VAT Increase, a solution or just a short-term fix to a long-term crisis?

Dr Velenkosini Matsebula

The South African government has once again turned to taxation as a means of addressing its fiscal challenges, announcing an increase in the value-added tax (VAT) rate by half a percentage point in 2025/26 and another half a percentage point in 2026/27, bringing the final rate to 16%. This decision, though justified as necessary to fund critical social services, is yet another indication that the economy is caught in a self-perpetuating cycle of stagnation, increasing public debt, and over-reliance on a shrinking tax base. The key question we must ask is whether this increase is asustainable solution or merely a stopgap measure that exacerbates deeper economic challenges.

A shrinking tax base and limited options

The government has defended its decision to raise VAT by arguing that alternative revenue-raising measures, such as increasing corporate or personal income tax would do more harm than good. Certainly, corporate tax revenue has already declined due to falling business profitability, and personal income tax collections are among the highest relative to GDP in the developing world. Given that nearly 28 million South Africans rely on social grants, there is little room to squeeze additional revenue from personal incomes without further weakening consumer spending power.

Meanwhile, South Africa’s GDP growth has been stagnant, averaging below 2% over the pastdecade. The 2024 growth rate stood at only 0.6%, with projections of only 1.8% over the medium term. This slow economic growth severely limits the state’s ability to generate additional revenuethrough natural tax base expansion. Without higher growth, every additional tax hike simplydeepens the burden on existing taxpayers without meaningfully improving the fiscal position.

The VAT burden on SMEs and consumers

Small businesses and low-income consumers will bear the brunt of the VAT hike. While larger businesses may be able to absorb increased costs, micro-entrepreneurs and informal traders, who already operate on very thin margins, will struggle. Many of these businesses are not VAT-registered and cannot claim input VAT credits, meaning their operational costs will rise without any relief. For consumers, the increase in VAT will further strain household budgets at a time when inflation, joblessness, high electricity prices, and rising transport costs are already eroding purchasing power.

The government has attempted to soften the blow by expanding the list of VAT zero-rated items to include canned vegetables, dairy liquid blends, and organ meats. However, this measure is unlikely to fully offset the impact of the tax hike, as the bulk of household expenditure is still subject to VAT. Moreover, there is no sufficient awareness of these products to the general public.

Debt servicing vs. development priorities

A major driver of the VAT increase is the cost of servicing government debt. The budget speech reveals that debt-service costs will amount to R389.6 billion in the current financial year, more than what the government spends on health, policing, or basic education. This means that every additional rand raised in taxes is increasingly being directed toward interest payments rather than productive investment. While stabilising debt levels is important, the government must ask whether further squeezing taxpayers is a viable long-term solution or whether deeper structural reforms are needed.

The missing ingredient: Economic growth and industrial expansion

Tax increases alone cannot resolve South Africa’s fiscal challenges, the solution here is a meaningful economic expansion. The government’s commitment to spend over R1 trillion on infrastructure spending over the next three years, signals a recognition of this fact. However, the effectiveness of these investments will depend on execution. Too often, large-scale infrastructure projects are discouraged by inefficiencies, corruption, and mismanagement, leading to cost overruns and delaysthat weaken their economic impact.

One critical area that has been neglected is the expansion of the secondary sector, including manufacturing and industrial production. A strong industrial base is essential for job creation andeconomic diversification. Currently, SA remains overly reliant on the primary sector (mining andagriculture) and services, while manufacturing has been in decline. Revitalising the manufacturing sector, through incentives, skills development, and infrastructure investment, could create millions of jobs and provide a more stable tax base. The government’s flagship initiative to accelerate economic reforms, Operation Vulindlela, has made some positive strides, particularly in stabilising the electricity supply, opening logistics networks, and reducing red tape for businesses. However, more aggressive implementation and accountability is essential to deliver the rapid growth needed to broaden the tax base.

Industrial expansion would not only reduce unemployment but also lessen the government’s reliance on taxing consumers through VAT increases. Policies that promote value-addition industries, such as agro-processing, automotive manufacturing, and green energy technology, should be prioritized to drive sustainable growth.

The informal sector is a missed revenue opportunity

Another overlooked opportunity for revenue generation is the regulation and formalisation of the informal sector, particularly the spaza shop economy. The informal trade sector is valued in the hundreds of billions and plays a crucial role in supplying basic goods to low-income households. It is also a significant beneficiary of social grants, as many grant recipients spend their money at these businesses. However, because many spaza shops operate outside the formal tax system, the government misses out on substantial potential tax revenue. Regulating and integrating these businesses into the formal economy could help expand the tax base without increasing VAT.

A more sustainable fiscal path

Instead of relying on tax increases, the government should focus on a multi-pronged approach toimproving fiscal sustainability:

1. Expand the tax base through growth: Encouraging investment, reducing policy uncertainty, and improving the ease of doing business will allow more enterprises to thrive, there by increasing tax revenues naturally rather than through higher rates.

2. Enhance tax compliance: The South African Revenue Service (SARS) has identified 156 000 taxpayers who are not registered or have failed to file returns despite significant economic activity. Strengthening enforcement and reducing tax evasion could generate more revenue without imposing additional burdens on compliant taxpayers.

3. Reduce government waste and corruption: Spending reviews have identified inefficiencies in government programs. A stronger commitment to cutting wasteful expenditure could freeup resources for essential services without raising taxes. A starting point could be doingaway with "ghost workers" in the public sector.

4. Reform State-Owned Enterprises (SOEs): SOEs such as Eskom and Transnet continue to befinancial black holes. Enhancing private-sector participation and enforcing strict financialdiscipline could reduce the fiscal drag these entities exert on the national budget.

5. Encourage formalisation of the informal sector: South Africa’s large informal economy remains outside the tax net. Policies that incentivise formalisation, such as simplified taxregistration, reduced regulatory burdens, and improved access to credit, could graduallybring more businesses into the tax system. Moreover, regulating informal businesses such as spaza shops not only broadens the tax base, but also ensures fairer competition with formal retailers.

The VAT increase is a symptom of a much deeper economic crisis, one that cannot be solved through taxation alone. While the government faces difficult choices, increasing the tax burden on businesses and consumers without addressing the root causes of economic stagnation is a short-sighted strategy. Without structural reforms, improved public sector efficiency, and a clear focus ongrowth, South Africa risks entering an endless cycle of tax hikes, lower growth, and worsening public finances.

The real challenge for policymakers is not just balancing the books but creating an environmentwhere businesses can thrive, employment can expand, and government revenues can groworganically. Anything short of this will keep South Africa trapped in an economic tailspin, chasing itsown tail, but never moving forward.

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