Tax hikes and austerity: Gigaba’s tough balancing act

As finance minister Malusi Gigaba prepares to deliver his maiden budget speech, he faces a mammoth task: Finding the right balance of tax hikes and austerity measures to put South Africa back on a path of fiscal consolidation without stifling economic growth.

There is also an expectation that government should promote policy certainty and restore credibility.

Credibility is a critical issue, says Citi economist Gina Schoeman. Markets and the public will have to believe that giving up more in terms of tax will result in fiscal consolidation, efficient government spending and ultimately improved GDP growth.

While the budget numbers are important, it is also vital that the overall message should be credible, inspire confidence and build on the new mood in the country created by the election of Deputy President Cyril Ramaphosa as ANC president, says Prof Raymond Parsons of the NWU School of Business and Governance.

“The overarching challenge is to present a Budget which is credible and boosts confidence in ways which enable SA to avoid universal junk status. In the event of the latter the costs of borrowing for both public and private sectors will rise because of the bond market consequences.”

The tax base remains small, tax hikes in the last Budget were counterproductive and generated less revenue, and although growth is improving, it remains relatively weak, he adds. The minister has to navigate between avoiding a “debt trap”, yet help the country to escape a “low growth trap” or the country risks drifting into a negative “tax-and-spend” cycle that has been the bane of many other economies.

Effectively, the challenge is to decide how the pain of economic improvement should be spread between different stakeholders, Parsons notes.

Yet, none of the major challenges highlighted by S&P Global Ratings in November, have disappeared.

“The 2018/19 Budget balancing act promises to be among the sternest of economic tests for South Africa in recent years.”

Growth

The International Monetary Fund recently lowered its GDP growth expectation for South Africa in 2018 to 0.9% from an earlier 1.1%, while the South African Reserve Bank adjusted its projection upwards from 1.2% to 1.4%. National Treasury is expecting growth of 1.1%.

Against the background of low growth, concern about state capture and deteriorating fiscal numbers, it is the perfect time to institute reform – both structural and tax reform – as a way to stimulate the economy, Nazrien Kader, managing partner for Africa Tax and Legal Services at Deloitte says.

Gigaba’s announcement during the Medium-Term Budget Policy Statement (MTBPS) that tax revenue was projected to fall short of the earlier estimate by almost R51 billion in 2017/18 and that the budget deficit would widen to 4.3% of GDP (from 3.1%) sent shockwaves through the investing community, leading S&P to downgrade South Africa’s local currency rating to junk. Its counterpart, Moody’s, placed the country on review for downgrade, and will be watching Gigaba’s moves closely. Taxpayers will also be particularly interested in the steps government is taking to address wastage and corruption at state-owned enterprises.

Since the MTBPS, Gigaba’s fiscal challenges have got bigger, Parsons says.

But a current assessment of the projected budget deficit is difficult, and will depend on how “big ticket items” like free tertiary education, nuclear power, public sector salaries and state-owned enterprises like Eskom will be reprioritised in the Budget, he adds.

Kader estimates the revenue collection shortfall to be between R50 billion and R65 billion for 2017/18.

Nazeer Essop, public sector industry leader at Deloitte, says free tertiary education will need to be implemented in phases over a period of three to five years.

“It will not happen once-off because it is just unaffordable.”

He argues that a separate fund, funded by taxpayers and administered by the private sector, could alleviate some pressure with regards to free tertiary education.

Taxes

Even though a VAT hike is regarded as the most efficient way of raising revenue, the Davis Tax Committee previously said a one percentage point increase could impede growth by around 0.2 to 0.3 percentage points.

Schoeman estimates that a two-percentage point hike in the VAT rate would generate roughly R30 billion in revenue, but warns that it is also likely to deter spending. Therefore, a VAT rate hike of one percentage point might be considered with the removal of the zero-rating on some items, such as fuel.

Treasury proposed in its 2017 Budget that the zero-rating on fuel be removed, subject to consultation.

While some commentators believe the VAT rate could be increased to 16%, Kader doesn’t agree, and says the introduction of a tiered VAT system with a far higher rate on luxury items is more likely. Despite criticism that this approach is administratively burdensome and failed in countries like Namibia, it doesn’t mean that it shouldn’t be revisited and built on, she adds.

A VAT hike has been debated for the last few years. The primary concern is the impact it would have on low-income earners, says Severus Smuts, indirect tax specialist at Deloitte.

“I think we’ve reached a stage where we have to find answers to that question. We have to find a way to make that work because that is really the only cost-effective way to collect R20 billion-plus in the current environment.”

While there is significant concern about the impact of further hikes in personal income taxes on this fiscus, there is a possibility that the marginal tax rate for certain very high-income earners could go up to 50%. Government may also only allow partial relief for bracket creep for individuals in other tax brackets, Erika de Villiers, head of tax policy at the South African Institute of Tax Professionals (Sait), says.

But commentators warn that South Africa may have reached a point where further personal income tax hikes will not yield additional tax revenue, and rather lead to lower production, tax morality and revenues.

De Villiers says if tax collection could improve, it could make a significant contribution, but this would not be a short-term project, as it depends on the efficiency of the South African Revenue Service (Sars).

Gigaba announced in November that tax administration and governance at Sars would be probed, but no further information has been released.

While Deloitte estimates that tax policy changes related to trusts, estate duty and donations could yield between R3 billion and R5 billion in revenue, Bernadette Abbott, personal tax specialist, does not expect to see any “legislative detail” about the introduction of a new wealth tax. The implementation of a wealth tax will be difficult and a lot more deliberation is necessary.

Brought to you by Moneyweb

ALSO READ:

//