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Pricing pressures as food prices increase

03 June 2008 Ernst & Young

The government has been inundated with requests from various stakeholders urging it to combat the rising cost of food. The steep price increases come as fuel and interest-rate hikes are also hurting consumers.

A pool of analysts was asked to list and to rate (on a scale of one to ten, with one having the least impact) the ten most significant trends or uncertainties that may impact retail and consumer companies. Industry panellists who were surveyed rated pricing pressures as one of the top ten challenges for 2008.

Panelists also pointed to a dramatic escalation of input prices on several fronts – including volatility of raw materials prices, uncertainty of energy sources, and escalating agricultural prices caused by the demand for biofuels. The higher input prices, combined with pressure on market pricing, are putting the squeeze on consumer product companies and making the management of input pricing a serious strategic challenge.

According to Rising Food Prices: Policy Options and World Bank Response, increases in global wheat prices reached 181 percent over the 36 months leading up to February 2008, and overall global food prices increased by 83 percent. Food crop prices are expected to remain high in 2008 and 2009 and then begin to decline, but they are likely to remain well above the 2004 levels through 2015 for most food crops. The bank has also warned that putting food on the table isn’t going to get easier for the world’s poor anytime soon. The global food price increases have led to riots some countries, rice and flour smuggling in others and thinner wallets all round.

A number of local commentators have gone to extent of suggesting the abolishment of VAT on food stuffs in order to make them more accessible to the poor. VAT is a regressive tax, which effectively results in an increased tax burden for low income earners.

This suggestion has been met with mixed feelings. The South African tax legislation already stipulates the zero rating of VAT on “basic” foodstuffs which are made up of staple foods such as maize meal, milk and vegetables. The argument for the removal of VAT is that food is an essential commodity and therefore must be made more affordable to the poorest section of the population. There is also the debate about what constitutes “Basic” in these modern times? For example, some would consider rice to be basic instead of maize meal.

South Africa’s recent boom in the middle income class has resulted in the increase of spending power thereby making VAT a significant contributor to the fiscus. Removal of VAT on food stuffs may potentially result in a massive “hole” in the fiscus and this will present the government with a different dilemma.

A more suitable option for both the fiscus and the consumers is to broaden the ‘basic’ foods category. The downside to this suggestion is that it will require system changes (coding per product type) by the suppliers which will have a financial impact. A slow phase-in of additional categories of ‘basic’ food will present consumers with greater choice while allowing the tax man to continue collecting VAT on the remaining foodstuffs which is crucial to the fiscus. This is viable but will not provide an immediate relief in the consumer’s pocket.

Rather subsidise the relief to be given to the poor through an effective VAT system instead of creating other administrative burdens. In the Business to Business environment there will be no tax on the value add on the selected foodstuffs. This effectively means that these products will be subsidised by government through an effective tax mechanism administered by SARS. In the Business to Consumer environment immediate financial relief will be secured for the end consumer.

It is imperative that the proposed ‘basic’ foodstuffs be zero rated per product type rather than intended use. The treatment of maize has shown the complexity arising in applying ‘intended’ use as a classification.

This leaves the government with tough decisions to make such as whether to incentivise food producers, meet its revenue needs for the fiscus or make food more accessible for the poor? One will have to give way to the others. Which one? Only time will tell!

By Derek Engelbrecht, director for Retail and Consumer Products at Ernst & Young and Charl Niemand, director for Tax Services at Ernst & Young

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