Focus on the financial health of South Africa’s tax base

By Lesiba Mothata on Feb 16, 2018 in The news

 

Much took place during former President Jacob Zuma’s tenure. Most notable is the fragile state in which he left the National Treasury. After inheriting a sound fiscal position on his arrival in office, with a budget surplus of nearly 1% of GDP in 2007, and a small deficit of a similar magnitude recorded in 2008 induced by the global financial crisis (GFC), his administration presided over a sharp deterioration of public finances. Some of the factors underpinning the decline in fiscal revenues were due to global factors related to the GFC. However, data from the Bank for International Settlements, a Swiss-based central bank, shows that, relative to its emerging market peers, South Africa borrowed the most since the Lehman Brothers collapse. Having had debt levels of around 26% of GDP prior to the GFC, the mountain of debt has steepened and is expected to exceed 60% of GDP over the next three years (see chart below).

The impact of Zuma’s legacy, among other factors, is the erosion of confidence in the National Treasury as one of the pillars of South Africa. The musical chairs witnessed at the leadership of the institution has eroded confidence, as has the exodus of talented and experienced staff from the institution. The credit rating downgrades that ensued were a reflection of this decay.

After almost a decade of deterioration in South Africa’s fiscal position due to the Zuma administration, another blow was dealt to South Africa’s fiscal health during the October 2017 Medium-Term Budget Policy Statement (MTBPS). Outcomes of the MTBPS showed a worrisome picture for South Africa’s fiscal trajectory: a burgeoning debt load, state-owned enterprises continuing to require recapitalisation with related guarantees on the rise, new expenditure items such as the National Health Insurance put on the table, and funding for free tertiary education to be sourced.

The MTBPS was delivered in a context of anaemic GDP growth and lofty expenditure plans. While sentiment in the country has improved following the African National Congress’s elective conference, the fiscal matrix has not changed. The onerous demands put in the budgeting plans leave one wondering whether what was proposed in the MTBPS will be revised completely, or adopted wholesale. To continue with the proposals would imply that South Africa has committed itself to an unsustainable fiscal path. The newly elected leadership of the ruling party has its work clearly cut out: they will need to demonstrate how they are going to restore the credibility of the budgeting process – and that of the National Treasury, one of the most important institutions in a constitutional democracy.

The effective credit rating on foreign-denominated debt (10% of total) is already non-investment grade from all ratings agencies. Moody’s continues to hold a more constructive view on South Africa, with a rating one-notch better than that of Standard & Poor’s Global and Fitch, but is likely to downgrade South Africa if the budget outcomes mirror those planned in the MTBPS. It can be argued that financial markets are already priced for non-investment grade. If Moody’s does downgrade South Africa further, the country will get removed from global bond indices. Given the constructive global environment, and the strong demand for emerging market debt, South Africa will continue to find demand for its issued debt.

The fourth industrial revolution has brought about rapid changes in the world of work, which need to be considered in the budgeting framework. According to the World Economic Forum (WEF), South Africa is highly exposed to global technological trends, but possesses a low capacity to deal with such tectonic shifts. Due to its second-to-last position on the continent in terms of the quality of education and high unemployment, South Africa is poorly positioned to meet these global challenges. The WEF has estimated, for example, that as many as 77% of our current jobs stand to be impacted by these changes. In other words, the tax base, already too thin, will be materially affected.

Individuals contribute the most to the South African government’s tax revenue. Personal income tax makes up 38% of tax collections, versus 17% from companies (see chart below). One of the major stakeholders in the National Treasury are ordinary South Africans who toil day and night to earn a living and pay tax. The financial health of South Africans matters for the country’s success. It is the responsibility of fiscal authorities to protect consumers’ savings and maximise their ability to earn income in a sustainable way.

The concept of a well-being economy resonates profoundly for South Africa. Given the importance of individuals in tax collections it is critical to pay attention to the financial well-being of tax payers. Although the intention is to raise further revenue through higher taxes, the goal needs to shift towards adding more individuals to the tax base as opposed to squeezing more out of the incumbents.

The management of public finances should maximise overall peace of mind about financial prosperity for citizens. When people have full control of their personal finances, and can withstand unpredictable financial shocks, the longevity and sustainability of tax collection is strengthened. Overburdening a frail consumer tax base with additional taxes contributes negatively to the financial well-being of citizens.

Even though the financial well-being of consumers is pressed, it is clear that the Minister of Finance will be faced with declining tax revenues from personal income tax, value-added tax (VAT) and corporate taxes; while at the same time having to continue providing a lifeline to State Owned Enterprises (SOEs), which continue to drain the fiscus. In response to the possible revenue shortfalls, the following revenue raising measures are likely to be announced:

  1. Petrol does not attract VAT at the moment. A 14% VAT is likely to be introduced on fuel which could increase the petrol price by more than a full rand per litre;
  2. Electronic services, such as cloud computing and online transactions, to attract VAT;
  3. Additional wealth-related taxes (perhaps a luxury tax);
  4. Reduction in the medical tax credits to fund National Health Insurance;
  5. Allow consumers to feel the effects of inflation.

Although these initiatives will not in themselves, at this stage, be a final straw for individuals’ financial well-being, they will increase the tax burden which, in turn, will limit the room for further tax takes.

Lesiba Mothata

Executive Chief Economist. Lesiba joined Alexander Forbes Investments (previously Investment Solutions) in 2013 as Head of Market and Economic Research after a two-year spell at the SA Reserve Bank as a risk specialist responsible for the strategic asset allocation of the foreign-exchange reserve portfolio (about $50 billion). He serves on the exco of Alexander Forbes Investments to contextualise the greater economic and market conditions we operate within.

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