Plan to raise South Africa’s taxes will backfire: analysis

The Free Market Foundation (FMF) has warned that any plans to raise tax rates and introduce new taxes to pay for the National Health Insurance scheme will likely backfire.

This is because South Africa’s tax revenue is likely to decline as tax rates increase in line with the ‘Laffer curve’, it said.

“The economic theory behind the Laffer curve is simple: if people’s incomes, for example, are taxed at increasingly higher marginal rates then, beyond a certain rate, it will no longer be worthwhile to work for a net salary that is too low relative to the effort required to do the work,” it said.

“The implication of the Laffer curve is that if government wants to increase tax revenue, it should rather lower tax rates on the assumption that they’ve gone past the point of maximised tax revenue.”

Growing distrust

Another issue is the growth in public distrust in the state’s capabilities to deliver returns on taxes, the FMF said.

When this happens, as is the case in South Africa, the Laffer curve will shift left and downward because a higher incentive to avoid and/or evade taxes will have developed, it said.

“In South Africa, there is growing pressure to increase tax rates. The reasons are two-fold: growing debt and growing expenditure. Government is reliant on taxes as a means of funding not only its expenditure but also its debt obligations. To fund debt repayment by incurring even more debt is not a financially sound idea.”

“Two prominent examples of the Laffer effect are taking hold in the South African economy. Total tax revenue on income, profits, and capital gains have been decreasing even though the extremely high tax rates on individual income, profit, and capital gains have not been lowered.”

The FMF said that value-added tax (VAT) revenue has also been declining. Most noticeable is the sharp decline after the new 15% VAT rate was brought into operation in April 2018, it said.

“Tax revenue is not going to increase as South Africa is likely far past the point of maximised tax revenue already.

“There is no reasonable basis for persistently taxing South African citizens to their detriment and that of the whole economy.

“The ethical and legal arguments against taxes that do indeed serve a utilitarian goal is beyond the scope of this article. However, it is evident that even on pragmatic grounds, increasing tax rates or introducing new taxes is arbitrary and likely to be unconstitutional.”

Read: What you need to know about a tax revolt in South Africa