Zero Rating Foodstuff: A Computable General Equilibrium Analysis

Poverty in South Africa is severe. Zero-rating food can possibly reduce poverty as poor households spend the largest proportion of their income on food. Zero-rating food can also reduce the regressiveness of Value Added Tax (VAT) for the same reason. However, zero-rating food will results in a loss in revenue for government. Zero-rating food should be considered in conjuction with alternative sources of revenue, such as increasing direct taxes proportionately or increasing VAT on all other commodities, or alternatively increasing VAT on commodity or services used mostly by high-income households. A Computable General Equilibrium (CGE) model is used to analyze the combined effect on zero-rating food and using alternative revenue sources to compensate for the loss in revenue. The results indicate that zero-rating food, while increasing VAT on either business or financial services could turn a regressive VAT into a progressive VAT. However, this would require excessive high increases in the statutory VAT rates of these services. More realistic options investigated are increasing direct taxes, or alternatively increasing VAT on all other commodities to 16 percent. Increasing direct taxes is most successful in creating a more progressive tax structure, and still generating a positive impact on GDP. The results indicate that zero-rating food combined with a proportional percentage increase in direct taxes can improve the welfare of poor households, without impacting negatively on other households.