cost is difficult because households differ in expenditure patterns and needs. Zero rating is administratively easier to implement, but at least in theory harder to target than transfers to households in cash or in kind

Discussion
Ms T Tobias (ANC) appreciated the presentation and felt the classification of consumer goods should have clearly determined those primarily consumed by households in the lowest income deciles. Also, the VAT increase was being supported on the understanding that it is a short-term measure to address revenue shortfall in budgeted expenditure- it could not be supported as a permanent solution. Other alternatives ought to be explored as a means to identify concrete and long-term relief to budget pressures on the expenditure side.

Mr A Lees (DA) thanked the Panel for the work it had done. He asked about the rand value of the recommended items to be added to the zero-rated list? What would be the total cost, of revenue foregone, to the fiscus? Had the Panel’s life now come to an end? What was the cost of the Panel?

Mr D Maynier (DA) asked if Treasury arrived at the same figure, of R4 billion, as the Panel- given the two appear to have applied different methodologies.

Mr M Hlengwa (IFP) noted the items recommended by the Panel for zero-rating. He asked how zero-rating uniforms could possibly assist the poor as this, in the main, was a once-off yearly purchase. Whether the VAT increase is implemented or not, those who could not afford would remain in that position. How would the free sanitary pads intervention assist the poor specifically? He did not believe any of the recommended items would provide immediate relief to the poor. It was regrettable that the Panel was given a limited timeframe to work within given the complexity and gravity of the matter- more work still needed to be done. Further, the cost that would be borne by the poor following the VAT increase will be very steep, adding to fuel and other price increases. The suggested interventions were too high level and would thus not address the plight of the poor in the immediate. In the main, the interventions might only yield results after leaving a trail of destruction. The practical realities of the people out there needed to be grasped clearly.

Ms D Mahlangu (ANC) said the commendable work done by the Panel was a starting point. The recommendation that sanitary towels should be free was welcome. In as much as there were various areas of contention, it was encouraging that the work of the Panel appeared to be biased in favour of the poor.

Mr N Nhleko (ANC) welcomed the excellent piece of research work and said it would be essential not to be bogged down around definitions. A codified approach that would take into account the totality of the situation which sought to be addressed would be ideal.

Ms P Nkonyeni (ANC) appreciated the report particularly the recommendation that sanitary towels should be free.

The Chairperson noted Parliament was going to ultimately take decisions. At this stage, the Committee could not make any determination until it hears from stakeholders. However, unless convinced otherwise, the majority felt the VAT hike should have a timeframe- it might be wise to set a timeframe for its review. This must be signalled to the Executive and they must respond to stakeholder inputs sympathetically. He welcomed brief inputs from stakeholders present.

Ms Pearson Kirsten, Coordinator, Budget Justice Coalition, expressed concern about the limited timeframes afforded to consultative processes. The public needed to participate in the formulation of the fiscal framework and in all budget-related discussions. There were questions about the methodologies used by the Panel as it was unclear how the decision to recommend the zero-rating of some of the items was reached.

Mr Lionel Adendorf, Activist, Fair Play Movement, expressed disappointment with the outcome of the Panel process. For instance, the old list of zero-rated items was not reconsidered in recognition of changes in consumer and dietary preference changes over the last 27 years. The current basket of zero-rated items as well as the recommended one did not speak to people’s nutritional needs; the exclusion of chicken on the list being one case in point.

Prof Woolard, in response, said the comments were well-taken but it had to be understood that as a tax Panel with limited timeframes and capacity constraints, it would not have been feasible to think about how the tax system could be re-imagined to ensure that it becomes more progressive and pro-poor. If the numbers reached by the Panel were underestimates- then the underestimates would be across the board, such that if the revenue shortfall was underestimated, then the impact of the VAT increase might have been underestimated as well. The estimates and mitigation measures recommended by the Panel were not perfect; some poor households may not get the full benefits suggested. The amount of tax leakages would get bigger as the definitions are broadened and relaxed. She noted that micro-data from the LCS was used. All 760 consumption items were analysed and zeroed down to 66 as identified by the report. The Panel believed the existing list of zero-rated items was serving the country very well, thus there was no need for its reconsideration.

Dr Leoka said the Panel consulted widely and some of the submissions received from stakeholders had been thoroughly researched. The various items suggested for zero-rating had been fully considered, with particular focus on low-income households’ consumption patterns. For instance, the VAT foregone if chicken was zero-rated would be R5.6 billion. More so, the benefits of zero-rating chicken might not necessarily be accrued by the poor owing to the complexity of value-chains within markets. The Panel had to make tight balancing acts, mindful of the underlying considerations in the analysis of tax policy.

Mr Cawe added that the Panel did not just rely on written submissions but did get an opportunity to interact with stakeholders at NEDLAC. In recommending school uniforms for zero-rating, a number of considerations were made; such as the extent of inequality and income distribution within society. The issue of uniform prices and their affordability was also being looked into by the Competition Commission, from a market structure perspective. Although a once-off yearly purchase, it is a big ticket item for low income households, especially considering the high dependency ratios in most of these households. The interventions should not be analysed in isolation. 

Mr Ismail Momoniat, DDG: Tax and Financial Sector Policy, National Treasury, said the Panel did a commendable job given the complexity of the matter it was tasked to deal with. On the cost of the Panel, its members came in very cheap and showed incredible commitment. Given that zero-rating is a blunt instrument, monitoring government’s in-kind programs to ensure their effectiveness in addressing the plight of the poor was crucial. Ensuring pro-poor programs work and their implementation is transparent was crucial. Furthermore, the state was in need of revenue. The VAT increase is going to be here for a while. It is not a one-year matter. The money that was needed, if one looks at the fiscal envelope, was actually required at least for the medium-term expenditure framework period. Unless government expenditure was reduced drastically and economic growth picked up, there was no scope to reduce tax rates over the next three to five years. Treasury was still working on the estimated cost of zero-rating six additional items, as proposed by a Panel of experts that estimated the revenue loss to the fiscus of this zero-rating would be R4 billion. The Panel had delivered on its specific mandate. Treasury would come up with a response document to stakeholder inputs, and the process would be taken forward from there.

The Chairperson reiterated that the majority felt the law should stipulate that a review of the necessity for the hike be undertaken after a specified period. He insisted the increase could not be here forever. The Committee at this stage, unless it is presented with a convincing argument by the Executive otherwise, believes that there must be a time frame on the VAT increase. The Committee takes into account that there are several other considerations — economic growth, the need to contain expenditure in the state, not least Parliament, the need to extract from those who are responsible for illicit financial flows the monies that are due to the fiscus, and a variety of other attempts to get growth and job creation. The Panel had done a very good job.

The meeting was adjourned.

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