Huge tax flop for South Africa

Analysis by the United Nations University’s World Institute for Development Economics Research (UNU-WIDER) has found that the South African government’s attempt to boost tax revenues by increasing the marginal tax rate likely had the opposite effect.
In 2017, the National Treasury increased the maximum tax rate from 41% to 45%, applicable to anyone earning more than R1.5 million a year.
At the time, the rate hike was expected to impact around 100,000 taxpayers.
According to UNU-WIDER, rather than the R5.5 billion of extra revenue that should have accrued from the increase, South Africa actually recorded a R6.5 billion drop in total personal income tax revenue collected.
UNU-WIDER has partnered with the South African Revenue Service (SARS) to build a personal income tax (PIT) simulation model (PITMOD) that has proven to be 99% accurate in processing local tax data.
Using its data to simulate the mechanical and the actual impact of the 2017 reform on PIT revenue
collection, the group compared the PIT revenue collection from treated taxpayers in the pre-reform
year (2017) to simulated tax revenue collections under the revised PIT schedule—accounting for the increased top marginal tax rate.
“In the absence of behavioural responses, tax revenue collection from high-income earners would have increased by R5.46 billion,” the group said.
However, “taking the strong estimated taxpayer response into account suggests that personal income tax revenue collection dropped by R6.48 billion in response to the policy reform, putting the new top tax rate on the wrong side of the Laffer curve.”
The Laffer curve represents the “tipping point” at which increased taxes and intensified taxation tactics lead to lower tax revenues, typically through increased tax evasion or tax revolt strategies from taxpayers.
The group noted that South Africa’s top marginal tax rate was already high compared to other countries at the same development stage before the 2017 tax reform, but was even more so after. It added that the reform also caught the public by surprise, which would have delayed any response.
Further analysis from UNU-WIDER showed that there is a high chance of “drop off” from PIT the higher the taxable income, and the more the government wants of it.
It identified three main ways these taxpayers “exit” PIT:
- First, taxpayers may leave the country to live in other (lower-tax) jurisdictions. While being a drastic response, South Africa has a non-negligible underlying emigration rate from the country, which might make emigration responses more likely.
- Second, individuals may, in response, stop working and earning income or, evasion-driven, stop reporting income to the authorities.
- Third, individuals may incorporate businesses and shield income from higher PIT by declaring it as corporate income.
Business Leadership South Africa (BLSA) chief executive Busi Mavuso said the more concerning finding of the paper was that companies that employ top-bracket earners reduced sales after the increase.
“The authors say this is consistent with reduced efforts by top earners after the tax hike. This is obviously negative for GDP overall.”
UNU-WIDER said that a decline in employer-reported incentive and bonus pay and non-monetary compensation is consistent with a real taxpayer response.
However, it added that related adjustments might also reflect “collusive tax evasion” by employers and their employees in response to the reform—for example, by understating the fraction of the private use of company cars, laptops, and cell phones, or private elements of business travel, etc.
Over the Laffer curve
Mavuso said that businesses have made the point often enough that the government cannot raise revenue simply by increasing taxes—but the state could still inflict significant economic damage.
“This point has been important in debates about how feasible it is to fund major new social programmes through higher taxes,” she said.
The proposed National Health Insurance (NHI) scheme is one example—the funding of which remains an unresolved issue.
Conservative estimates put the cost of the scheme at over R200 billion if it provides relatively minimal benefits and much higher for more comprehensive cover. Some estimations have put the required funding as high as R1 trillion.
The government has made it clear that more and higher taxes are the only way this can be achieved.
While the NHI Act specifies that rearranging budgets is the first step to financing the scheme, surcharges, payroll taxes and income tax adjustments are explicitly mentioned as other funding sources.
Mavuso said that, even at R200 billion, this would imply a 10% increase in tax revenue is needed. This is before counting in other planned social projects like the ‘coming’ basic income grant, which could cost R300 billion, depending on the amounts available.
“A 10% increase in tax rates will not raise 10% more revenue,” Mavuso said,
“In fact, the UNU-WIDER paper shows it may have a net negative impact, actually reducing the total tax that can be raised.”