The disaster that will engulf South African’s fiscal and revenue calculations and economy as a whole if the country’s sovereign credit rating is downgraded cannot be overstated, the head of the Davis Tax Committee has warned.
Speaking at the 2016 Tax Indaba, judge Dennis Davis warned that if South Africa gets downgraded and the status quo persists, there wouldn’t be enough revenue to cover expenditure, as all new forms of loans will attract considerably higher rates of interest.
“Consider what the effect would be of another R20 or R30 billion on our interest costs.”
South Africa’s single biggest expenditure item is interest cost.
Davis warned that the poor stand to be far more affected by a downgrade than middle and higher income groups.
“It would affect those who dream about a social democratic society envisaged in our constitution and who are not getting it at present.”
“It would be a disaster of manifold proportions and we need to do something about that now. It is in our hands.”
Davis said South Africa can be justly proud of its tax and transfer system which is regarded as the best in the world. It has reduced the Gini Coefficient (a measure of income inequality) from roughly 0.77 to 0.59, which is far better than almost any other developing country for which statistics are available.
While there is still considerable room for improvement, a downgrade could put efforts to reduce income inequality at risk.
“If we compromise the system, we have less for that [reducing inequality] and by goodness, that is going to create a level of social instability which would keep us all awake at night,” he warned.
Ratings agencies will review South Africa’s sovereign credit rating towards the end of the year.
S&P and Fitch both have South Africa on the lowest investment-grade rating (BBB-), but S&P has a negative outlook while Moody’s rates the country two notches above sub-investment grade (Baa2) with a negative outlook. While South Africa avoided a mid-year downgrade to junk status, numerous analysts have warned that it may not be able to do so in December given the current economic and political situation.
Anthony Julies, head of assets and liability management at National Treasury, said he is expecting that by the time the minister of finance tables his medium-term budget policy statement (MTBPS) there would be a package of announcements of steps it has taken to avoid a downgrade.
One of the key areas it is working on is state owned enterprise (SOE) reforms which has been identified as an area prohibiting higher levels of growth.
Julies said there is process underway under the leadership of deputy president Cyril Ramaphosa and a number of announcements will be made on the reforms in the MTBPS.
Another focus area is labour, secret balloting and how to avoid the frequency of strikes.
Konrad Reuss, managing director of Standard and Poor’s (S&P) South Africa, said it clearly understands that “something miraculous” would need to happen for the South African economy to start growing by 2% to 4% given the low growth pattern the world is in.
The question is what can be done in the medium-term to stimulate growth.
S&P would want to see progress on labour market reforms, and in particular secret balloting, collective bargaining and the minimum wage.
Another quick win is the Minerals and Petroleum Development Bill, which has been out there for a long time – “get it done”. Although the reform of SOEs is really difficult given the political developments that are unfolding, it is an important structural reform, Reuss said.
“We highlighted that as an important structural reform to really get to a situation where [the] business climate, business investment climate is improving again and that ultimately then will actually lead to higher growth in the South African economy.”
Ettienne le Roux, chief economist at RMB, said if business confidence is low businesses wouldn’t hire more people and invest. If there is good news about reform it will go a long way to change CEOs’ opinion about what is going on in South Africa and there is a good chance of other variables to follow.
Room to collect more?
While tax commentators often argue that a VAT increase would be the best way of increasing tax revenue, labour unions vehemently oppose such a step.
Davis said a 3 percentage point increase in VAT results in the same amount of revenue as an overall 6 percentage point increase in the marginal rates of individual income taxes across the board.
“So clearly VAT is your only engine room for tax increases.”
Davis said the problem with VAT is the potential for a retrogressive effect, but there are ways to address this. In a capable state, a significant sum of revenue can be targeted at the poor by introducing feeding schemes in rural areas for all children for example.
However, econometric modeling suggests that a 1 percentage point increase in VAT could increase inflation by roughly 0.2 to 0.3 percentage points and retard growth by the same number.
“Now how on earth can you increase VAT if you aren’t growing at all? That is just not on.”
“The big tax issue is that the major possibility of collecting additional revenue is in a sense not available to you when you are in the particular economic context that we are in at present.”
Davis said there is no doubt that base erosion and profit shifting (Beps) is also something that should be looked at very carefully. When the South African Revenue Service audited a number of companies about five years ago it collected more than a R1 billion because of inadequate transfer pricing.
“There is unquestionably some scope there.”
Davis was also curious about the fact that only 95 000 people report income of over R1.5 million per annum.
“I find that very low and I am curious as to why that is and is there a hemorrhaging within the system.”
With regard to capital taxes – Capital Gains Tax (CGT) and Estate Duty – there is not a huge sum of money available – “couple of billion, but no more”, Davis said.
It is however possible that the Special Voluntary Disclosure Programme (SVDP) could bring in a considerable sum of money over the next year or two if it is handled properly.
“I think there is a potential between R10 and R15 billion out there, which at least could tie us over for a year and it is really important as we try to restructure the process,” he added.