Budget 2015: Why Treasury still has breathing space – for now

Futuregrowth’s Zain Wilson shares his expectations for Wednesday’s National Budget Speech – and why he believes Finance Minister Nhlanhla Nene has the tools to close a R12.5bn revenue shortfall. But he warns that unless economic growth improves, the breathing space will close. Wilson tells Biznews’s Alec Hogg that South Africans can expect to pay higher taxes on petrol; more on capital gains and dividends, and a couple percentage points more at the top end on income tax. – AH

This undictated podcast is brought to you by Futuregrowth.

Zain Wilson from Futuregrowth joins us a couple of days before the Budget.  It’s coming up on Wednesday, Zain.  No doubt, you’ve done a little bit of your own research into what Nhlanhla Nene might be telling us.

Definitely.  It’s obviously important for us, given the last couple of years since the crisis.  South Africa’s fiscal metrics has deteriorated quite a bit.  We are relatively positive looking into this Budget.  We think the statement that Nene made last October to cut down on fiscal expenditure as well as slightly better revenues and personal income tax and VAT, should hold up relatively well for this Budget.  We’re rather positive.

Let’s start with revenues.  There are talks or little whispers coming out of SARS that they haven’t been as successful because of the change in management and the ructions that are going on there.  Are you concerned that this is going to affect the budgeting process this year?

If you look at SARS, compared to what we have already, they’ve always had a reputation as being one of the stronger institutions in the country.  Obviously, it’s a concern that there are some rumours on ill management as well as what’s going on regarding political influence in SARS.  For the immediate term, we don’t think that’s going to be a risk.  We think the numbers are quite strong and we think the management as a whole, even excluding individuals who’ve been singled out, should continue to hold up the strong work that SARS has done previously.

Okay, so it’s relatively good news on the revenue side.  We’ll get into more detail shortly.  On spending, as you mentioned in October, the Finance Minister did say that he was going to try to rein in spending to some degree.  Are you expecting more positive sentiments on that side?

Yes.  To date, we’ve seen that spending is slightly behind Budget, which is good because revenue hasn’t been as good on the corporate side as they had budgeted and adjusted for in October.  You can actually see the work that’s been done and expenditure has been good.  The trick is obviously going to be for the next year and for 2015/2015 for the current year as well.  GDP has come much lower and so has inflation.  It means that they might require additional expenditure cuts, going into 2015/2106.  If that is the case, I think that Treasury realised that we’ve almost reached a point of no return on the fiscal metrics.  I think that they do need additionally, cut back on expenditure or adjust revenues.  We expect that they will that.

So taxes look like they might be hiked.

Yes.  There are a couple of different options.  What’s happened with fuel prices over the past year means that there’s a little bit of fat from treasury to use their fuel levy to possibly buffer against slower and other areas as well as expenditure.  Instead of reining in expenditure, they can a fuel levy.  The other option they is to hike the marginal personal income tax, which is near 40 percent.  We looked at some calculations.  If they hike that by one percent, they get more or less R2.5bn in additional revenues and then a whole lot of other combinations they can use.  We obviously think they won’t be too aggressive in using one metric or one measure – just hiking individual income tax by five percent to get R12.5bn, which they’re targeting but rather, use a combination of incremental hikes on income tax with the highest marginal rates.  Use a fuel levy because it’s creating opportunity and possibly other options such as the capital gains tax or dividend tax as well

Just on those two – capital gains and dividends – given that we’re looking at a target number of R12.5bn, how much do you think is going to be required from those sources?

Those two are obviously, much smaller.  Something like 75 percent of the revenue intake comes from corporate income tax, personal income tax, and VAT.  The additional gains you get from capital gains tax and dividends tax would be quite small.  You’d get about R1bn from the two percent on the capital gains tax side and just over R1.5bn for one percent increase in dividend tax.  We don’t think a majority of the revenue adjustments will come from there but it will allow treasury to use other factors and not hikes through individual income taxes alone or the fuel levy alone.  It’s going to be a combination of different hikes, we think.

If we take capital gains and dividends, that’s R2.5bn.  Every one percentage point increase in the marginal income tax rate is another R2.5bn.  Are you expecting two percentage points there on marginal income tax?

