VAT’s on the menu?

The hidden cost of staggered VAT increases

Imagine running a small shop in South Africa. You hear the government plans to raise VAT from 15% to 16%, not all at once but in two steps – an extra 0.5 percentage points in 2025/26 and another 0.5 the year after. A gradual increase sounds gentler than a one-time 1 percentage point hike. But as you pull out the pricing gun to update your stock twice in two years, you might wonder: is peeling the band-aid slowly actually worse than one quick tug?

Economists have a term for the hassle of updating prices: menu costs – named after the literal cost of reprinting restaurant menus when prices change. The term emerged in the 1980s as part of the New Keynesian school of thought, which sought to explain why prices are often ‘sticky’ rather than adjusting smoothly to shifts in supply and demand. While the idea of frictions in price-setting had existed earlier, it was Gregory Mankiw, in a 1985 QJE paper titled Small Menu Costs and Large Business Cycles, who popularised the term and formalised its role in economic theory. Mankiw concluded that ‘small menu costs can cause large welfare losses’.¹ Businesses do not just update price tags – they reprogram software, adjust invoices, notify suppliers and field customer complaints. These small frictions add up.

Changing prices frequently can eat into profits. The implication is that firms do not reprice casually – they do it when they must. And if forced to do it more than once, they will find ways to make up for it, often by passing even higher costs onto consumers. One consequence: inflation.