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Income tax issues: The problem lies in reducing expenditure, not increasing income

Wednesday, 04 March 2015   (0 Comments)
Posted by: Author: Ian de Lange
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Author: Ian de Lange (Seed Investments)

Last week, the South African Minister of Finance tabled the government budget in parliament. This process actually provides a very detailed look into government finances. Naturally of most interest are some of the specific changes to the tax act that will affect both individual and corporate taxpayers. In Western democracies, we have become so accustomed to high rates of tax on both the corporate and individual level, that we think that this has always been the norm in society.

Yes, the concept of a tax has been around for much of civilisation and, in the case of the Roman Empire, consisted of a modest percentage levied against wealth in the form of land, homes, slaves etc. Rome also collected customs duties on imports and exports as well as a form of sales tax.

But in many ways the concept of an income tax as we understand it is a relatively modern concept – modern in that it has been around since approximately 1800 in Great Britain, introduced to pay for weapons and equipment for the French Revolutionary War. A tax on income does presuppose that there is a common understanding and recording of receipts and expenses, accurate recording of profits and reliable records etc.

In the US, the first income tax was suggested during the war of 1812 but was never inaugurated. Then the Tax Act of 1862 was passed with rates of 3% on income above $600 and 5% on income above $10 000. It was primarily to finance the Civil War and while the population accepted the tax imposed, compliance was not very high at all.

In the US, this Act was repealed in 1872 and in 1913 an amendment was passed, which allowed Congress authority to tax US citizens on income from whatever source. Over the years, the tax act has become progressively more complicated.

In South Africa, income tax was first introduced in 1914. The Tax Act was updated again in 1962 and from that stage has gone through numerous updates and amendments. It is known as a progressive income tax system in that the higher the earnings, the higher the rate of tax. In the latest budget announcement, the top tax rate was increased from 40% to 41%.

In the latest budget for the year ahead, government is looking to bring in a tax revenue just shy of R1,2 trillion, up from R1,1 trillion. The three biggest components of this revenue are individual tax at 36%, VAT at 26% and corporate tax at 19%. The main sources of tax revenue are reflected in the table below.

Expenditure is budgeted to come in at R1,35 trillion, leaving a budget deficit of R162 billion, which will need to be financed through the raising of fresh government debt.

The country’s gross domestic product (GDP) is expected to be in the region of R4,2 trillion and so revenue as a percentage of GDP comes in at 28,4%, while expenditure comes in at a massive 32,2%. The budgeted deficit as a percentage of GDP is a number that is followed closely. This is now budgeted to come in at 3,9%.

As the government’s debt burden increases, so does the interest component in servicing this debt, which in itself is a large component of expenditure. The interest bill was R121 billion in the last financial year and in three years’ time is expected to grow to R158 billion and average 3,2% of GDP.

However, because of the threat of an investment downgrade, despite increasing in absolute terms, debt as a percentage of GDP has been revised downwards from the projection in the medium term budget policy statement in October 2014. Total gross loan debt as a percentage of GDP is expected to rise from 46% to 47,6% in three years’ time.

There is little argument that the South African government has little wriggle room when it comes to increasing government expenditure, raising meaningful levels of new taxes and increasing its debt levels, without having an adverse consequence. Just like any business or household that has a tight budget and high levels of debt – i.e. higher than annual revenue – it has no choice but to continue to look for ways to increase its revenue. But probably of greater importance is to look for ways to ensure greater efficiency in expenditure. This is going to be the real challenge in the years ahead.

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