The big question around South Africa’s VAT-free food

For years, President Cyril Ramaphosa has touted that the South African government is looking to expand the basket of essential food items exempt from value-added tax (VAT) and undertake a review of administered prices.

Most recently, in his annual address to the National Council of Provinces on 28 November, Ramaphosa said that “to ensure that all South Africans have affordable access to sufficient food, government is looking at whether the basket of food items that are exempted from VAT could be expanded to include more basic products.”

This discussion has come up because, for example, StatsSA’s General Household Survey showed that in 2023, an estimated 15% of the country’s population (~9.34 million) experience hunger, while over one-quarter of households experience worryingly complex access to food.

The calls for expansion of the list of zero-rated foodstuffs claim two main reasons:

• It will reduce the cost of food items for poor households in the wake of high food price inflation.

• 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, some have argued that the VAT system is not an effective tool to provide relief to poor and low-income households.

History of zero-rating food products

Director in Tax & Exchange Control practice at Cliffe Dekker Hofmeyr, Gerhard Badenhorst, said that “without any zero-rating or exemptions, VAT is inherently a regressive tax.”

This is “because the amount of VAT paid by lower-income households on essential goods and services as a percentage of their disposable income is higher than that of high-income households,” said Badenhorst.

Zero-rating basic foods is seen as a means to help mitigate this.

When VAT was introduced in 1991, only brown bread and maize meal were zero-rated. Over time, the list expanded, with significant increases in 1992, 1993, and 2019, including items like flour and sanitary towels.

Currently, the basket of basic foodstuffs that are zero-rated comprises 21 food items.

Past studies

Several studies, both globally and in South Africa, have been conducted over the years.

Notable ones identified and discussed by Badenhorst include:

• Katz Commission (1995): Found that zero-rating provides modest benefits to the poor in absolute terms, but significantly greater benefits to higher-income households. Only about a third of the total revenue loss from zero-rating actually went to low-income households.

• National Treasury Study (2006): Determined that zero-rating specific foodstuffs offers a larger proportional benefit to the poor, but a larger absolute benefit to the rich, who consume more.

• Studies by Professor Ingrid Woolard and Inchauste et al: Showed that the zero-rating of foodstuffs makes the South African VAT system essentially neutral or slightly progressive. While the poor benefit more from zero-rated staples like brown bread and maize meal, the wealthy benefit substantially more from the zero-rating of items like milk, fruits, and vegetables.

• Organisation for Economic Cooperation and Development (OECD) Study (2015): Found that reduced VAT rates on food are a poor tool for targeting support to poor households. In some cases, the benefit to wealthy households is so large that reduced VAT rates have a regressive effect.

• Davis Tax Committee (2018): Concluded that zero-rating is an ineffective method for achieving equity objectives and recommended against adding any further zero-rated food items.

• Independent Panel of Experts (2018): Appointed to review the zero-rating of various items by the Minister of Finance recommended increasing social grants and old-age pensions as a more effective alternative to zero-rating.

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

“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,” he added.

Implications

Badenhorst said that apart from the concerns raised by these studies, the following identified consequences of zero rating should also be considered:

• Revenue Loss: Zero-rating results in a substantial loss of revenue for the government. The sources indicate that the current zero-rating of 21 food items costs the South African government approximately R30 million in lost revenue. Additionally, if individually quick frozen (IQF) poultry parts were to be zero-rated, it would cost the government an estimated R2.1 billion in foregone VAT revenue.

• Definition and Abuse: Accurately defining which food items qualify for zero-rating is crucial to prevent misclassification, abuse, and potential litigation.

• Distorted Consumer Preferences: Zero-rating can distort consumer preferences by increasing demand for zero-rated items, potentially leading to shortages and price increases, negating the intended benefit for low-income households.

• Administrative Burden: Both suppliers and the South African Revenue Service (SARS) face administrative complexities in identifying, accounting for, and reporting on zero-rated items.

• Uncertain Benefit Pass-Through: There’s no guarantee that suppliers will pass on the benefits of zero-rating to consumers. Suppliers could maintain pre-zero-rating prices, citing increased production costs, and capture the benefits as higher margins. This occurred when illuminating kerosene was zero-rated.

• Ineffectiveness for the Poorest: If a household cannot afford a particular food item in the first place, zero-rating will likely not make it affordable.

• Potential Increase in Imports: Zero-rating foodstuffs upon importation could incentivise imports, impacting local producers. While reviewing import tariffs on newly zero-rated items might benefit low-income households, it could negatively affect local producers.

Going forward

“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, even more by those who can afford the food items and to pay the tax,” said Badenhorst.

He said that based on the studies, “there is no clear evidence” that VAT causes food price inflation, which is mainly driven by input costs.

The Katz Commission, Davis Tax Committee, and experts argued that collecting VAT on food and redistributing it through targeted transfers could be more efficient.

Badenhorst said that specifically targeted relief measures aimed at poor and low-income households.

These include increased social grants and old age social pensions, food vouchers and the expansion of the national school nutrition programme, which he says are better suited to address the difficulties faced by these households in relation to high food prices and malnutrition.

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