Zero VAT rating of products does not help poor people – expert

While the minister of finance made a big deal of adding to the basket of zero VAT-rated items in Budget 2025 to help poor people, as he also called for a 0.5% increase in VAT, an expert says zero VAT rating certain items does not help low-income consumers.

At the opening of parliament after the national election in July last year, President Cyril Ramaphosa stated that the government of national unity (GNU) would look to expand the basket of essential food items exempt from value-added tax (VAT) and undertake a comprehensive review of administered prices.

Subsequently, politicians, members of parliament, trade unions, the South African Poultry Association and the Red Meat Producers Organisation all called for the expansion of the list of zero-rated foodstuffs.

Gerhard Badenhorst, director for tax and exchange control at law firm Cliffe Dekker Hofmeyr, says this is not surprising since the 2024 National Food and Nutrition Security Survey indicated that 3.7 million households in South Africa reported inadequate or severely inadequate access to food, with food security at its lowest point in 2023 compared to the period 2010–2023.

In addition, the number of people not meeting the minimum energy requirements in their diets increased from 1.8 million in 2001 to 4.7 million in 2021 and by 2023, 23.6% of households were consuming a lower variety of food than usual given economic constraints.

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Two main reasons behind call for VAT zero-rating

Badenhorst says the calls for expansion of the list of zero-rated foodstuffs cite two main reasons. “Firstly, it will reduce the cost of food items for poor households in the wake of high food price inflation and secondly, that adding more protein to the zero-rated basket will encourage poor and low income households to add more protein to their diets to address malnutrition.”

However, the question is whether adding more food items to the basket of zero-rated foodstuffs will indeed reduce their cost and whether it will address malnutrition.

Badenhorst points out that without any zero-rating or exemptions, VAT is inherently a regressive tax because the amount of VAT lower-income households pay for essential goods and services as a percentage of their disposable income is higher than that of high-income households, although high-income households may spend higher amounts on VAT in absolute terms.

When VAT was introduced on 30 September 1991 at a rate of 10%, only two food items were initially zero-rated: brown bread and maize meal. The number of zero-rated food items was subsequently temporarily increased from 30 September 1991 to 31 March 1992 with the addition of another eight items.

Since 7 April 1993, when the VAT rate was increased from 10% to 14%, the basket of zero-rated food items was expanded by a further nine items to increase the total number to nineteen. After the VAT rate increase from 14% to 15% on 1 April 2018, the zero-rated basket was expanded further with the addition of cake wheat flour and white bread wheat flour, while sanitary towels were also zero-rated since 1 April 2019.

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Current VAT zero-rated basket contains 21 food items

The current basket of basic zero-rated foodstuffs consists of 21 food items, while zero-rating also applies to petrol and diesel and illuminating kerosene. However, petrol and diesel are subject to excise duties, the fuel levy and the Road Accident Fund levy. Public transport by road and rail and the provision of residential accommodation are also exempt from VAT.

A number of studies were conducted over the years to determine the effect of zero-rating basic foodstuffs on alleviating VAT’s regressivity and the implications of zero-rating. The Katz Commission extensively considered the zero-rating of basic foodstuffs.

The Commission stated in Its interim report in 1995 that zero-rating benefits the poor modestly in absolute rand terms and benefits the non-poor by substantially greater amounts. Moreover, it found that, of the total revenue loss due to zero-rating, only approximately a third of the benefits went to low income households.

A study conducted by the Organisation for Economic Cooperation and Development in 2015 found that, despite the progressive effect of reduced rates on food products, reduced VAT rates are a very poor tool for targeting support to poor households.

The Davis Tax Committee also considered the zero-rating of basic foodstuffs, and in its final report on VAT to the minister of finance in 2018, it referred to a study conducted by the National Treasury in 2006 that found that the zero-rating of specific foodstuffs provides a larger proportional benefit to the poor, thereby enhancing progressivity, but it provides a larger absolute benefit to the rich, who consume larger quantities.

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Independent panel could not agree on VAT zero-rating

Badenhorst says when the VAT rate was increased from 14% to 15% in April 2018, the minister of finance appointed an independent panel of experts to review the zero-rating of various items, including bread, white bread flour, cake flour, school uniforms, baby formula, individually quick frozen (IQF) poultry parts, sanitary towels and nappies.

However, the panel could not reach a consensus on zero-rating individually quick frozen poultry parts, as the definition was not sufficiently clear, that zero-rating could encourage imports and that the benefits would not be passed on to consumers.

“Although there is consensus that zero-rating of basic foodstuffs alleviates the regressivity of VAT, there also seems to be consensus that no further food items should be zero-rated as a means to alleviate the impact of high food prices on poor and low-income households.

“There is also no evidence that adding more protein to the zero-rated food items basket will get poor or low income households to add more protein to their diet.”

Badenhorst points out that zero-rating basic foodstuffs benefits all consumers but forfeits money from the fiscus, while the foods are not always clearly defined. It also distorts consumer preferences. He also points out that zero-rating can lead to shortages and that there is no guarantee that suppliers will pass the benefit of zero-rating on to consumers.

“If a poor or low-income household cannot afford to buy a particular food item in the first instance, the zero-rating of the item is unlikely to make it affordable.”

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What is the alternative to VAT zero-rating?

If the zero-rating of basic foodstuffs is not an effective means to alleviate the plight of poor and low income households, then what is the alternative? The Katz Commission, the Davis Tax Committee and the panel of experts all stated that it would be substantially more efficient to rather collect the tax revenue on food items and to redistribute the additional income through a targeted transfer to the poor, Badenhorst says.

“As confirmed by various global and local studies, the VAT system is not an effective tool to provide relief to poor and low-income households, mainly because the benefit of zero-rating is enjoyed by all consumers.

“There is no clear evidence that VAT causes food price inflation, which is mainly driven by input costs. There is general consensus that specifically targeted relief measures aimed at poor and low-income households, such as increased social grants and old age social pensions, food vouchers and the expansion of the national school nutrition programme, are better suited to address the difficulties faced by these households in relation to high food prices and malnutrition.”