Possibly two, so two would give you R5bn and then the capital gains and dividends tax gives you another R2.5bn combined, but then there’s a huge chunk, which you can get from the fuel levy.  With the fuel levy by itself, you get R2bn from a ten percent increase.  We’ve had the price come down by just over R4.00, so you have the option of treasury possibly getting 35 cents to 50 cents increases in the fuel levy.  If you get 50 cents, you get R10bn by itself.  They can take quite a large chunk of that out of the fuel levy.

That’s interesting.  Are those the three that you’re expecting to see the combination from perhaps two percent on the marginal income tax with your 5 capital gains and dividends (7.5).  Fuel levy: even 20 cents would then be sufficient to close the gap that we spoke about in the beginning.

Yes.  The other one that many other analysts have talked about and looked at is that.  That is politically a bit more difficult.  What makes it easier to hike the marginal rate on individual income tax, and capital gains tax, is that it fits in with the redistribution mandate that Treasury has and that the ANC is pushing.  Politically, it makes much more sense.  We think that could be used maybe in a year or two years’ time to help fund something like AHI.  Between individual capital gains tax and the fuel levy, we think the majority of the R12bn will come from the three discussed.

Zain, if the R12.5bn is raised in the way you’ve anticipate it, do you think there’s going to be negative kickback from business in particular and maybe nigh nett worth individuals?

It’s always a risk.  Not so much business, because it’s not directly going into company income tax and our corporate taxes are relatively low compared to the rest of the world, and relatively low compared to Africa and emerging markets.  Obviously, the more you squeeze out that individual income tax, the more likely you are to start seeing those individuals leaving the country.  At the same time, we obviously have a skills problem.   There’s a cap on what Treasury can do.  You don’t want to get into a position where you’re progressively hiking taxes and squeezing out high skilled labour.  At the same time, it’s obviously going to have a knock-on effect on growth.  The risk for us, going into the next four years, is that GDP growth doesn’t look amazing – averaging somewhere between one-and-a-half to two-and-a-half percent, depending on what Eskom does.  If we don’t manage to pick that up, which is going to be the ultimate driver of fiscal consolidation, then we are stuck in a position where GDP growth is slack, taxes are hiked and that pulls back further on GDP growth.  That is a four-year problem and not a 2015/2016 problem.

Exactly, and I suppose that’s the point.   Currently there is still capacity.  There’s still breathing space.  If the economy doesn’t start playing ball; in a few years’ time, there’s not going to be breathing space left.

Exactly.  I think that Treasury has realised this.  Another important thing to come out of the budget would be how much we starting to see the NDP being implemented.  There’s been a lot of talk over the past two years but we’re now at the point where you’re not going to have Government supporting growth as much.  You’re not going to have Government supporting employment.  With the absence of private sector starting to pop up support for growth and employment we could, very easily, become stuck in a low growth trap.

Every year, in the Budget, there’s some surprise.  Something comes out of left that nobody’s really predicted.  If you put on your lateral thinking hat, where might it be this time?

I think the surprise we would hope to hear is what exactly the plan for nuclear implementation is and what the funding plan is going to be – one of two big worries, which we have on the medium term. How do we fund nuclear and (2) how do we fund NHI?  That’s what we’ve pegged at the back of our minds, that those increase will be kept, for in 2/3/4/5 years’ time to fund those two.  The other thing that would be interesting to see is if Treasury announces a set of fiscal rules, because that’s been a transition that we’ve seen grow over the years, especially in the developed world.  You’re starting to see those economies that have had a worsening of the fiscal metrics, moving towards announcing fiscal rules to help alleviate some of the stress.  I hope we’ll see something like that coming from Treasury.

What do you mean by fiscal rules?

What I mean is it would be a more stringent cap on where our GDP ratio can go as well as how we can fund.  Ergo, more stringent caps on how we fund from IOB or a nominal side as well as maybe targeting a fiscal surplus or a primary surplus on the fiscal side.  Some combination of those three, which gives rating agencies in particular a bit more confidence about Treasury and Government’s ability to rein and any deterioration we might see (or a bit more confidence on a medium-term type of trajectory).

Good stuff.  Zain Wilson is with Futuregrowth and this undictated special podcast was brought to you by Futuregrowth.

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