What if Zuma drew up the budget?

2017-03-07 06:50 - Jac Laubscher
Jac Laubscher
Economist Jac Laubscher. ~ Fin24

IT IS COMMON that South Africa’s public finances and how they are managed are currently a topic of great angst. The ongoing political struggle between different factions within government to gain control of the national purse strings continues to make headlines.

The consensus view is that only the current leadership of the National Treasury (NT), viz. the Minister and Deputy Minister of Finance and senior management, stands between prudence in managing government finances and profligacy (and then for private gain rather than the benefit of the general public) should their opponents gain the upper hand.

It is therefore reasonable to ask what 'they' (meaning the opponents) would do differently if 'they' were to gain the upper hand. In other words, in what respect would the national budget differ if 'they' were in charge?

For a start, whoever compiles the national budget will be subject to the same limitations within which South Africa’s public finances have to be conducted at this point in time and for the foreseeable future and ignoring them will not be sustainable.

The revenue constraint

• Firstly, South Africa has run into a serious revenue constraint.

  • At 26% of GDP for main budget tax revenue and 30% at a consolidated level the tax burden has reached a level at which it increasingly impinges on the growth potential of the economy, which in turn is an important determinant of revenue growth. Compared with its
    emerging-market peers South Africa’s tax burden is rather high and tax revenue is furthermore largely used to cover consumption expenditure rather than growth-enhancing capital expenditure. We may well be close to an inflection point where further increases in
    the tax burden will act as a damper on tax revenue ? an inverted Laffer curve, so to speak.
  • The soft options for raising taxes have been largely exhausted with the introduction of a new super tax bracket with a marginal tax rate of 45% of personal taxable income above R1.5m per annum in the recent national budget. And even this, as dramatic as it may sound, is budgeted to bring in only R4.4bn in additional tax revenue from 100 000 individuals.  The disincentive effect this will have is not only about those being affected possibly putting in less effort, but also about their being confronted with the decision of whether they are prepared to work in such an environment. The problem is that this increase targets exactly those people who are internationally mobile ? taken together with their total tax burden and the limited benefit they derive from government expenditure it may just push them to ask “For whose benefit am I actually working?” and decide to opt out.
  • Possible increases in wealth taxes such as estate duty as recommended by the Davis Tax Review Committee will deliver limited additional tax revenue. New indirect taxes such as the proposed carbon and sugar taxes will bring in additional revenue but not enough to create room for vastly increased spending. After all, their purpose is to effect behavioural change and not to act as cash cows. Although increasing the corporate tax rate would be politically popular it would be growth depressing, and in any case there is little room (if any) for doing so bearing in mind South Africa’s comparative position internationally.
  • The only remaining option that would raise substantially more revenue would be to increase the VAT rate. However, it is generally accepted that this option has been reserved for financing the gradual implementation of National Health Insurance over time.
  • The ability of SARS to collect taxes is being questioned for the first time since its development into the formidably effective institution it became under the leadership of the current Minister of Finance. It is unfortunate that the decline in SARS’s capability to collect
    taxes is coinciding with tax morality coming under pressure because of public perceptions regarding wastage, patronage and corruption in the public sector, as acknowledged in the recent budget speech.
  • So what would “they” do when faced with this constraint? Would “they” approach tax policy differently in order to raise more revenue to allocate to their pet projects? With the benefits of patronage1 increasingly meaning that “they” will be liable for taxes targeting higherincome groups and the wealthy (provided of course that tax administration is effective and efficient) it may well dampen their appetite for further personal income tax increases. Or would “they” find ways of hiding their gains so “they” can avoid paying the implied tax?

Paul Collier makes an interesting suggestion when he says that “in future, taxation needs to make distinctions based less on how much money has been made, and more on how it has been made”.

He then goes on to distinguish between those “who made their fortunes from innovation against those who made it from capturing rents”. In conclusion he suggests that in response to the increasing complexity of economies, “taxes will need to become context-specific instead of incomespecific.

The new strategy will be to tax pockets of rents”.

Paul Collier: How to save capitalism from itself. The Times Literary Supplement. 25 January 2017.

  • And what about corporate taxes? Would the newly empowered business owners produced by radical economic transformation, including the promised 100 new black industrialists, be happy with an increase in the corporate tax rate?
  • Would “they” really be prepared to face the resistance to an increase in the VAT rate without being able to demonstrate the benefits of such a step to the poor?
  • Furthermore, if “they” want to control SARS to serve their own interests it may well come back to bite “them” if the tax collection capacity of SARS is undermined in the process. How will “they” deal with such a challenge?

