The charts that show South Africa’s shrinking tax base

A research note from Momentum Investments, ahead of the 2020 Medium Term Budget Policy Statement, highlights South Africa’s tax collection woes in a shrinking tax base.

Tax revenue collection has been below forecasts for some time, compounded by the fact that the country is in a deep recession. Debt levels continue to climb, as does the unemployment rate, while state enterprises remain a tied to constant bailouts.

Currently, approximately three million South Africans account for 97% of the country’s personal income tax collected in 2019.

President Cyril Ramaphosa will on Thursday, 15 October, 2020, present a ‘widely consulted’ South African Economic Reconstruction and Recovery Plan to a Joint Hybrid Sitting of Parliament.

The 100-page document, seen by Bloomberg, warns that South Africa will not be be able to meet its finance ministry’s debt targets and it may be undesirable for it to attempt to do so when the economy is being battered by the fallout from the coronavirus.

The president’s Economic Advisory Council, who prepared the document, said spending cuts could hold back growth and have other adverse consequences.

Instead, the council proposes a number of tax hikes and changes be considered, including:

  • Increases to the fuel levy and estate taxes;
  • A three-year ‘solidarity tax’ that would increase taxes for higher earners;
  • The introduction of a basic-income grant that could cost R243 billion a year and would necessitate tax increases;
  • Pension funds and other private investors backing infrastructure projects if there is a clear pipeline for the next 10 to 20 years.

Finance minister Tito Mboweni has said he plans to arrest the increase in debt levels at 87% of gross domestic product in the 2023-24 financial year, falling to 74% in 2028-29, Bloomberg reported. Without an intervention, the ratio could climb to 141% over the next decade, he said.

The bottom line is that South Africa is running out of money, and time to address its financial woes.

South African Revenue Service (SARS) commissioner Edward Kieswetter in a parliamentary presentation last week, highlighted poor economic conditions, low business confidence and a lack of reliable electricity supply as some of the key contributors for the decline in tax revenue witnessed over the past few years.

Kieswetter said that SARS has also seen an increase in retrenchment, lower-wage settlements, reduced bonus payments and a slower growth in consumer spending over the year.

Economists at Momentum Investments pointed out that a standstill in economic activity, triggered by the lockdown restrictions, had a detrimental effect on government revenue, which has disappointed on a fiscal year to date (YTD) basis relative to the average for the past five years.

“Meanwhile, expenditure trends were only slightly weaker as government embarked on a counter cyclical fiscal approach to prop up economic growth through government spending,” it said.

At a year-to-date growth rate of negative 20.6%, total tax revenue is lagging the past five-year average of 1.2%, but is only marginally lower than the negative 18.3% projected by Treasury in the June 2020 Supplementary Budget, it said.

Meanwhile, total government expenditure is growing at a year-to-date average of 4.2% in comparison to the past five-year average of 7.4% and government’s June 2020 estimate of 7%.

South Africa had the sixth largest fiscal stimulus response to the pandemic from its emerging market (EM) peer group and second largest monetary stimulus (in the way of policy rate cuts), but the country still suffered the third worst contraction in growth in the second quarter of the year in comparison to the peer group, Momentum Investments said.

This suggests reduced effectiveness of the country’s stimulus response.

In its Monetary Policy Review for October 2020, the SA Reserve Bank highlighted low and falling fiscal multipliers – change in GDP from a change in government expenditure.

“If government spending is paid for with higher taxes, multipliers will tend to be low. Funding through debt can support a higher multiplier where debt is perceived as sustainable,” the economists’ note said.

“Where sustainability is in doubt, more debt will tend to reduce capital inflows, raise interest rates for the entire economy, and undermine confidence in the economic outlook, thereby lowering the multiplier,” the economists said.

The underperformance in revenue has been largely broad-based, however momentum appears to be recovering in corporate income tax (CIT) and value-added taxes (Vat), Momentum Investments said.

Citing the Revenue Service, it noted that the hardest hit sectors contributing to CIT included finance and manufacturing, which were negatively affected by load shedding, depressed confidence and heightened uncertainty.

On the other hand, personal income tax (PIT) collections continue to struggle against the backdrop of accelerated job losses and deep pay cuts.

Personal Income Tax (PIT) is a direct tax levied on personal income including wages and salaries, director’s fees, dividends, royalties and rental income, among others.

PIT reached 10% of GDP in fiscal year (FY) 2018/19, reaching levels last seen in FY1998/99. This is in spite of country-wide wage trends having dipped, Momentum Investments said.

And, despite an increase in the number of registered taxpayers to 21.1 million in FY2017/18, the number of assessed taxpayers has dropped to 4.9 million, highlighting a narrowing in the tax base.

Of particular concern is that SARS tax directives for retrenchments in 2019/20 reflected a total of 287,000 versus 239,000 for the prior year.

This signals an erosion of the tax base, especially for PAYE, as the 287,000 represents a number of PAYE contributors that will are likely not to contribute to the FY2020/21 tax base unless reabsorbed into employment, SARS said.

Momentum Investments said that the Treasury will likely provide an update on its expectations for the tax buoyancy ratio which is currently tracking above one (i.e. indicating slightly more tax revenue per unit of GDP), unlike the average observed since the global financial crisis.

Tax buoyancy is a measure of the sensitivity of tax revenues to changes in economic growth, and has been declining in recent years, and has been exacerbated by the fallout of the Covid-19 pandemic.

In July 2020, Treasury noted it was considering the recommendations of the Davis Tax Committee (DTC) for a wealth tax, particularly with its links to estate duties and land taxes. “We do not see this as a significant source of revenue, but it may be used, in our opinion, to pave the way for more broad-based taxes to fund rising social needs,” Momentum Investments said.

Read: Tax hikes proposed for South Africa

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The charts that show South Africa’s shrinking tax base