Why the price of bread did not go down after the budget

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

22 June 2008

In his budget speech last week, Finance Minister Amos Kimunya proposed to “zero-rate VAT on bread”. Afterwards, many people were shocked to find that price of this essential commodity did not drop by 16 per cent – the current VAT rate. So what went wrong?

Firstly, if VAT is removed from a product, the price would NOT drop by 16 per cent. To illustrate, suppose the price inclusive of VAT is Sh 100. In that case the tax charged is Sh13.79 (not Sh16). Thus the ex-VAT cost is Sh86.21 (not Sh84). If you doubt this, work it out for yourself: Sh86.21 + 16 per cent VAT, equals Sh100.

Now, 13.79 out of 100 is 13.79 per cent, therefore should this have been the expected percentage drop in the price of bread? Not quite.

Even before the budget speech, bread, like all other food commodities, did not attract VAT. So, was the Minister playing a joke on us? Actually, no. Previously, bread was “exempt” from the tax and now it is “zero-rated”.

The difference between the terminologies is that when a product is “zero rated”, the supplier can claim back any VAT paid on inputs that go into manufacturing, marketing and distributing it. On the other hand, when it is “exempt”, the supplier cannot get the refunds.

The question then is: what proportion of the inputs attracts VAT? The main ingredients in the making of bread are wheat flour and water. Both do not have any VAT. The only major costs that attract VAT would be electricity (for the ovens) and transportation. My guess is that these two account for about 25 percent of the production (NOT retail) cost.

Now bread normally moves directly from the manufacturer to the retailer – there are usually no middlemen. By allowing a 5 percent profit margin on each stage, we can work out the production cost thus: Retail price is Sh35, therefore, wholesale price at the bakery is Sh33.30, and so, the production cost is Sh31.75.

My assumption is that only 25 per cent of this figure attracts VAT. In other words, out of the Sh31.75 production cost, only Sh7.94 has VAT in it. When the tax is removed, this amount drops by Sh1.09 to Sh6.85 but all the costs remain the same. Thus the production cost goes down from Sh31.75 to Sh30.66.

We can now work backwards to find the retail price maintaining the same percentage profit margin: the new wholesale price at the bakery is Sh32.19 and the new consumer price is Sh33.08, or simply, Sh33.

But there is a catch: when a manufacturer makes a claim for a refund, it takes a long time before the payment is made – some times more than six months. So the real question is whether any manufacturer will rush to cut the price of bread by one shilling and then wait for six months to get it back from the Revenue Authority. If I was a baker, I wouldn’t!