Zimbabwe’s Tax Shift: Can VAT Reforms Boost Revenue Without Increasing Poverty?

Zimbabwe's 2024 VAT reforms aim to boost revenue by 0.88% of GDP by reducing exemptions, but they risk increasing poverty and inequality. The study recommends targeted cash transfers to protect low-income households while maintaining fiscal stability.

Zimbabwe’s tax system has long relied on Value-Added Tax (VAT) as a primary source of revenue, surpassing Pay-As-You-Earn (PAYE) since 2009. However, inefficiencies in tax collection, extensive exemptions, and a high degree of informality have created significant revenue shortfalls. A recent study by the World Bank, in collaboration with researchers from institutions such as the International Monetary Fund (IMF) and the Zimbabwe Revenue Authority (ZIMRA), examines the fiscal and distributional impact of VAT reforms introduced in the country’s 2024 budget. These reforms, aimed at broadening the tax base, involve limiting VAT zero ratings to exports and reducing exemptions on many essential goods. While designed to enhance revenue collection and improve tax efficiency, the policy changes carry significant consequences for household welfare, particularly for lower-income groups.

Revenue Gains, But at What Cost?

The 2024 VAT reforms are projected to increase tax revenue by 0.88% of GDP by shifting a significant portion of previously zero-rated and exempted items to the standard VAT rate. While this move expands the tax base and aligns with international tax practices, it also raises consumer prices, disproportionately affecting the poor. The study finds that the policy shift will increase the national poverty headcount by 1.4 percentage points, pushing an estimated 320,000 people into poverty. Additionally, inequality is expected to rise, with the Gini coefficient increasing by 0.14 points. These results align with global evidence showing that VAT, when exemptions are removed without compensatory measures, can have regressive effects, worsening economic hardships for vulnerable populations.

A detailed tax gap analysis highlights that Zimbabwe’s VAT system has a total tax gap of 5.4% of GDP, consisting of a 4.1% policy gap caused by exemptions and zero-ratings and a 1.3% compliance gap due to tax evasion and informality. This means that over three-quarters of the VAT shortfall is due to policy choices rather than poor enforcement. While reducing exemptions can help close the revenue gap, the study warns that these gains will come at the expense of increased financial pressure on lower-income households, which could lead to worsening living conditions.

The Hidden Burden of Informal Markets

Zimbabwe's economy has a high level of informality, which plays a crucial role in shaping VAT’s progressivity. The poorest households source 83% of their consumption from informal markets, compared to 42% for the wealthiest households. This informal economy shields low-income consumers from the full impact of VAT but also weakens tax collection efforts. Eliminating informality or enforcing stricter VAT collection would double the tax burden for the poorest households, making it even harder for them to afford basic goods and services.

Despite VAT being technically progressive—since wealthier households pay more VAT in absolute terms due to their higher consumption levels—the benefits of VAT exemptions and informal purchases disproportionately favor the richest decile. Nearly 44% of the total VAT exemption benefits go to the wealthiest 10% of the population, while only 10% reach the bottom 40%. This indicates that VAT exemptions, though intended to support low-income groups, are an inefficient tool for poverty alleviation. Removing them entirely would generate more revenue but would not effectively redistribute resources to those most in need, highlighting the need for alternative social protection strategies.

A Smarter Approach: Compensating the Poor

One of the key recommendations from the study is the implementation of a targeted compensation mechanism to mitigate the negative impact of VAT reforms on the poor. Three potential compensation scenarios were evaluated:

1. Full redistribution of additional VAT revenue to the bottom 40% of households – This approach would reduce poverty by almost eight percentage points, making it a highly effective but fiscally unrealistic solution.
2. Compensating only for the actual increase in VAT payments incurred by the bottom 40% – This would maintain the poverty headcount at current levels while allowing the government to retain 0.73% of GDP in additional revenue.
3. Compensating only current recipients of the Harmonized Social Cash Transfer (HSCT) program – Since HSCT covers only 0.4% of the population, this approach was found to be largely ineffective in addressing the broader impact of VAT increases.

Investing in Social Protection for Long-Term Stability

Zimbabwe lacks a unified social registry, making it difficult to efficiently target the most vulnerable households for compensation. Without an effective social protection framework, direct cash transfers remain administratively challenging. The researchers stress the importance of developing a nationwide targeting mechanism to ensure that compensatory measures reach the right beneficiaries. They argue that a fraction of the additional VAT revenue—just 0.15% of GDP—could be redirected toward an expanded cash transfer system, providing a sustainable solution without undermining the revenue gains from the reforms.

The study emphasizes that VAT reforms should not just be about increasing revenue but also about ensuring that fiscal policies do not deepen existing inequalities. Instead of relying solely on broad VAT exemptions, Zimbabwe could use part of the additional revenue to fund targeted cash transfers, ensuring that fiscal reforms do not come at the expense of social equity.

A Balanced Tax System for a Fairer Future

Zimbabwe’s VAT reforms present both opportunities and risks. While they provide a crucial avenue for increasing government revenue and improving tax efficiency, they also risk exacerbating poverty and inequality if not carefully managed. The study underscores that VAT exemptions, though inefficient as a redistribution tool, have provided some level of protection to low-income consumers. The government must find a balance between fiscal sustainability and social welfare by ensuring that VAT reforms are accompanied by effective compensation measures.

A well-structured compensation mechanism could allow Zimbabwe to broaden its tax base while protecting vulnerable households from increased financial strain. Investments in social protection and better VAT administration would not only support economic stability but also ensure that tax policies remain fair and equitable. By addressing these concerns, policymakers can achieve a stronger and more inclusive economy where taxation plays a role in both revenue generation and social protection.