reference income which in the case of direct taxes is market income.<sup>35</sup> Although all countries have progressive direct taxes as shown above for South Africa, some are more progressive (figure 6). For example, when compared with Brazil, the direct tax incidence for South Africa is less progressive at the bottom (due to the relatively higher exemption threshold) but more progressive at the top.<sup>36</sup> The lower progressivity at the bottom as well as the comparatively higher level of inequality in market income probably explains why South Africa has a lower Kakwani coefficient for direct taxes than comparator countries. When PIT and payroll taxes are combined, the Kakwani index of progressivity for South Africa equals 0.13, compared to 0.27 for Brazil and 0.30 for Mexico.

# **Indirect Taxes**

Our incidence analysis covers VAT, excises on alcohol and tobacco, and the fuel levy. Together they comprise 9 percent of GDP (table 1). VAT accounts for roughly one-quarter of tax revenue in any given year<sup>37</sup> , excise duties contribute about 3.5 percent of tax revenue, and the general fuel levy contribute about 5.2 percent of total tax revenue.

We assess the incidence of indirect taxes with respect to (and ranked by) disposable income (which is defined as the sum of market income plus direct transfers, net of direct taxes). We do this because households make their consumption decisions taking into account government cash transfers as part of their income, and therefore consume much more than their labor (or other market) income would allow them to consume in the absence of these transfers (see table 8 below), and would therefore have paid much less in indirect taxes.

<!-- Start of picture text --> Figure 7. South Africa Concentration Curves of Indirect Taxes<br>(share paid by disposable income deciles)<br>100%<br>90%<br>80%<br>70%<br>60%<br>50%<br>40%<br>30%<br>20%<br>10%<br>0%<br>Cumulative proportion of the population<br>Disposable Income VAT<br>Excise Tax Fuel Levy<br>45 Degree Line<br>disposable income/tax<br>Cumulative proportion of<br><!-- End of picture text --> Indirect taxes as a whole (see Box 3) are slightly regressive (figure 7 and table 4).<sup>38</sup> Up to the seventh decile, the cumulative share paid of Cumulative proportion of the population total indirect taxes exceeds their cumulative Disposable Income VAT share of disposable income by a relatively small Excise Tax Fuel Levy margin. VAT and the Fuel Levy are progressive, 45 Degree Line with all the bottom deciles paying a lower share in such taxes than their share in disposable Source: Own estimates for South Africa based on IES 2010/11. income. In fact, VAT is progressive partly due to the zero-rating of basic food items.<sup>39</sup> Excise taxes, in contrast, are regressive and the bottom deciles pay a substantially higher share of the total than their share of disposable income (figure 7 and table 4). This is the result of the fact that the poor consume proportionately more of the so-called sin goods.<sup>40</sup> 35The tax concentration coefficient is calculated in the same manner as the Gini, but using a tax concentration curve. If the Kakwani coefficient is greater than zero, the tax is progressive (in the tax redistribution sense), if it is equal to zero, the tax is neutral; and if it is less than zero, the tax is regressive. As a practical rule and in line with international practice, we have defined as neutral, those taxes for which the Kakwani index lies between -0.1 and 0.1.

36 This can be observed by comparing pairwise the incidence by decile for Brazil and South Africa.

37For the 2010/11 fiscal year, it was estimated that zero rated goods reduced revenue intake by R34 billion (or 1.2 percent of fiscal year GDP) and exempt goods and services reduced revenue by another R1 billion, or 0.03 percent of fiscal year GDP (2014 Budget Review). 38 The results are nearly identical if we use market income or consumption as the welfare measure.

> 39 Indeed, if the zero-rating of basic food were replaced with the standard rate, we find that VAT would be regressive, with the bottom 60 percent of the distribution paying a higher share of VAT than their share in disposable income. Moreover, under that scenario, both poverty and inequality would increase. Results of this simulation are available upon request.

> 40 See Box A1 in Appendix 1 for a comparison of the consumption basket of the poorest and richest decile. Both report that they consume about 1 percent of their consumption baskets on alcohol and tobacco, and 8 percent on transport. Following previous fiscal incidence analysis done for South Africa (Woolard et al, 2005), the analysis adjusts for under-reporting of alcohol and tobacco consumption in the IES relative to what is reported in the national income account.

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