Budget 2025: Was the decision to increase VAT by 2% such a bad idea?

The decision to increase Value-Added Tax (VAT) by 2% in the undelivered Budget 2025 will increase inflation, which will, in turn, give the Reserve Bank reason to pause cutting the repo rate in an environment where consumers are already battling to keep their heads above water.

Frank Blackmore, lead economist at KPMG, says the reality in South Africa is that a high proportion of most consumers’ expenditure would become more expensive from 1 April 2025. He points out that according to the Pietermaritzburg Economic Justice and Dignity Household Affordability Index, the average SA worker spends about 57% of their monthly earnings on transport and electricity and consequently underspends on food by around 46%. 

“The imposition of two percentage points on VAT would therefore impact all aspects of the welfare of the average working South African by increasing the costs of both food and transport components of the consumption basket and would reduce their disposable income available for other goods.”

He says it would be inflationary and, from a tax perspective, is regressive since the same amount of tax is paid by both poor and more wealthy households, and therefore, the cost falls disproportionally onto the poor.”

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2% VAT hike will put more pressure on consumers

Maarten Ackerman, chief economist at Citadel Investment Services, says a further 2% increase in the VAT rate will significantly strain consumers already under pressure.

“Given the cost-of-living crisis we are dealing with, our interest rates are still fairly high and we are sitting with high unemployment. Therefore, any additional tax will be quite negative for the consumer base in South Africa.”

He says the impact of a 2% increase in VAT is also inflationary. “The last time VAT increased from 14% to 15% in 2018, it added around about 0.5% to inflation. That implies that the South African Reserve Bank (Sarb) would probably be more cautious in terms of cutting rates because that will add to inflation pressure in the economy.

“The Sarb will then probably keep rates unchanged for the rest of 2025, which is then just another impact for the consumers who are already under pressure.”

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A VAT increase of 2% could affect inflation and repo rate

Sanisha Packirisamy, an economist at Momentum Investments, agrees. “Our view is that the Sarb possibly has room to cut the repo rate once more in the cycle based on the outlook for inflation and risks to the inflation outlook.

“There are also other upside threats to the inflation outlook despite lower electricity tariffs and a downward bias to inflation created by the new rebasing and reweighting exercise undertaken by Statistics SA, namely the rand affected by negative news flow, while the increase in global protectionism could lead to supply shortages and higher global inflation outcomes due to higher tariffs.”

She says while a VAT increase would be treated as a once-off, there will still be an impact on core or underlying inflation. “As such, with these factors at play, the hurdle to easing further is growing. While we could still possibly get one more cut in the cycle, easing beyond that is seen as more unlikely.”

Is there any other way to increase revenue rather than increasing VAT by 2%? Ackerman says there is: we must fast-track reforms and structural changes to get the economy going. “I think that is the silver bullet.”

Packirisamy there are options but as government is aiming to increase the competitiveness of local corporates, increasing corporate tax would be in contrast to this goal. “Personal Income Tax rates at the highest bracket are high relative to global players, suggesting our already small tax base would shrink more if personal income tax rates were hiked.

“Wealth and luxury goods taxes are difficult to implement and monitor and would not raise as much revenue. Therefore, other options would have to include further expenditure restraint and outright cuts or an increase in borrowing. Over the longer-term, efficiency gains and a higher growth profile, led by structural reforms, would aid in higher revenue collection.”

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2% VAT increase could increase inflation to above 4.5% midpoint

Blackmore says since a VAT increase of 2% would be applied across most goods and services, imposing such an increase would result in an increase of around 2 percentage points increase in inflation above the current level of inflation.

“That would mean that inflation would most probably be above the 4.5% midpoint of the inflation range and would, therefore, prevent further easing of the interest rate by the Sarb. It is even conceivable that interest rates may need to be increased if underlying inflation is any faster than current levels. This would obviously negatively impact consumption and investment spending and eventually result in lower economic growth and higher unemployment.”

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What about the concrete steps in Budget 2025 to help consumers?

Would the concrete steps in the speech, such as zero-rating more food items and not increasing the fuel levy, make any difference if VAT is increased by 2%? Blackmore says they would, but as the minister says, they chose a VAT increase precisely because it is the most efficient and broad-based option.

“Therefore, applying zero ratings in more goods would somewhat erode its efficient and broad-based nature, requiring higher rate changes as the potential VAT collected from those goods would need to be shifted to other goods.”

He says leaving the fuel levy unchanged would assist somewhat as fuel-related transport costs would not increase, but the cost of vehicles, parts, services and driver salaries would still increase, leading to higher transport costs anyway.

“The same is true for the adjustment of personal income tax brackets and above inflationary increases in social grants. It is unlikely that these would fully compensate for additional price increases caused by higher VAT.”

Ackerman says that is what the Government of National Unity (GNU) members who were against the increase are demanding – for policy and reform that can really speed up the economy instead of trying to squeeze out further revenue by taxing the economy even further.

“Obviously, on the other side of that same coin is really cutting back on unnecessary expenses and the elephant in the room remains the wage bill that again just got a 5.5% increase in wages.”

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Is it worth it to let consumers suffer for making R58 billion on more VAT?

According to the undelivered Budget 2025 speech, increasing VAT by 2% would ensure that government gets additional revenue of R58 billion, but is it worth it to have poor consumers suffer to make R58 billion?

Ackerman says it is not worth it, although part of the proposal was to increase the zero-rated food items, typically the kind of goods and services that the poorer part of the community will spend money on.

“The plan was that then, with that additional R58 billion, to continue with social grants and also increase that by more than inflation. There was a plan also to compensate so that the lower income consumers are not really paying the full price for this change.”

Blackmore says in the end the citizens of a country will always need to pay the government bill for proposed expenditure. “That payment can take place now through higher taxes or later using debt repayments. 

“What is highlighted here is the danger of allowing public debt to grow to such large levels that the service costs required 22% of total expenditure and therefore crowd out the potential growth and social applications of these funds.“

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Budget 2025 will be a careful balancing act

Packirisamy points out that balancing a VAT increase to strengthen government finances while protecting the poor requires a carefully designed strategy. “A higher VAT rate can help boost revenue, reduce budget deficits and stabilise public finances, which in turn supports long-term economic growth and investor sentiment.

“However, since VAT is a consumption tax that affects all income groups, measures must be in place to shield low-income households from its impact. Expanding the list of VAT-exempt essential goods, increasing targeted social grants and enhancing tax rebates for vulnerable groups can help offset the burden.”