The debt constraint

• Secondly, government debt has reached the limit of what South Africa can afford.

  • At 53% of GDP gross government debt still compares reasonably well with debt burdens among our peer group. It is nevertheless regrettable that South Africa’s debt burden has almost doubled in a decade with very little to show for it in terms of lasting benefit ? debt
    has by and large been used to finance consumption expenditure, including the sharp increase in government’s wage bill. In other words, the increase in debt has not been accompanied by an increase in the tax buoyancy of the economy in order to service the
    higher debt level.
  • However, the cost of servicing this debt has reached a debilitating level at 13% of government revenue (compared with 8% in 2009/10) and 3,5% of GDP (2,4% in 2009/10), once again comparing very unfavourably with our peer group. Debt service costs will continue to be the fastest-rising expenditure item in the next three years, increasing by a projected 10.5% per annum. It is furthermore at risk from increasing interest rates on new debt that could result from higher market rates as a result of the global economic recovery,
    increased risk premiums on South African debt caused by political developments, and downgrades to below investment grade by major credit rating agencies.
  • Although a small (0,2% of GDP) positive primary balance (essential for the stabilisation of the debt level) is projected from 2018/19, it will not take much to push it back into negative territory.
  • The contingent liabilities of government, in particular guarantees provided to state-owned enterprises, are increasingly being taken into account together with the actual government debt in considering South Africa’s risk profile. Currently they amount to R478bn (10%
    of GDP), of which R308bn (6% of GDP) has been taken up. Sound corporate governance and financial probity in state-owned enterprises are therefore essential to prevent some contingent liabilities from turning into actual liabilities. However, investors
    and rating agencies will discount such an event long before it becomes a reality.
  • It is nevertheless likely that “they” would take a softer line on government debt, including guarantees to state-owned enterprises, pushing up the debt ceiling and brushing off the response of the rating agencies and the markets. Of course debt service costs will then
    take up even more of the budget, but would that concern “them”? There has been indications that “they” perhaps have a distorted view of the real burden of debt. For example, it has been reported that “they” naively believe vendor finance to be free.

The institutional constraint

 Thirdly, the budgetary process provides strict discipline in managing government expenditure within the limits imposed by the available resources.

  • The perception that has been created that the NT decides unilaterally on budget allocations to different government functions is plain wrong. The national budget is the result of an Extensive collective process of prioritising and decision making at a technocratic and
    political level, with a ministers’ budget committee involved at the political level before the budget goes to the full cabinet for its approval.
  • However, the NT does have the responsibility of pointing out the constraints on the available resources (see above), as unwelcome as the message may be. The scarcity of resources of course forces prioritisation and not all projects, some of which may well have
    merit, will make the cut, to the frustration of their promoters. The expenditure ceiling under which government has been operating since 2012 makes the competition for the available resources even more difficult than usual, with expenditure cuts requiring the portioning out of pain rather than gain.
  • The question is whether “they” are represented on the ministers’ budget committee (presumably “they” are) and what role “they” have been playing in determining the outcome. Too much is perhaps being made of the complaint of the Minister of Water Affairs
    about not being allocated enough funds for her department’s perceived needs and blaming the NT for it ? it is normal for ministers to take this line, even more so in the current tight environment. But perhaps “they” would find the drawn-out budgetary process with all its technicalities too cumbersome and rather opt to just bypass it ? enter the state-owned enterprises.

Conclusion

So what does this imply for what “they” would do differently?

Indications are that “they” are more focused on the expenditure side of the budget rather than the revenue side, and in particular on expenditure by state-owned enterprises. The revenue side is apparently seen as little more than a fund-raising project to be left to the NT.

So “their” interest has more to do with the management of the expenditure side of the budget at a micro-level, viz. procurement processes, the application of the Public Finance Management Act, the role of government as shareholder in state-owned enterprises, etc.

It is therefore possible that what “they” would do differently would initially have limited impact on the national budget at an aggregate level. But at the end of the day “they” are subject to the constraints of the real world just as much as anyone else. The problem is that “they” may turn a blind eye to this, causing much damage to be done.

Apart from the direct financial implications, e.g. pushing up debt servicing costs, the result will be greater inefficiency in the public sector, lower growth and higher inflation. The acid test will remain the sustainability of the government debt burden.

* Jac Laubscher is economic adviser for Sanlam Limited. Opinions expressed are his own.

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