Watch out for VAT changes in 2018 Budget Speech

Maarten Ackerman, Chief Economist and Advisory Partner, Citadel.

February’s budget speech is expected to hit a slightly more optimistic note as a result of resurgence in business and consumer confidence. But South Africa’s growing debt levels and alarming budget deficit means that consumers should still prepare for the possibility of an increase in the VAT rate, cautions Maarten Ackerman, Chief Economist and Advisory Partner at Citadel.

This follows Finance Minister Malusi Gigaba’s recent statement that the country is facing a difficult fiscal framework, and that South Africans will have to bear some pain as a result of tough decisions being made to stabilise debt levels.

Last October’s Medium Term Budget Policy Statement (MTBPS) painted a bleak picture of South Africa’s economic outlook: the consolidated debt to GDP ratio had widened to 4.3% from a target of 3.1%, the projected tax shortfall for 2017 was estimated at R50.8 billion, while debt-servicing costs were cited as the fastest growing expenditure item on the national balance sheet.

“Government may also be backed into a corner by the promise of free education. They will not be willing to borrow more, and increasing the VAT rate would represent the simplest method for producing the greatest amount of income needed,” says Ackerman.

“While politically sensitive, the ANC could very well be willing to risk the controversy of this decision on the back of goodwill generated by Ramaphosa’s ANC conference victory, and the hope that any political fallout would have been forgotten by the time of the next national election in 2019.”

South Africa’s VAT rate has remained unchanged since its increase to 14% in 1993, owing to concern over the effect that further tax increases would have on the poor.

He notes that government could consequently consider introducing a variable VAT rate such as in the UK, with a higher rate charged on so-called luxury items such as alcohol and sweets, while extending the number of basic items that have a zero-VAT rating.

Government could also consider lifting the VAT exemption on fuel.

He adds, however, that South Africans should also expect a range of other tax measures to be implemented towards assuaging populist ANC factions, and reaching a compromise between government, civil society, business and labour on the measures taken to increase revenue.

“Raising corporate tax rates is unlikely, as this could impact business’ incentive to create more jobs, but both Capital Gains Tax and personal income tax rates for upper income earners are expected to increase.”

“Some form of wealth tax on the net-asset-value of an individual’s estate could also be a possibility,” he says.

Reasons for optimism in February’s speech

According to Ackerman, February’s budget speech is unlikely to be all doom and gloom, however.

“For example, revenue and tax collection are likely to be better than projected in October’s MTBPS, as economic growth is expected to reach 1.3% rather than the previously estimated 0.7%.”

He notes that the biggest threat that still remains to the economy is the upcoming credit ratings decision by Moody’s due to be announced in March.

A downgrade would see the country’s rating drop from investment grade to “junk status”, excluding South Africa from Citigroup’s World Bond Index and triggering a flight of investment capital.

“However, Moody’s held back from making a decision in November, and there have since been many positive developments which now make a downgrade less likely,” he says.

“For example, political uncertainty over ANC leadership has been resolved with the election of Ramaphosa, who also seems to be playing hardball in seeing that the right policies are delivered and dealing with corruption.”

“Poor governance and corruption at state owned enterprises was the next biggest concern cited by ratings agencies and we’ve also seen action already being taken, beginning with the replacement of the board at Eskom.”

Finally, he states that ratings agencies will be watching to see how funding and liquidity issues at the SOEs are dealt with in the budget speech, given the extreme risk to the fiscus posed by extensive government guarantees to Eskom, South African Airways, the SABC and the South African Post Office.

“Ramaphosa is the best person to act as a bridge between government, business and SOEs, so the next best outcome would be to see government under his leadership welcome some form of private participation or partnership towards ensuring that the SOEs funding needs are met and that they are run effectively and profitably.”

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