Economic ramifications of VAT increase: higher inflation, lower GDP

While politicians fight about the VAT increase, a study has shown that the economic ramification of the increase will see inflation increase and GDP decline.

Although it will boost government coffers by about R30 billion.

A study by researchers at the National Agricultural Marketing Council and the University of Pretoria quantifying the economy-wide effects of VAT increases and excise duties reveals that the VAT increase will have an inflationary effect of 0.04% in 2025 and 0.03% in 2026.

In addition, the study shows that gross domestic product (GDP) is projected to decline by 0.21%, while household consumption will contract by 0.22% in the medium term.

The council researchers, Bhekani Zondo, Lwazi Dladla, Lesedi Mokoena, Nokuthula Khulu, Ricardo Smith, Phelelani Sibiya, Dr Moses Lubinga, Dr. Solly Molepo and Dr Victor Thindisa, working with Prof. Heinrich Bohlmann from the University of Pretoria, noted that the reduction in disposable income and subsequent decline in economic activity due to the VAT increase may result in lower personal income and corporate tax collections, counteracting some of the anticipated revenue gains.

They say considering the general equilibrium effects, an increase in the VAT rate to increase government revenue is projected to increase a net tax collection of only approximately R20 billion and not the R30 billion government is targeting.

ALSO READ: Budget speech: VAT increases by 0.5%, with another 0.5% hike next year

VAT increase will affect agricultural output

They expect that output across all subsectors in the agricultural sector will decline, with forestry (0.4%), livestock (0.26%), field crops (0.24%) and horticulture (0.23%) experiencing notable contractions.

Food manufacturing will also be affected, with the fisheries industry experiencing the sharpest sales decreases (0.41%), followed by grains (0.34%), and meat processing (0.29%).

While VAT is a consumption-based tax, aimed at improving revenue collection efficiency and reducing tax evasion, excise taxes, that will also increase, are duties imposed on specific commodities, such as alcohol and tobacco which are domestically produced and imported.

Excise taxes serve a dual purpose to discourage consumption of alcohol and tobacco while also generating revenue.

The researchers say VAT and excise duties are particularly relevant to the agricultural and food sectors.

The proposed 6.83% increase in excise duties on alcoholic beverages is expected to have ripple effects across the agricultural industry, specifically the wine and brandy industry, while the 0.5% increases in VAT are also expected to have regressive effects on lower-income consumers and households.

ALSO READ: Budget 2025 passed with VAT increase while rand tanks

Excise duties on wine and brandy made in SA

They point out that the domestic alcohol beverage industry plays an important role in economic development by contributing to the country’s GDP, generating employment opportunities, and foreign exchange earnings.

According to the Drinks Federation of South Africa, the beverage industry contributed approximately 3.6% (about R226.3 billion) to the GDP and 6.7% (R96.9 billion) in government tax revenue collection in 2022.

The entire alcohol beverage industry employs approximately 500,000 people and sustains about 498,999 jobs. However, despite its importance, it is still plagued by several challenges that compromise its competitiveness and sustainability and discourage investments in the sector.

These challenges include climate change-related issues, a reduced number of wine producers/cellars, illicit trade and increasing excise duties.

ALSO READ: Budget speech: VAT increase decision not made by someone who knows hunger

Expanding basket of VAT zero-rated foods

The researchers also say although government plans to expand the basket of VAT zero-rated foodstuffs and not increase the general fuel levy to mitigate the impact of this increase on households, the proposed VAT means a more substantial portion of the income of low- and middle-income households will go toward taxes, reducing their disposable income.

In addition, many households are food insecure since not all households have access to adequate food.

According to Statistics South Africa approximately 3.7 million households faced moderate to severe food insecurity, while 1.5 million households endured severe hunger in 2023.

The researchers say this highlights the persistent issue of unequal access to food, particularly among low-income households and marginalised communities, where poverty, inequality and high unemployment rates exacerbate the problem.

They warn that while tax increases serve as a critical tool for revenue generation and promoting a healthy lifestyle, their broader economic implications should be carefully managed through complementary policies to ensure balanced and inclusive economic growth for local industries as well as ensuring household welfare.

ALSO READ: Budget speech: Here’s how much more you’ll have to pay for alcohol and cigarettes

Increase in VAT and excise duties will increase revenue but have adverse effects

“The analysis of the proposed increase in VAT and excise tax indicates that while these tax measures will generate additional government revenue, they will also have adverse effects on economic growth, household consumption and productivity among key agricultural industries.”

The increase in excise duties on alcoholic beverages are expected to generate R1 billion and will have relatively minor macroeconomic effects but will significantly have a negative impact on the beverage industry, particularly the wine and brandy subsectors, leading to an estimated 1.5% decline in sales.

This, the researchers say, could place up to R150 million in wage earnings at risk within the industry, along with potential indirect losses in the agricultural and retail sectors.

They recommend expanding the list of zero-rated food items to soften the impact, especially on low-income households.

In addition, they recommend that government should explore policy measures to support the competitiveness of the domestic beverages industry, such as trade promotion strategies and incentives for value-added production.

“Given the potential impact of VAT on food affordability, strengthening food security policies, particularly for vulnerable households, should be prioritised to prevent an increase in hunger and malnutrition,” the researchers say.