We’re rowing against the fiscal deficit stream – IRR - BizNews, 23 February 2017

By Gwen Ngwenya & Frans Cronje 

The Minister of Finance presented his budget to Parliament yesterday. Contrary to the views expressed by other analysts we do not view the budget as considered or sound. On the contrary it suggests a government at the brink of fiscal catastrophe and without a plan for either growth or austerity.

Tax revenue as a proportion of GDP has increased from 21.9% in 1994/95 to a projected 29.8% in 2017/18. The state is therefore taking a greater proportion of the wealth generated in the economy. The implication is that the state believes it is able to spend more effectively and efficiently than consumers and the private sector.

A related point is that government expenditure as a proportion of GDP has increased from 26.4% in 1994/95 to a projected 33% in 2017/18. By international standards this is a very high level. Our data on the subject extends back to the 1960s and the current level is the highest on record.

The difference between revenue and expenditure levels produces the budget deficit or surplus. The high deficits inherited from the apartheid era were progressively reduced after 1994 and, in 2006/07 and 2007/08, surpluses were even recorded. But deficit levels have since broadened to -3.4% of GDP.

As the deficit expanded, government debt levels escalated. In 2008/09 debt levels bottomed out at 26% of GDP – more than twenty percentage points below the 1994 level. However, debt levels have since escalated sharply and are projected to reach 50.7% of GDP for 2016/17.

As debt levels have increased, so the government’s interest bill has increased, too. The state’s debt cost amounted to 8.8% of total expenditure in 2013/14 but is forecast to increase to 11% in 2019/20. At that level, servicing the debt bill will be equivalent to spending on health or housing and community development. Debt is starting to crowd out other areas of expenditure. It is nonsense, therefore, to suggest, as the government has done, that revenue from increases in taxation will be employed to build more houses, schools, and hospitals. To a great extent, those increases will go to servicing the debt incurred through higher levels of borrowing.

From whichever angle you approach the budget the story is one of a government that is running out of money. To get out of trouble, there are six options available to the government.

The first is to increase corporate tax rates above the current 28%. But threats to property rights, counter-productive labour policy, and onerous empowerment requirements have already reduced South Africa’s economic competitiveness to a point where corporate tax increases will do more harm than good.

The second is to increase the VAT rate. The political consequences of such a move would be too difficult for the minister to consider, so alternatives have been found in secondary taxes such as those on sugar-sweetened beverages. There is room to expand such taxes to other food groups, but the effect of doing so will be very much the same as increasing the VAT rate – these are essentially VAT increases by stealth. Like a VAT increase, such taxes will reduce the living standards of poor households and thereby indirectly trigger a host of negative political consequences for the government.

The third is to further increase the individual income tax rate. The minister raised the top individual tax level from 41% to 45% and, while further increases are possible in future years, the law of diminishing returns risks playing itself out. The government has tried to present the individual income tax increases as a tax on the rich with the implication that the middle classes and the poor will be spared, but this is as much nonsense as suggesting that higher taxes will be used to build more schools. The great bulk of extra revenue raised through individual income tax increases will come from taxpayers in lower brackets.

The pressure that such tax increases will place on households will reduce overall levels of consumer expenditure, property transactions, savings, entrepreneurship and investment – the costs of which will filter through society down into poor households. Household debt levels are 60% higher than they were 15 years ago. Administered price increases, toll roads, and electricity price increases have further eroded household incomes. In a country where the political climate is seeing mobile, high net-worth individuals increasingly considering emigration, the risk is that further individual tax hikes may push South Africa’s top business and entrepreneurial talent out of the country.

The fourth option is to spend less money. Around 60% of the budget goes to social protection expenditure. Personnel expenditure accounts for 35% of the budget. These are the only two areas of expenditure that offer the government any real fiscal breathing room. Cutting the former will trigger a range of negative political and economic consequences for the government. Cutting the latter will slow the growth of the middle class, reduce income tax revenue, dampen consumer expenditure (and therefore economic growth), and stall the dispensing of new patronage through the ANC’s cadre deployment policy.

The fifth option is to cut wastage and corruption, the extent of which is hard to quantify but could probably be measured in points of GDP. However, the political will to do so does not exist.

The sixth option is, of course, the most obvious one – to grow the economy faster. But many in the Cabinet remain hostile to the structural reforms necessary to entice higher levels of investment into the country. Neither the President in his recent State of the Nation Address nor the Minister of Finance in his budget speech made any compelling statements that suggest the government is serious about reform. It is one thing to call for growth, but it is another to actually take steps towards attracting the requisite investment. In relying on tax increases to a greater extent than spending cuts or pro-investment reforms the minister has actually worsened the investment and entrepreneurial climate.

We cannot, therefore, go along with analyst views expressed in the media and elsewhere this afternoon that the minister has done well to deliver a considered budget. Our view is that the government has come close to maxing out the revenue it can extract from the economy – but has no workable plan to create new revenue. Further borrowing will raise debt levels and hasten the prospects of rating downgrades. Austerity will serve to directly undermine the political future of the ANC. The government has very little room to manoeuvre. If current growth and revenue collection targets are not met, the government may find itself in a considerable degree of fiscal, and therefore political, difficulty.

*Gwen Ngwenya is COO and Frans Cronje CEO of the IRR – a think tank that promotes political and economic freedom. Follow the organisation on Twitter at @IRR_SouthAfrica 

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