Answer to jobs crisis does not lie in the tax regime
27 November 2012
Posted by: SAIT Technical
By Catherine Grant-Makokera and Itumeleng Rantao (Business Day)
Executive summary (SAIT Technical)
According to the OECD, only 40% of South Africans of working age are employed compared to 65% in Brazil.. A report by the WEF indicates that tax is not the problem in South Africa. The report finds that leading obstacles to expanding the private sector in South Africa through SMEs and FDI are an inadequately educated labour force and restrictive labour regulations. These cannot be resolved by tampering with the effective tax rate. South Africa should focus on labour laws in the short term and education in the longer term so as to create a favourable business environment.
IN AUGUST, economist Chris Hart made headlines by classifying South Africa's unemployment levels as "exceptional”. As reported in this newspaper, he compared the country's unemployment situation to the employment success story of Brazil and counselled that tax policies, not labour laws, were to blame for our persistent unemployment.
This focus on a reduction in tax is in line with the New Growth Path, in which the government has announced its desire to attract more foreign direct investment (FDI) in manufacturing by implementing low effective tax rates. FDI is viewed as critical for development. Given the drop in FDI in SA this year, in the context of rising FDI in the continent as a whole, lowering effective taxes is being seen as a silver bullet of sorts.
Hart is right. Unemployment is a critical problem faced by South Africa. This year, the Organisation for Economic Co-operation and Development reported that, in South Africa, only 40% of those of working age have jobs, compared with 65% in Brazil. We took a direct comparison of South Africa and Brazil and drew conclusions different from those advocated by Hart.
Cross-country studies by the World Bank last year show that lowering taxes can attract investment, reduce tax evasion, enhance the creation of small and medium enterprises (SMEs) and ultimately raise sales and gross domestic product. SMEs are rapidly being seen as the solution to South Africa's persistent youth unemployment. A study by Trade and Industrial Policy Strategies provides a solid basis for this belief, finding that, between 1985 and 2005, 90% of all formal jobs in South Africa were created by SMEs. As such, reducing effective taxes with an objective of attracting manufacturing FDI and creating SMEs is being seen as a means to resolving this market failure.
But the 2012 World Economic Forum (WEF) global competitive report indicates that tax is not the problem in South Africa. The report finds that effective tax rates and regulations represent the least important of all obstacles to doing business in South Africa, amounting to only 0.7% of all obstacles.
So if tax is not South Africa's major problem, what is? The report finds that leading obstacles to expanding the private sector in South Africa through SMEs and FDI are an inadequately educated labour force and restrictive labour regulations. These cannot be resolved by tampering with the effective tax rate as initially believed by the government and advocated by Hart.
What more can be said of the Brazilian example? Like South Africa, Brazil has very stringent labour laws. However, according to the WEF report, stringent labour laws in Brazil account for only 10.1% of obstacles to doing business there, whereas they account for 18.5% in South Africa. Crucial barriers to doing business in Brazil appear to be tax regulations, accounting for 18.7% of all obstacles, inadequate supply of infrastructure (17.5% of obstacles), and effective tax rate (17.2% of obstacles).
Despite this, Brazil has managed to increase its employment levels while South Africa has not. Brazil created 8-million formal jobs between 2003 and the 2008 global financial crisis, which shed 600,000 jobs. After the crisis, Brazil doubled its pre-September 2008 job creation rate.
Lessons from Brazil seem to indicate that both the supply side and the demand side matter. Increased school coverage and increased labour subsidies nurtured and improved skills of the labour force in Brazil. These accelerated the creation of SMEs and attracted FDI, which led to the recovery of growth effects on the elasticity of the demand for labour.
Perhaps the most important underlying lesson here is context. In Brazil, major obstacles to expanding the private sector include tax regulations, infrastructure and high effective tax rates. By contrast, in the case of South Africa, pressing issues include an inadequately trained labour force and restrictive labour laws. South Africa ranks 143rd out of 144 countries on hiring and firing practices, and 140th on flexibility of wage determination according to the WEF global competitive index. Brazil ranks significantly higher on these scales (114th and 118th, respectively).
As such, it only makes sense for South Africa to focus on labour laws in the short term and education in the longer term so as to create a favourable business environment. The government is on the right track in amending labour laws because, in South Africa, tax on its own is not the silver bullet.