VAT Merit goods - 15 Oct 2007

Executive Summary Background to this study Prior to the introduction of value-added tax (“VAT”) in South Africa in October 1991, a policy decision was taken to introduce a broad-based VAT system, with concessions restricted to a minimum and the needy being assisted as far as possible outside the tax system. Pressure from various lobby groups and an inability on the part of the Government of the day to prove that the necessary assistance would in fact be given to the needy to compensate for the effect of VAT, resulted in various last-minute concessions being introduced to ensure the smooth introduction of the tax. As a result, the VAT system in operation in South Africa today is more differentiated (and has a narrower base) than was originally intended and the existing concessions have created a precedent for other interest groups to request preferential treatment for goods and service on grounds that the differentiation is merited. While the claim for concessionary VAT treatment is often based on a desire to address the perceived regressivity of VAT, other arguments are also advanced to justify merit good status. These include: The goods or services are in the public interest; The goods or services are essential; Poorer households should not have to pay VAT on the goods or services; Direct targeted budgetary assistance is not capable of ensuring that the goods or services can be supplied to everyone; The goods or services are of a cultural nature; The goods or services are of an educational nature and taxation thereof would amount to a tax on knowledge; or The goods or services can, from a political point of view, not be taxed. The aim of this study is to determine whether the current VAT concessions should be retained and also to ascertain whether the policy considerations which applied when VAT was introduced are still relevant, or whether changed circumstances would justify the introduction of further concessions for other merit goods and services. A framework for the evaluation of changes to VAT The first chapter provides an a priori framework for analysing the likely effects on the economy of any changes to the composition of the tax system. Amongst other things, this framework attempts to establish a set of norms to guide the assessment of changes to the current VAT system. The analysis relies heavily on empirical evidence that supports the theoretical premises of a sound tax framework.