VAT increase warning for South Africa

The government is likely to increase value-added tax (VAT) in the future as there is room to raise additional revenue from a higher rate and broaden the tax base while doing so. 

However, it remains crucial that this increase is coupled with measures to limit its impact on poorer households and reforms to maximise its collection. 

This is feedback from the Organisation for Economic Co-operation and Development (OECD) in its latest economic survey on South Africa. 

The organisation said that government revenue has consistently underperformed expectations over the past decade, excluding temporary jumps from favourable commodity prices in 2022 and 2023. 

South Africa’s revenue collection has weakened significantly due to sluggish economic growth and the hollowing out of SARS during the era of State Capture. 

This is not due to a lack of tax increases, as personal income tax rate increases and VAT rates between 2016 and 2020 had a limited effect on revenue collection. 

These increases have not resulted in significant changes in South Africa’s tax-to-GDP ratio, which currently stands at 24.5%. This is higher than most emerging economies but lower than the OECD average. 

The organisation said that various tax provisions and exemptions lower effective tax rates below statutory levels, suggesting revenue gains through policy streamlining. 

Personal income tax remains the largest source of revenue for the government, contributing 37.3% of total collections. 

This tax is highly concentrated in the top 20% of taxpayers, who account for three-quarters of total collections. South Africa’s personal income tax rates also remain significantly higher than those in peer countries. 

While there appears to be some room to increase personal income tax rates, the OECD said this is unlikely to have the desired effect due to the highly concentrated tax base. 

“Evidence suggests that raising the top marginal tax rate would have a limited impact due to Laffer curve effects,” the organisation said. 

Alternative options include lowering the threshold at which various tax rates apply to broaden the tax base and reducing deductions and allowances. 

The declining benefit of higher tax rates on individuals is evident in the graph below, where South Africans earning over R500,000 per year pay a lower real tax rate than those in the next two brackets.

The case for raising VAT

South Africans may still face a VAT hike next year if the National Treasury fails to identify areas for more efficient government spending and if SARS fails to close the tax gap sufficiently. 

The National Treasury was clear in its 2025 Budget Review that additional, unspecified tax measures might need to be implemented in the coming financial years to raise approximately R20 billion annually. 

This suggests a small VAT hike could be back on the table, with political buy-in beforehand to ensure it makes its way through Parliament. 

The value-added tax, the second-largest revenue source, contributed 35.4% of total tax revenues in the 2024 financial year, but remains below the OECD average.

This suggests there is room to increase both the tax rate and its base while alleviating the impact on the most vulnerable, the OECD said. 

To maximise the impact of any increase in the VAT rate, it is key to adopt complementary reforms to enhance collection. Otherwise, there would be a risk that revenue gains may fall short of expectations. 

Potential measures include enhanced registration, mandatory e-filing and the introduction of electronic invoicing, which has proven to be very effective in other OECD countries.

This must be coupled with the continued strengthening of tax administration capacities to tackle illicit trade and improve compliance. 

Furthermore, a list of zero-rated VAT items has also been defined to offset the impact on the most vulnerable. 

However, means-tested household support could achieve similar objectives with lower revenue costs, the OECD said. 

To improve VAT collection, the 2025 Budget bill shortens the submission period for VAT claims and introduces changes to the electronic services regime to address low compliance among domestic and foreign providers. 

The bill also addresses VAT challenges in the digital economy by introducing a simplified VAT registration system for offshore companies transacting with South African firms, which aligns with OECD recommendations. 

The graph below shows South Africa’s VAT rate in comparison to the OECD average and other economies.

This article was first published by Daily Investor and is reproduced with permission.