South African tax increases are unlikely to be effective

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There is growing pressure on government to reduce the budget deficit and slow the rate of debt accumulation, which has reached unsustainable levels, Nedbank economists said in a research note on Friday (29 January).

The economists cited the October 2020 Medium Term Budget Policy Statement which recommended a combination of tax hikes and spending cuts, notably to the public sector wage bill, to reduce budget deficit gradually to 10.1% of GDP in 2021/22 and then down to 7.3% by 2023/24.

However, tax hikes are unlikely to be effective, Nedbank said.

“The special tax proposed to fund the acquisition of Covid-19 vaccines, which government did not budget for, will add to an already high tax burden.

“National Treasury acknowledged that there were limits to what could be achieved through higher taxes alone. This is because tax buoyancy has fallen to below one, with every 1% increase in GDP producing a less than 1% increase in tax revenue.”

Nedbank said that raising taxes will only reduce tax buoyancy further and that South Africa has reached the point where nominal spending cuts are the only route to fiscal sustainability.

“It will be difficult to effect in the middle of a health crisis, a shrinking economy, calls for continued financial aid from state-owned enterprises and with fierce resistance from public-sector unions.”

However, the economists warned that failure to reduce spending now will add fuel to the debt service cost burden, trigger further sovereign risk ratings’ downgrades deeper into junk status with negative feedback loops, and force even more disruptive adjustments at some point in the future.

“We expect considerable constraint in the years ahead, with government expenditure forecast to increase by a marginal 0.3% in 2021,” it said.

Fiscal cliff

Similar concerns have previously been raised about the government’s spending in proportion to the revenue it can raise.

In a November 2020 report, the Fiscal Cliff Study Group (FCSG) said that South Africa has now hit its ‘fiscal cliff’ as public sector remuneration, social assistance payments and debt-service costs have effectively absorbed government revenue.

It showed that these items made up:

  • 55% of tax revenue in 2007/08;
  • 75.5% of tax revenue in terms of February 2020 budget;
  • > 100% of estimated tax revenue in terms of 2020 MTBPS.

The group said that South Africa was likely to reach the fiscal cliff this year based on the assumption of a revenue reduction of around R312.8 billion.

This will be combined with a once-off social grant payment increase of R41 billion, additional borrowing requirements for government debt and concomitant increase in debt-service costs of R3.7 billion in 2020/21, it said.

The FCSG said that it has been predicting a fiscal crisis since 2014 and that “the fiscal cliff has now been reached”.

“Although some recovery could follow after the 2020/21 expenditure spike; we have seen a structural shift closer to the cliff face,” it said.

It added that steps should now be taken to avoid a permanent fiscal crisis and that disclosure of trends in public-service compensation data should continue.

The group said it was also important to protect institutions that still function well, but refrain from helping non-essential failed state-owned enterprises such as Alexkor, Denel, SA Express, and South African Airways.

It said that government should also limit or reduce the remuneration and bonuses of executives at SOEs

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