Countdown to Budget Day – how Gordhan might play his tax mix.

Just how Finance Minister Pravin Gordhan plays the tax proposals in his February 22nd national budget will give the clearest idea yet of any further shifts in government policy. Jac Laubscher, economic advisor for Sanlam, hopes VAT will be the predominant tool-of-choice, given the need to bump up South Africa’s woeful growth rate by side-stepping hikes in corporate taxes. However, that’s probably unlikely. A triple whammy of bumping up all income and wealth-related taxes, VAT and corporate taxes – with a juggling of the mix being the art of any country’s economic management – is almost certain. Perhaps the most important question to consider is whether Gordhan will be there at all, given the increasing rumours of an imminent cabinet reshuffle and the ANC’s provincial moves to nominate a successor. Nobody truly knows what most influences President Zuma’s decision-making, though Nenegate certainly points in a highly negative direction. If he’s at all concerned about the nation’s economic fortunes he’ll keep Gordhan at the helm – or at the very least wait until the budget is delivered before any political jack-boot “shuffles” begin… – Chris Bateman

By Jac Laubscher*

All eyes will be on government’s tax proposals in the upcoming national budget, to be tabled in Parliament on February 22.

The minister of finance already indicated in his mini budget that the fiscal authorities will be looking for additional tax revenue of R28bn in the 2017/18 fiscal year, plus a further R15bn in 2018/19, which will require more than routine tax increases.

This is almost double the amount envisaged at the time of the tabling of the 2016 national budget, which indicated planned increases in tax revenue of R15bn in both 2017/18 and 2018/19, after an increase of R18bn in the current fiscal year.

Pravin Gordhan, South Africa’s finance minister, gestures as he speaks during a news conference ahead of his mid-term budget speech in Cape Town, South Africa, on Wednesday, Oct. 26, 2016. Photographer: Waldo Swiegers/Bloomberg

As unwelcome as these increases are at a time of general weakness in economic activity, they could have been substantially higher if National Treasury had not been as successful in maintaining the expenditure ceiling as has been the case.

Although increases in tax (in particular direct taxes) are generally regarded as anti-growth, one could argue that at this juncture they will contribute indirectly to higher economic growth by helping to maintain South Africa’s credit ratings and in that way prevent an increase in the cost of capital.

The choice of taxes through which to raise the required additional revenue will nevertheless have to be exercised carefully to minimise any anti-growth bias.

The tax increases to be announced will in a sense be ad hoc in nature to address the current pressing problem of stabilising the government debt/GDP ratio. However, they will have to be contemplated within the context of the longer-term, fundamental tax reform envisaged at the time of  the appointment of the Davis Tax Committee.

The pronouncements in this connection in the 2016 Budget Review should therefore be noted, viz. “Key considerations include the need to maintain the progressive nature of South Africa’s fiscal system and ensure that tax measures do not unduly prejudice economic growth or poor households.”

Furthermore, “In future, the balance between taxes on income (direct taxes) and consumption (indirect taxes) will be an important consideration in ensuring a diversified, equitable and sustainable tax system.

“The current mix suggests that there may be greater room to increase indirect taxes, such as VAT. Any proposals along these lines would need to be accompanied by measures to improve the pro-poor character of expenditure programmes so that the fiscal system remains progressive.”

The comment about a possible increase in the VAT rate contrasts with the recent statement by Judge Davis that an increase in VAT would be inappropriate at this point in time, but then of course the judge does not make policy.

It is therefore not surprising that the tax proposals in the 2016/17 budget relied mainly on increases in indirect taxes to raise additional revenue, but they could not avoid limiting the allowance for fiscal drag to less than what full compensation for inflation would have required (although shunning a further increase in marginal rates of personal income tax after the one percentage point increase in 2015).

So what does this tell us about the possible nature of tax increases in the 2017 national budget? Judging by the principles set out in the 2016 Budget Review as quoted above the emphasis should once again be on indirect taxes, viz. increasing rates for a variety of taxes (e.g. excise taxes and the fuel levy) by more than inflation, but also looking at broadening the indirect tax base by the introduction of new taxes such as the proposed sugar tax.

The problem is that the amount of additional revenue (R28bn) required at this point in time is probably too large to raise the lion’s share of it from indirect taxes without increasing the VAT rate.

The comments from the National Treasury quoted above indicate that they have accepted the eventual inevitability of a higher VAT rate, but one must acknowledge that there will always be political push-back against this because of the alleged regressive nature of an increase in the VAT rate (ignoring the World Bank’s finding that the way South Africa’s VAT regime is structured results in it actually being progressive).

Oddly enough, the regressiveness of increases in other indirect taxes does not get a mention.

A key question is how the expenditure side can be made even more pro-poor as envisaged in order to make an increase in the VAT rate politically more palatable.

For this reason any compensating adjustment will have to be visible and its effect demonstrable. One possibility would be an ad hoc increase in social grants coinciding with an increased VAT rate becoming effective, but then one should guard against diluting the revenue gain from an increased VAT rate too much.

For example, a one percentage point increase in the VAT rate will result in approximately R22bn in additional tax revenue in the first year.

If all social grants were simultaneously increased by 1% (which would amount to overcompensating for the higher VAT rate) it would cause a revenue loss of approximately R1.5bn, resulting in a net increase in tax revenue of approximately R20.5bn.

This would be enough to almost close the tax gap, while the remainder could be raised from routine adjustments to other indirect taxes and tweaking the allowance for the effect of fiscal drag.

Without an increase in the VAT rate, increases in income and wealth-related taxes (capital gains tax is to my mind closer in character to a wealth tax than an income tax), including adjustments to marginal rates of personal income tax, will be unavoidable.

(An increase in corporate taxes, although politically popular, would be extremely unwise given the imperative of raising South Africa’s growth rate.)

If this route is chosen, income taxes should only be raised in so far as they fit into government’s longer-term strategic view of the future tax system. By now government should already have a sense of how it will respond to the work of the Davis Tax Committee, and any tax changes at this stage should not be contradictory to the anticipated response.

Tax reform should be aimed at broadening the tax base in order to enhance the possibilities for lower tax rates, rather than politically expedient tax increases aimed at plucking the goose to get the maximum amount of feathers with the least amount of hissing (with due acknowledgement to Jean-Baptiste Colbert).

In view of South Africa’s highly unequal distribution of income and wealth a markedly progressive tax system is not only inevitable but also justifiable as a matter of principle. However, one should bear in mind that directing government expenditure towards pro-poor items is an even more powerful tool for redistribution.

As a rule many South Africans are inclined to uncritically revert to “the rich must pay” (to put it in populist terms) whenever the issue of financing public expenditure is raised.

The cumulative extent of all redistributionary measures are rarely considered and although the disincentive effect of any single measure may not be that great, together it may well add up to having a significant influence, e.g. on the international mobility of high-skilled labour.

Given the amount of extra tax revenue required, an increase of at least 2 percentage points in marginal tax rates would be a reasonable expectation if the bulk of the required additional revenue was to come from increased personal income tax.

The final answer will depend on how much allowance is made for fiscal drag, if any, and whether the lowest marginal rate (18%) will again escape from being increased as in 2015. – News24

Source: http://www.fin24.com/Opinion/sas-tax-dilemma-hiking-vat-vs-wealth-taxes-20170127

* Jac Laubscher is economic adviser for Sanlam Limited. Opinions expressed are his own.

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