VAT was introduced in South Africa in 1991 to replace GST. VAT is an indirect tax and is levied on the value added in production during the different stages (Metcalf in Baker and Elliott,1997:413). In South Africa VAT is levied on the supply and importation of goods and services, while exported goods and services are exempted. The South African Value-Added Tax Act No.89 of 1991 makes allowances for exemptions, exceptions, deductions and adjustments that effectively lower the VAT liability. VAT was imposed in 1991 at a statutory rate of 10 percent; the rate was increased to 14 percent in 1993. To reduce the regressiveness of VAT, various basic food items where exempted from VAT when introduced. Later, in 2001 paraffin, an energy source used by most poor households, was also exempted (RSA,2001:16). The latest changes in VAT aim at improving the administration of VAT with the objective to reduce the administrative burden especially for small businesses (RSA,2002a:17). When VAT was initially introduced there were some questions on whether or not VAT can replace GST as a revenue source for government, to what extent VAT would increase inflationary pressures, and how regressive VAT would be.
This chapter first gives a brief history of VAT; next it discusses issues within a VAT system with specific focus on South Africa. The last section analyzes VAT in South Africa since its inception in September 1991 till 2001, and addresses the questions: How important is VAT as a revenue source for government? How inflationary is VAT? What is the impact of VAT on the trade balance? How regressive is VAT taking current zero-ratings into consideration? What is the long- and short run variables that determine VAT collections?
Analyzing VAT from 1991 until 2001 will also provide clues in terms of issues to be considered for the future within the South African VAT system.
VAT is a tax instrument used by countries all over the world. Japan was the first country to introduce a VAT-like tax just after World War I. However, this tax was short-lived. Brazil, followed by Denmark, introduced VAT in 1967. Denmark was the first European Community (EC) (now the European Union (EU)) country to adopt VAT. Other countries in the EC like France, Germany, the Netherlands, Luxembourg, Belgium, Ireland, Italy, and the United Kingdom followed. The VAT structure differed from country to country and therefore VAT could not be imposed uniformly throughout the EC. In 1977 the sixth directive on VAT brought together the former directives of the EC, and established consistent rules for VAT in the European Community. Other countries in the EC like Greece, Portugal, and Spain also introduced VAT. (Metcalf in Baker and Elliott,1997:417-419).
VAT is also used by various developing countries. An example is Bolivia, who introduced VAT in 1986 as one of the country’s centerpiece taxes. When introduced, the statutory VAT rate was 10 percent, but in 1992 it was raised to 13 percent. In 1993 VAT contributed about a third of the total tax revenue of the country. (McMahon and Schmidt-Hebbel in Fiscal Reform and Structural Change in Developing Countries. Vol. 2,2000:184). Another example is the Philippines, which introduced VAT in 1988 to replace all forms of sales taxes at that time. The statutory VAT rate at inception was 10 percent. VAT, in the Phillipines, is levied on final destination and exempts the primary sector, while exports are zero-rated. The tax credit method is used – credit for VAT paid on inputs are thus allowed. (Clarete and Diokno in Fiscal Reform and Structural Change in Developing Countries. Vol. 2,2000:102).
Other countries that also use a VAT system are New Zealand, Norway, Switzerland, and Turkey, (Metcalf in Baker and Elliott,1997:417-419) as well as Brazil, Colombia, India, South-Korea, and Taiwan. The list is not inclusive, and in April 2001 about 123 countries had a VAT-like tax (Ebrill et al,2001:8).
VAT is generally experienced by most countries as an effective tax. Apart from Japan only five other countries ever removed a VAT, which are Vietnam, Grenada, Ghana, Malta and Belize. Three of these countries, Ghana, Malta and Vietnam, as well as Japan have since reintroduced the VAT (Ebrill et al,2001:14). Australia and the United States are the only OECD countries not ever to have introduced a VAT (OECD,1997:7), however, one state in the USA employs a VAT tax; the state of Michigan introduced VAT in1975 (World Bank Symposium,1990:4).
