Cape Town - The government needs more tax money to make the fiscal numbers add up in the budget. Low economic growth has limited Finance Minister Pravin Gordhan's options in terms of the effect raising tax income in the main categories - value-added tax (VAT), personal income tax and company tax - will have on both the economy and individuals.
Will raising VAT hurt the poor more?
The debate about the VAT rate emerges every year at budget time. While most analysts acknowledge that it will be the easiest and most effective way to collect the shortfall, conventional wisdom is that the social and political consequences of such a move make it undesirable and unfeasible, as it will affect the poor the most.
The VAT rate, currently at 14%, contributes 26.3% of total tax income. Standard Bank economist Siphamandla Mkhwanazi says raising this means increasing the living expenses and decreasing the purchasing power of all consumers. He argues though that the negative effect is higher for lower income households.
READ: VAT may well be Gordhan's biggest political headache - analyst
According to Bureau of Market Research data, households that earn less than R89 000 per year spend between 36% and 42% of their income on food and drinks. Raising the VAT rate will therefore have a bigger effect on them than on households that spend a smaller portion of their income on these items.
The other side of the coin is that wealthier people will buy other (more expensive) commodities and will probably contribute by far a bigger portion of the extra money collected through the VAT increase.
Arthur Klamp, economist at Sanlam Investments, has pointed out that VAT is also more growth friendly than taxes on income. The reason: it supports savings and investment, whereas the latter is a disincentive to work and invest. SA desperately needs more domestic savings.
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Bracket creep will hit middle income earners the hardest
More money can be collected from personal income tax in three ways: by growing the tax base (more taxpayers paying more tax); by increasing tax rates (last done in 2015 for the first time in 20 years by then finance minister Nhlanhla Nene), and/or bracket creep. The latter means extra money will be collected by not adjusting the income tax brackets to make provision for inflation.
Most analysts expect the economy (gross domestic product) to structurally underperform over the next three years. This makes it unlikely that enough new job opportunities will be created through economic growth to substantially grow the tax base.
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Bracket creep is less visible and drastic than hiking rates when you need to increase tax from personal income tax, which accounted for 36.4% of total tax collected in 2015/16, compared to 33.8% in 2011/12. Another hike in rates, or a new bracket (or two) for top earners, might drive the biggest wealth creators out of the country.
Mkhwanazi says bracket creep will affect middle income earners the most, in other words people whose annual income is between R89 000 and R707 000. This is because they rely on salaries and wages as a primary income source to a greater extent than people who earn less or the more affluent taxpayer.
Company tax hits a ceiling
The percentage company tax contributed to total tax collected decreased from 20.6% in 2011/12 to 18.1% in 2015/16. This was due to lower economic growth and the fall in commodity prices.
Mkhwanazi says raising the company tax rate (currently 28%) is seen as counterproductive. That is because SA has apparently reached the threshold above which the tax income will be negatively affected. In other words, raising the rate above 28% will result in less company tax collected.
The improvement in commodity prices has boosted mining companies' earnings and more company tax than expected was collected the last couple of months, according to Mkhwanazi.
He expects commodity prices to stay at current levels in 2017, which will have a positive effect on company tax income in the fiscal years 2017/18 and 2018/19.
Closing the income gap
Mkhwanazi stresses that the government's fiscal policy helps to narrow the income gap in SA, which is still one of the largest in the world.
About 17 million South Africans currently receive a social grant, and about 24% of households rely on that as their primary income.
The estimated ratio of the average income in the lowest income group (R0 – R20 500 per year) to the highest income group (R2 414 001+ per year) fell from 1:8086 in 2011 to 1:4578 in 2016 (about 43%).
This means that for every R1 someone in the lowest income group earned in 2011, a person in the highest group earned R8 086. It decreased to R4 578 for every R1 in 2016.
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