Most South Africans will be listening out for dreaded tax hikes when finance minister Tito Mboweni delivers the Budget speech on Wednesday (26 February).
However, according to Carla Rossouw, tax lead at Allan Gray, the minister’s focus and effort should be directed to towards three more important things that will better serve the country’s economic future.
A revenue shortfall of R50 billion was announced in the Medium-Term Budget Policy Statement (MTBPS) in October 2019, and this sets the scene for the 2020 Budget, said Rossouw.
Whether any interventions announced on 26 February are enough to fill the gap remains to be seen.
“What is clear is that there is little room to make significant tax adjustments when the tax burden is already so high, and the economy is not growing,” said Rossouw.
Instead, she said, more focus and effort should be directed to towards:
- Reducing inefficient government spending;
- Job creation (so that more people can earn an income and pay taxes); and
- Improving the efficiency of our country’s tax administration.
Taxes, damned taxes
With the main revenue levers being corporate income tax, valued added tax (VAT) and personal income tax, Rossouw questioned whether there is any room to cover this shortfall by increasing taxes.
The South African corporate tax rate has remained unchanged at 28% for several years, yet it is still high compared to the global average, she said.
“In the current climate where global average corporate tax rates continue to decline, and South Africa is desperate to remain competitive and attract foreign investments, there is not much room to increase this.
“Increasing corporate tax would inevitably push investments to countries with more attractive tax rates.”
South Africa’s VAT rate is currently sitting at 15%. Even though this was increased by 1% in 2018, it is still relatively low compared to the rest of Africa and the world, said Rossouw.
“While it may be the most effective tool to raise revenue, it is also the most politically difficult.”
South Africa’s personal income tax rates rank amongst the highest in the world, alongside Belgium and Germany.
Rossouw said that a further increase may see more South Africans formally emigrate; a trend already evident with the introduction of the new ‘expat tax’ effective March 2020.
The latter limits the exemption South Africans can claim for foreign service income to R1 million, resulting in an additional tax liability which some just simply cannot afford.
“And the unfortunate reality is that it is unlikely to raise any substantial additional revenue for the fiscus due to the relatively small number of people this will affect,” Rossouw said.
Allan Gray expects ‘bracket creep’, which is the process by which inflation pushes up wages and salaries into higher tax brackets, without corresponding relief in adjusting the income tax brackets, to continue.
Not adjusting tax brackets for inflation is an increase in itself and a ‘silent’ revenue generator for the government as it is not immediately evident to most taxpayers, Rossouw said.
The Budget may also see new taxes being introduced to generate revenue, said Allan Gray. Other measures that may come up, but will not make a substantial contribution to the tax coffers, include:
- Dividends tax: The dividends tax rate (currently at 20%) does not rank amongst the highest in the world, but an increase could negatively impact investments.
- Capital gains tax: In 2016, the maximum effective capital gains tax (CGT) rate for individuals was increased from 13.7% to 16.4%. The effective rate then jumped to 18% in 2017 with the introduction of a 45% personal income tax bracket. But raising CGT doesn’t result in an immediate revenue injection (as the government has to wait for taxpayers to sell property, investments etc.), which something like a VAT rate increase achieves.
- ‘Sin’ taxes/fuel levy/carbon tax/sugar tax: These taxes are all soft targets and relatively easy levers to pull to generate additional revenue given that they are generally more acceptable than other taxes. Increases to some or all of these taxes are therefore likely.
Tax hikes and spending cuts inadequate
Elna Moolman, head: SA macroeconomic, fixed income and currency research at Standard Bank South Africa said that following more than a decade of marked deterioration in public finances, the typical tax hikes and spending cuts are now inadequate given the magnitude of SA’s fiscal shortfall.
Moolman said that more piercing adjustments are required to avoid a debt spiral.
She said that even full implementation of the proposed savings will be inadequate to ensure debt stabilisation or to preserve the sovereign credit rating in isolation.
“We estimate that the government debt-GDP ratio will still rise to above 71% from 48% when Moody’s first downgraded SA to its current credit rating (the lowest investment grade rating) and 22% before the global financial crisis.
“Put differently, the debt servicing cost is expected to increase to around R300 billion by FY22/23 and R400 billion by 2025 from around R200 billion in FY19/20 – this compares to annual social grant spending of around R210 billion – R220 billion and around R160 billion for total government infrastructure spending.”
Standard Bank said it also expects the government to rather focus its efforts on expenditure, where many years of public sector wage bill growth well in excess of that of the private sector or inflation, and a series of cash injections for inefficient SOEs, have been major contributors to the unsustainable fiscal stance.
“Change here will, however, take time,” Moolman stressed.
“We expect these savings to ultimately constitute the bulk of the fiscal consolidation steps in the coming years, with ongoing incremental tax hikes playing a secondary role.”
Moody’s looms large
Despite the anticipated efforts to get government’s finances on a sustainable path again, Moolman said that she expects that Moody’s will strip South Africa of its only remaining investment grade rating, which will trigger its automatic expulsion from the World Government Bond Index (WGBI).
“Although Moody’s has to date elected to retain South Africa’s sovereign debt investment status, the risks of a downgrade to junk bond status are real,” said Prof Andre Roux, economist at the University of Stellenbosch Business School (USB).
He highlights that there is particular concern among investors about the financial crisis being experienced by Eskom and other state-owned enterprises.
As the government continues to bail them out, the mountain of debt continues to grow.
Should Moody’s decide to relegate South Africa’s government debt instruments to junk bond status, the consequences will be severe for South Africa’s immeiate future growth.
“To start off with, it will become more difficult and more expensive to secure new loans. Rising borrowing costs will be borne ultimately by tax payers and consumers, thereby suppressing consumer spending and economic growth.
“At the same time, the cost of living will probably rise at a faster rate. The exchange rate of the rate will possibly weaken more severely than would otherwise have been the case.
“Foreign investment sentiment will be negatively influenced. Social spending by government will be constrained, unemployment could rise, and the overall socio-economic state of the country would be compromised,” said Roux.
Mboweni’s budget is unlikely to convince Moody’s Investors Service that he has a credible plan to rein in government debt, Bloomberg reported.
Of 19 economists surveyed by Bloomberg this month, 14 expect Moody’s to downgrade the country to junk this year and nine of those say it’ll happen in the first half.
That’s after the ratings company in November cut the outlook on the nation’s assessment to negative and said it would look to the budget for a feasible strategy to contain rising debt.