Broad Issues Within a VAT System
There are eight broad issues within a VAT system. These issues are usually dealt with at the design stage of a VAT system. The choices when designing a VAT system are:
- The broad type; whether VAT should be based on consumption, income, or gross product.
- The regime for international trade: whether VAT should be levied at the place of origin or alternatively at the place of destination.
- The method that will be used to compute tax liability. The methods available are the subtraction, tax credit or invoice methods.
- The products, firms or sectors to be free of tax.
- Whether to apply exemptions or zero-rating to products, firms or sectors free of tax.
- The special rules or regimes that will apply to certain products, firms or sectors.
- Whether or not to use a single-rate or multiple rates within the VAT system.
- Whether or not to apply a tax-inclusive rate or alternatively a tax-exclusive rate. With the former tax is levied on the total amount of money transferred, including the tax itself. (World Bank Symposium,1990:5).
The rest of this section looks at some of the issues listed above by firstly discussing them in general, but then also discussing them specifically in the South African context. The issues of taxes on services, and tax evasion, are also discussed.
VAT: a Tax on Consumption
When introducing VAT, the most basic choice is to decide whether or not VAT would be imposed as a consumption, gross-product or income type tax. The following table illustrates the difference between the three types:
The three types of VAT differ in terms of the items deductible from the VAT base. With a gross-product type of tax only purchases of materials and services are deductible. The gross-product type of tax often leads to double taxation, as capital goods are taxed when first purchased, but may be taxed again when sold. The income type tax, on the other hand, also allows for the exclusion of depreciation on capital goods, however, the calculation of depreciation is a problematic issue. A consumption type tax allows for the deduction of purchases of materials and services as well as investment purchases. Most countries adopted a consumption-based tax, since VAT was in most cases intended to replace another consumption type tax, such as the sales tax. Consumption-based VAT also does not create a disincentive for investment like the other two types. (Sicat,1988:71-72).
South Africa’s VAT is also a consumption type tax. Even though VAT is levied on production, VAT is generally seen as a consumption tax, as the consumer pays it at the final stage of production.
VAT and International Trade
VAT may be based on the location of production (also known as the origin principle) or on the location of final consumption (also known as the destination principle). A consumption tax is usually based on the destination principle. Under the destination principle exports are usually excluded from VAT, while imports are taxed. South Africa’s VAT is also based on the destination principle, as exports are zero-rated. (Sicat,1988:73).
Methods Used for Computing VAT Liability
There are three methods that may be used to impose VAT, namely the subtraction, invoice (or also known as the credit method) and cash flow methods. The most common method used to impose VAT is the invoice (credit) method where VAT is calculated on total sales at each stage of the production process, and where a credit for any VAT paid on inputs in the production process is allowed. A firm is required to supply proof of the payment of input VAT before allowing the credit. With the subtraction method VAT is calculated by multiplying gross sales net of intermediate goods purchases at each stage of the production process with the statutory VAT rate. With the invoice method VAT is calculated by multiplying gross sales and allowing for credit on VAT payments by other firms at previous stages of the production process (Metcalf in Baker and Elliot, 1997:413-414). With the cash flow method VAT is calculated on the cash flow for a firm. The following cash flow equation may be used to denote the sources and uses of cash in a firm:
S+K+ =L+M +K−
S is the proceeds from the sales of goods or services
K + is the capital inflows, including both new equity and borrowing
L is payments for labour
M is intermediate goods
K − is capital outflows, including dividend payments, interest payments, debt repayments and equity
VAT as calculated using the subtraction method is equal to S − M . Rearranging the terms give VAT as:
Therefore, VAT may also be calculated as payments to labor plus capital outflows less capital inflows. Old capital in the firm is taxed as it is repaid, or interest on it is paid, or servicing payments like dividends are made. (Metcalf in Baker and Elliott,1997:413).
South Africa uses the invoice (credit) method to determine VAT liability. Under the invoice method each trader charges output tax on sales. In turn the trader is allowed a credit on his/her own purchases against the output tax. The trader will receive a refund if the credits exceed the output tax on sales. (Ebrill et al,2001:20). The trader must supply proof of the credits.
