In February 2024 the National Treasury implemented a tax policy by omission: by failing to adjust the personal tax brackets for inflation, also known as “fiscal drag” or “bracket creep”. This is the first time in the history of SA as a modern economy that this has been done, and it reflects the difficult fiscal position the country faces.
South Africans are acutely aware of the rising pressures on their household budgets. From fuel and electricity hikes to higher food costs, disposable income is under pressure. Recent simulations conducted by the author using the UN’s OG-ZAF model highlight that fiscal drag actually already functions like a stealth tax increase, and when VAT is eventually raised — as seems inevitable — taxpayers will be hit twice.
To understand why the government has had to resort to tax by stealth, one needs to appreciate the scale of the country’s fiscal challenge. Public debt has surged to about 75% of GDP, a threefold increase in less than two decades. Debt service costs now consume more than a fifth of government revenue — about R1bn per day — crowding out spending on health, education and infrastructure. With unemployment stuck above 30%, growth anaemic at below 1% and the tax base highly concentrated among a small group of companies and high-income earners, options for raising new revenue are severely limited.
Faced with this situation, the Treasury has two tax proposals. The first is to allow fiscal drag to take effect by freezing income tax brackets while inflation rises, thereby effectively increasing tax liabilities. The second, though politically postponed in 2025, is a VAT hike of one percentage point, pushing the rate to 16% (with the possibility of a further hike in 2027). Neither measure solves the country’s structural problems, but both buy the state some breathing space.
Fiscal drag occurs when income tax brackets are not adjusted for inflation. As salaries rise nominally even if purchasing power stays constant, more taxpayers are pushed into higher tax brackets or pay a greater share of their income at existing rates. This increases government revenue without the need for explicit tax hikes, but does so at the expense of households’ real disposable income. In effect, it is a tax increase by omission, not by legislation.
Unlike VAT, which is visible on every invoice and overtly added to prices, fiscal drag is “stealthy”. Workers often notice only when year-end tax bills are higher than expected. Yet its cumulative effect can be substantial; over two consecutive years of frozen tax brackets, many households will have paid the equivalent of a one percentage point increase in their effective income-tax rate.
To better understand the implications, simulations were conducted using OG-ZAF, a dynamic overlapping-generations model of the SA economy. Two scenarios were tested separately: one with fiscal drag, and another with a single point VAT hike.
The results were striking. Despite targeting different tax bases — personal incomes in the case of fiscal drag and consumption in the case of VAT — their macroeconomic impacts were remarkably similar.
- Growth. In the short term, a VAT increase produced a modest positive effect on GDP (0.09%), while fiscal drag caused a slight decline (-0.17%). Over the longer term, both converged on near-zero growth impacts.
- Consumption. Both measures dampened household consumption, with VAT cutting spending slightly more (-0.82%) than fiscal drag (-0.54%) in the short run.
- Debt. Government debt declined under both scenarios, by about 5%–6% over two decades, due to higher revenues.
- Revenue. Total tax receipts increased by nearly the same amount in both cases — about 1.5% — demonstrating their fiscal equivalence.
It is clear from the model simulations that whether the government raises VAT or allows fiscal drag to persist, the economy absorbs a similar shock: reduced household consumption, a small hit to growth, and somewhat lower debt levels.
What makes this comparison concerning is the stealthy nature of fiscal drag. Taxpayers have been subject to its effects for at least two consecutive years. If a 1% VAT increase is introduced in 2026 or soon thereafter, households will feel a double impact: the ongoing squeeze of bracket creep compounded by the explicit burden of higher consumption taxes.
In plain terms, the government is already taking more from households by omission and may soon take more again by commission. For middle-income earners especially, this combination erodes spending power significantly. Second, because VAT is mildly regressive — it takes a higher share of income from the poor than the rich — there are social equity implications too.
Fiscal drag is a hidden tax because it embodies a deliberate choice by the government not to adjust brackets, knowing this omission will raise revenue. Such policies by omission are politically convenient: they avoid parliamentary debate, escape headline scrutiny and spread the burden across millions of taxpayers. Yet they are no less real in their economic effect than an explicit tax rise.
The danger is that citizens grow increasingly mistrustful of the tax system, perceiving it as opaque or manipulative. Transparency matters, especially in a country where tax compliance depends on a small, overburdened base of personal and corporate taxpayers.
Despite shelving plans for a VAT increase in 2025, the Treasury has limited alternatives. Corporate tax has already been cut to improve competitiveness, and personal tax rates are among the highest in the middle-income world. With debt service costs mounting and social demands rising, VAT — broad-based and relatively efficient — is the most likely lever to be pulled.
International lenders such as the IMF and the World Bank, while cautioning against over-reliance on taxation, accept that SA may have little choice in the short run. A one to two percentage point VAT hike in the near future thus seems inevitable, but when it does happen, it will affect households already squeezed by fiscal drag.
The deeper lesson from the OG-ZAF model simulations is that tax measures alone cannot restore fiscal sustainability. Both fiscal drag and VAT increases raise revenue and reduce debt, but they leave growth stagnant and consumption weakened. It is clear from the modelling work that SA cannot tax its way out of its predicament.
Only structural reforms — stabilising the electricity supply, modernising rail and ports, reducing regulatory red tape and fostering competitiveness — can raise productivity and unlock sustained growth. When simulated in the OG-ZAF model, a modest 2% productivity boost translated into average GDP growth above 3%, stronger revenues, and even an increase in social transfers to the poor.
SA’s fiscal dilemma has led the government to resort to the hidden tax of fiscal drag and contemplating explicit measures such as a VAT hike. Model evidence shows these policies are in effect two sides of the same coin — comparable in their economic impact. The risk is that taxpayers will soon face a double blow: stealth tax by omission, followed by overt tax by commission.
In the near term raising VAT may be unavoidable, but the true solution lies not in squeezing households further, but in overhauling government policy to create a more competitive, investment-friendly environment. Growth, not extraction, must be the engine of fiscal stability. Only then can SA escape the cycle of stagnation and debt and build a more equitable economic future.
• Stuart, an economist, is an associate of the Trade Law Centre.
Would you like to comment on this article?
Sign up (it's quick and free) or sign in now.
Please read our Comment Policy before commenting.