Expect tax hikes in South Africa to feed government’s addiction

South Africa’s government has an addiction, which is being funded by the country’s taxpayers, says Maarten Ackerman, chief economist and advisory partner at financial services company, Citadel.

He noted that during South Africa’s 90 days of lockdown, the minister of Cooperative Governance and Traditional Affairs, Nkosazana Dlamini-Zuma, has banned the sale of cigarettes, in part hoping that some addicted to the habit will quit smoking.

“However, the government has an addiction of its own: overspending. And it needs to curb the habit – and fast – if we are ever to see a balanced budget,” the economist said.

Finance minister, Tito Mboweni presented a very bleak, but expected budget this week. He has also said all the right things, again, said Ackerman.

But can government, finally, cut its spending habit especially now that revenue is drying up fast?

The economy is expected to contract by 7.2% in 2020, and while this represents the worst performance in 90 years, it is roughly in line with the market’s expectation, Ackerman said.

Economic growth is likely to return next year, with 2.6% in 2021 and 1.5% in 2022, which are realistic forecasts but still too weak to address many structural issues, the economist opined.

“The budget deficit, at close to 16% of gross domestic product (GDP), is slightly more than the 14% that the market was projecting. However, this compares to the 7% contained in the February 2020 Budget, which provides an idea of the extent of the deterioration in revenue while expenses remain heightened.”

The debt-to-GDP ratio for this year will be close to 82%, ahead of market expectations of around 76% and the 60% in the February Budget.

The virus response has added some R145 billion to government spending. However, through reprioritisation, Treasury has managed to shift about R100 billion in spending from other departments.

We will borrow more

“Debt is our weakness. We have accumulated far too much debt,” said Mboweni on Wednesday.

“Our Herculean task is to close the mouth of the hippopotamus. It is eating our children’s inheritance. We need to stop it now,” he said.

Ackerman said that the government is likely to undershoot its revenue target this year by about R304 billion, which will need to be funded.

Borrowing requirements are increasing rapidly to cover the shortfall, which now stands at R780 billion, compared to about R340 billion in the February Budget. Importantly, Ackerman said that government has mentioned getting some funding from external providers, including $7 billion from the IMF.

But taxes will also need to rise

“Over the medium term, there will have to be an increase in tax revenue.

“Government is looking for some R40 billion over the next four years. In part, this will come from stimulating the economy, which will obviously lead to increased revenue.

“But there are also likely to be some tax changes that will take place, which will be on the cards for October’s Medium-Term Budget Policy Statement and the February 2021 Budget,” Ackerman said.

And expenses will be trimmed

According to Ackerman, what is important is that Treasury is targeting a primary budget surplus by 2023/24, which means that by then the country will only spend what it can afford, excluding interest payments.

The aim is for debt-to-GDP to peak at about 87% and then be reduced to about 73%, through fiscal discipline.

“This will clearly place a considerable amount of pressure on government spending, but at least putting that peg in the ground shows determination in trying to get the fiscal environment under control.”

Mboweni made the point that for every one rand spent, 21 cents is used servicing debt. That is certainly not sustainable, said Ackerman.

Local funding

Sourcing the funding requirement locally is problematic, said Arthur Kamp, chief economist at Sanlam Investments.

“The problem is the limited domestic savings pool. In 2019, gross domestic saving amounted to R739.9 billion. Together with the foreign saving of R153.2 billion, this funded domestic investment of R893 billion.

Even if the domestic savings rate increases, GDP in current prices is expected to decline by 3.5% in 2020. “Hence, a limited, if any, increase can be expected in gross domestic saving in absolute terms relative to last year,” said Kamp.

“Even after taking into account planned foreign funding (R125.2 billion) and the use of government’s cash balances (R43.2 billion), the Treasury aims to fund R146 billion through short-term loans and R462.5 billion through long-term domestic loans.

“That implies substantial pressure on domestic savings unless large additional foreign capital inflows materialise this year. This can only be achieved at the expense of a collapse in private sector investment.”

Cutting spending by around R250 billion per year is bold

The Budget Review announced that government plans to implement economic reforms that would lift economic growth, while cutting spending.

“Spending reductions and revenue adjustments amounting to around R250 billion are required over the next two years. It’s a bold, ambitious move by the Treasury and it has been endorsed by the Cabinet,” said Kamp.

“To the extent, the promised adjustments imply tax increases it is likely to defeat the object of the exercise. And, we must wait for the October 2020 Medium Term Budget Policy Statement for details.

“In the interim, this year’s funding problem remains onerous.”

Zero-base budgeting

The minister made the point that in zero-base budgeting and in trying to reach a surplus position, it will require enormous discipline and cutting all expenditure that we can’t afford, said Ackerman.

“He made the point that we’re not as rich as we were ten years ago, so hopefully the reality is sinking in for government in general that we simply cannot continue to spend the way we have done. Unfortunately, he provided no further details on this, referring to the medium-term policy statement for more.”

The economist said that the country has to rebuild investor confidence and that means confidence in our fiscal strategy.

Read: New tax increases necessary to deal with South Africa’s debt: Mboweni

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Expect tax hikes in South Africa to feed government’s addiction