Tax hikes for South Africa as it faces a possible ‘debt trap’

 ·28 Oct 2020

Finance minister Tito Mboweni has confirmed that Treasury plans to introduce tax increases of R40 billion over the next four years to combat government’s growing shortfall.

Presenting the medium-term budget policy statement (MTBPS) on Wednesday (28 October), Mboweni said that these increases will help with ‘consolidation’ of the country’s finances, alongside a range of spending cuts.

“The impact of the Covid-19 economic contraction on South Africa’s public finances will be felt for years to come.

“Although the economy has begun to recover from the hard lockdown, tax revenue in the current year is projected to be R8.7 billion lower than the June estimate,” Treasury said.

“Gross debt is projected to reach 81.8% of GDP in the current year, up from 65.6% projected in February 2020.”

Additional fiscal pressures from the broader public sector – including state-owned companies, social security funds and municipalities – remain unresolved, it said.

“The fiscal trajectory is a major source of uncertainty, pushing up borrowing costs for the broader economy.”

To assist with the consolidation, government has projected tax increases of R5 billion in 2021/22.

This will be followed by increases of R10 billion in 2022/23, R10 billion in 2023/24 and R15 billion in 2024/25.

Treasury said that the government’s spending remains too high for the tax base – and this gap has likely increased as a result of the 2020 recession.

“Recent tax increases have generated less revenue than expected, and evidence suggests that tax increases can have large negative effects on GDP growth,” it said.

“Without a major reduction in public spending, debt will continue to accumulate and interest payments – which already consume 21 cents of every rand of main budget revenue – will crowd out other spending.”

Debt trap

Treasury said that South Africa’s deteriorating fiscal position reflects a combination of economic factors and fiscal choices.

Between 2007/08 and 2011/12, non-interest spending grew by an annual average of 14%, reflecting an increase in public-service compensation and an expansion of social grants, among other factors, it said.

“The introduction of the expenditure ceiling in 2012/13 constrained expenditure growth. But despite efforts to slow non-interest spending growth and raise taxes, the structural gap between revenue and expenditure has not been adequately addressed.

“While deficit spending has provided some support to the economy, real economic growth has declined over the past decade,” Treasury said.

Downward revisions to nominal GDP have also pushed up the budget deficit and debt-to-GDP ratio, it said.

In comparison with a wide range of other countries, South Africa’s average primary balance over the last 10 years falls in the middle of the distribution.

However, the data shows that South Africa’s three-year increase in debt to GDP is the largest among a group of developing countries.

“The probability of a debt trap – in which rising debt-service costs are increasingly paid from additional borrowing – has increased,” Treasury said.

“As debt has mounted, these deficits have become a drag on growth. Current expenditure is increasingly funded by debt, and borrowing is becoming more expensive. In June 2020, volatility in bond market auctions triggered the introduction of a bond-purchase programme by the Reserve Bank.”

Treasury said that fiscal distress is mounting in developing countries amid historically high indebtedness.

“A case in point is Argentina, where a decade of rapid spending growth reversed sharply over the past two years, culminating in a sovereign debt default in March 2020. In this environment of rising fiscal pressures, South Africa is losing ground to its peers.”


GDP growth

Mboweni said that the South African economy is expected to contract by 7.8% in 2020, while the 2021 outlook is more uncertain.

“Job losses have been particularly severe. But we cannot allow our recent fiscal weakness and the pandemic to turn into a sovereign debt crisis. Therefore, today government sets out active measures to avoid this risk,” he said.

“Our revised fiscal framework puts us on a course to stabilise the ratio of debt-to-GDP at around 95% within the next five years,” the minister said.

He said that the stock of gross debt will rise from roughly R4 trillion this year to R5.5trillion in 2023/24. “The medium-term fiscal strategy narrows the main budget primary deficit from an expected R266 billion in 2021/22 to R84billion in 2023/24 and we achieve a surplus by 2025/26.”

“We propose consolidated spending of R6.2 trillion over the 2021 Medium Term Expenditure Framework, of which R1.2 trillion goes to learning and culture, R978billion to social development and R724billion to health.”

Mboweni forecast the South African economy to grow by 3.3% in 2021, 1.7% in 2022 and 1.5% in 2023.

“In South Africa, the high frequency data that we collect suggests that green shoots are emerging. At this stage, it looks like there will be a strong rebound in the next quarter. These will be supported by government’s Economic Reconstruction and Recovery plan.

“Already there is progress on implementing the plan,” the finance minister said.

A sharp -and hopefully short -global recession is underway, the finance minister said. He noted that the International Monetary Fund expects global output to contract by 4.4%  in 2020, before rebounding to 5.2% in 2021 in their October World Economic Outlook.

Growth in advanced economies is strengthening. Next year, emerging market countries are set to grow by 6%, the minister said.

Read: Ramaphosa on South Africa’s biggest issues – including a second coronavirus lockdown, fraud and security drones

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