Items, Firms or Sectors to Exclude from VAT
Certain products, firms or sectors are often excluded from VAT. Economic, social and administrative reasons are often stated for their exclusion. Exclusions on economic and social reasons are mainly associated with welfare gains: Excluding certain commodities, for example food, may aid redistribution. Exclusions may also be on the ground of administrative impracticalities. Certain products, firms or sectors are difficult to tax, or too costly to tax. This usually applies to small firms. Retailing in most developing countries, as with South Africa, is characterized by a large number of small firms. Developing countries most often also have a large informal sector. Most agricultural activities are carried out by small-scale farmers. Usually operations are carried out as a household activity, the person often uneducated, with few or no records. This makes the collection and administration of VAT difficult and impractical. The cost of collecting taxes from small firms is very large in relation to the actual taxes collected, both in terms of compliance and administrative costs. There need to be some form of exemption of the small firm from the registration and returns requirement of VAT. (Due,1986:1-3).
To exclude small firms as a collection point a threshold is set. Small firms earning an annual turnover below the threshold are not required to register for VAT and are also not required to fill the VAT returns, or levy VAT on their products. Small firms, however, can then also not claim VAT credits. The main reason for the exclusion of small firms as a collection point, as stated above, is the fact that the compliance cost of small firms is proportionately larger than the compliance cost for larger firms. (Agha and Haughton,1996:304). To reduce the compliance cost for small firms the threshold may be raised (Sanford and Godwin,1986:14). It is unlikely that the small firm will escape from paying VAT at all. Through the stages on intermediate inputs VAT will be paid, unless all trade (even in the intermediate stage) takes place between non-registered traders (Due,1986:4-5).
The threshold for small firms in South Africa is R300 000. Any person whose total value of taxable supplies exceeds the limit of R300 000 per year must register for VAT (SARS,2003). Small firms supplying less than R300 000 per year are therefore not required to register as a VAT payer. Figure 2.1 shows the ratio of small, medium and large firms in the Sectors of Production for South Africa. The data is obtained from the 1998 Supply and Use Tables as published by Statistics South Africa.
CHAPTER 1: INTRODUCTION, PROBLEM STATEMENT AND METHODOLOGY
1.2 Poverty, Inequality and Unemployment in South Africa
1.3 Government Policy
1.4 Restructuring Value Added Tax
1.5 Using a Computable General Equilibrium Model to Simulate
Changes in VAT
CHAPTER 2: INTRODUCING VALUE-ADDED TAX
2.2 VAT Overview
2.3 Broad Issues Within a VAT System
2.3.1 VAT: A Tax on Consumption
2.3.2 VAT and International Trade
2.3.3 Methods Used for Computing VAT Liability
2.3.4 Items, Firms and Sectors to Exclude from VAT
2.3.5 Zero-rating Versus Exemptions
2.3.6 Single or Multiple Rates
2.3.7 VAT on Services
2.3.8 VAT Evasions
2.4 Analyzing VAT in South Africa from 1991 to 2001
2.4.1 VAT as a Revenue Source for Government
2.4.2 VAT and Inflation
2.4.3 VAT and the Balance of Payments
2.4.4 The Regressiveness of VAT
2.4.5 Developing an Equation for VAT Collections for South Africa
2.5 Future Issues to Consider Within a VAT System
CHAPTER 3: THE MODEL
3.2 Activities, Production and Factor Markets
3.4 Commodity Markets
3.6 Changes to the Standard IFPRI Model
CHAPTER 4: THE SOCIAL ACCOUNTING MATRIX
4.3 The Objectives or Uses of a SAM
4.4 Standard CGE Model – The SAM as Data Requirement
4.5 SAM Development in South Africa
4.6 World Bank Commissioned SAM
4.7 Other Data Sources
CHAPTER 5: RESTRUCTURING VAT
5.2 The CGE Model
5.5 The Macroeconomic Adjustment Rules
5.6 The Results
5.7 What the Model Does Not Say
CHAPTER 6: SUMMARY, CONCLUSIONS AND RECOMMENDATIONS
6.2 Conclusions and Recommendations
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