Budget speech: Who to tax?
23 February 2015
Posted by: Author: Jac Laubscher
Author: Jac Laubscher (Sanlam)
Next week’s National Budget will be the first since 1994 that will require increased taxes to raise revenue structurally rather than the usual increases in sin taxes or specific tax changes motived by some policy objective.
The latter would, for example, include the introduction of capital gains tax for the sake of a more equitable tax system, or the carbon emissions tax on motor vehicles to incentivise people to drive vehicles with lower emission levels.
The structural deficit in tax collections can be traced back to the adoption of the policy more than a decade ago to reduce the contribution of individuals to tax revenue while increasing the contribution of corporates (leaving arguments about tax incidence aside). As a consequence of the greater cyclicality of corporate income tax compared to personal income tax, the impact of the 2009 recession and the subsequent muted recovery on tax revenue was exacerbated.
Raising funds to finance existing government programmes
The promised tax increases will be unashamedly about money, aimed at raising funds to finance existing government programmes that have become unaffordable instead of reducing expenditure. Government has been forced into this position by the prospect of sustained lower potential economic growth undermining the revenue base and the imperative to stabilise its debt burden to avoid further credit rating downgrades that will make it more difficult and more expensive to finance deficit spending.
Speculation about who will bear the increased tax burden has been rife and will continue to escalate in the further run-up to the budget, with "the rich” being a fairly standard answer. But perhaps one needs to think a little bit more deeply about the answer to this question as it does not give enough recognition to the range of options available to the government.
For a start the additional amount needed is not high. According to the 2014 mini budget (MTBPS) "policy and administrative reforms will raise at least R12bn in 2015/16, R15bn in 2016/17 and R17bn in 2017/18”. This amounts to less than 0.5% of GDP in each year and should tax receipts perform better than expected as so often in the past even these relatively small amounts may be further reduced.
A tax increase of 1 - 2% of GDP
In fact, given the need to stabilise government debt and over time reduce debt as a percentage of GDP, raising taxes by a bit more that these amounts could be justified. I have argued in the past that a tax increase of 1 - 2% of GDP is required to bring the primary budget balance more quickly into a meaningful surplus that will reduce the debt ratio at an acceptable pace.
What these relatively small amounts also indicate is that it is not necessary to do anything drastic that will compromise future tax policy - we are after all awaiting the final report and recommendations of the Davis Tax Committee. It was therefore unavoidable for the National Treasury to consult with the Davis Committee as it did to get the latter’s input on possible tax changes to avoid inconsistencies in approach.
No increase in the VAT-rate
This is also why I believe an increase in the VAT-rate is not on the cards. An increase of half-a-percentage point will raise approximately R10bn in additional revenue and it could therefore cover the bulk of the revenue gap, with a small twitch to the fuel levy providing the rest to get to R12bn. The reference to "administrative reforms” in the MTBPS also points to further attempts at improving tax compliance and thus raising the amount collected without increasing tax rates or introducing new taxes.
But then an increase in income taxes on higher-income individuals may well have to accompany any increase in VAT to preserve the progressivity of the tax system and thus render a VAT increase politically acceptable. (It is nevertheless worth noting that the World Bank, in a study on fiscal policy and redistribution in South Africa published in November 2014, surprisingly found VAT to be progressive, with the share of disposable income paid in VAT increasing from just under 9.5% of the disposable income of the poorest decile to almost 12% of the disposable income of the richest decile.)
But is it really worthwhile facing the political backlash that will surely follow an increase in the VAT rate for so little benefit? Would it not be better to keep the powder dry on VAT with a view to the funding needs of the proposed National Health Insurance System? Motivating an increase in the VAT rate in order to finance a major new policy initiative that will benefit the poor proportionately more than the rich will surely be much easier.
So is increasing the top marginal tax rate for individuals a better option?
The argument is frequently heard that high income individuals already contribute such a high percentage of government revenue that it would be unfair to further increase their burden. However, the skewness of the contributions of various income groups to tax revenue is primarily a reflection of South Africa’s unequal income distribution and cannot be questioned per se.
In fact, the World Bank study mentioned above found that although South Africa has a highly progressive tax system that supports redistribution effectively the so-called Kakwani index (the tax concentration coefficient minus the Gini coefficient on income) is quite low (0.13 compared with 0.27 in Brazil, for example).
South Africa’s high unemployment rate
However, it would be wrong to conclude from this that an even more progressive tax regime would be in order. The real problem with inequality is South Africa’s high unemployment rate that puts upward pressure on the Gini coefficient and a more progressive tax regime will discourage the necessary job creation by entrepreneurs through its disincentive effects.
Increasing capital gains tax and estate tax (generally regarded as taxes on the rich) will also not do the trick. Both these taxes make such relatively small contributions to government revenue (R11.6bn from capital gains tax of which R7bn was paid by individuals and R1.1bn from estate duty in 2013/14) that they will have to be increased substantially to make any difference. The expected revenue from both these taxes is also less predictable and therefore not reliable to close the revenue gap with certainty.
The most likely solution as to which taxes should be raised to generate the additional revenue needed to stabilise government finances is therefore to do a little of a lot of things, viz. to raise the R12bn required in 2014/15 by a range of relatively small changes to a broad range of taxes and to improve tax compliance wherever possible.
However, the best solution to regaining fiscal space (while we wait for a step-up in economic growth) is still to reduce government expenditure. All that is required in 2014/15 is to cut expenditure by 1%. Can it really be so difficult or indeed impossible to find R12bn in savings across all expenditure items? Is government really such a mean machine?
This article first appeared on fin24.com.