Medium Term Budget Policy Statement 2009: Sanlam & IDASA comment

Meeting report

Examination of Medium Term Budget Policy Statement (MTBPS): Public comment
SANLAM - The 2009 MTBPS: Managing a Fiscal Calamity
Mr Jac Laubscher, Group Economist, SANLAM, pointed out the title of the presentation and stated that this was based on the fact that public finances had deteriorated substantially in 2009. The presentation illustrated the extent of this. Noting South Africa's previous growth path, he stated that the fiscal space had closed at a very inopportune time.

Using 1992/93 as a comparable recession year, he highlighted the similarities in the indicators, particularly the budget deficit and government debt. Fiscal deterioration in 2009 was extremely sharp and resulted in a decline of 6,2% in tax revenue. In spite the recession being relatively moderate, tax revenue has become more cyclical.

He continued the comparison with the 1992/93 financial year, regarding government finances, under the headings of Gross Domestic Product (GDP), tax revenue, government expenditure/GDP, budget deficit. He highlighted the comparative changes in corporate and personal income taxes. While the more stable personal income tax component had decreased in recent years, the more cyclical corporate tax component had increased, leading to the more cyclical tax profile.

The above average increase in the public sector wage bill was noted. This was difficult to reverse when the economy recovered, and therefore had long-term consequences. The increased cost of debt would also constrain discretionary spending in future.

Regarding the medium term outlook for revenue, he noted the uncertain global prospects as well as the likelihood that the debt/GDP would continue to increase beyond the MTBPS. Additionally, he was of the opinion that South Africa's already high tax burden would not be able to accommodate further increases and it would be prudent to avoid increased taxation.

In relation to fiscal sustainability he noted the primary deficit. This implied that government would be borrowing to pay off interest and would not be paying off the principal debt. The medium term outlook on expenditure was that improvement would be excruciatingly slow and that expenditure/GDP would remain high. He opined that expenditure/GDP needed to be reduced more aggressively, that expenditure priorities needed to be redefined, particularly the social protection pursuit of a welfare state. Greater efficiency and effectiveness in public expenditure were non-negotiable when compensation of employees equalled 57% of current payments. The macro-economic policy commentary focused in inflation targeting, the value of the Rand and the growth strategy, particularly the labour-absorbing strategy and the necessity of macroeconomic stability.

Discussion
Dr D George (DA) noted that the presentation referred to a sharp fiscal deterioration and related this to the more cyclical nature of tax revenue. His understanding was that tax revenue was always cyclical in nature, as it was tied to the business cycle, and asked what made this instance more cyclical.

Dr George pointed out that the medium term outlook for expenditure mentioned the welfare state. He asked if this meant that the State should cut spending on social security.

Dr George asked what a more manageable number would be for the public sector wage bill.

Dr George commented that the developmental State was much more than a difficult model. He opined that the model required a very efficient and capable State and this was something that South Africa did not have.

Mr L Ramatlakane (COPE) noted the opinion that the tax burden was high in South Africa and that further increases were not desirable. In light of this, he wondered how government would respond to the economic challenges, other than through raising taxes.

Mr Ramatlakane referred to the comment that the reappearance of government dis-saving was a worrying trend. He asked Mr Laubscher to explain this and to say what the alternatives were.

Mr Ramatlakane referred to the comment that the government wage bill was too big, at 57% of current payments. He asked what the alternatives to this were. He also wondered whether a social partners' deal was suggested to manage the wage bill issue.

M Z Luyenge (ANC) asked whether an automatic inflation management mechanism was possible to ensure that service delivery was not affected by rising costs

Mr B Mashile (ANC; Mpumalanga) asked what the most acceptable tax level would be.

Mr Mashile asked what the alternative for development of the State was, other than taxation. Specifically he asked how far corporate tax could be stretched before investment was no longer attracted.

Mr Mashile asked for an explanation of the following technical points of the presentation: the reduction of spending and taxes, the Rand being overvalued, the developmental state being described as a difficult model. In relation to the comment that the expenditure to GDP ratio should be reduced aggressively, he specifically asked if this referred to increasing exports without affecting supply to domestic consumption.

Ms Z Dlamini-Dubazana (ANC) wondered what factors informed the opinion that the developmental State was a difficult model. She also asked Mr Laubscher to suggest better models.

Mr E Sogoni, Co-Chairperson, noted the relative changes in personal income tax and corporate tax in the comparison of the 2009/10 and 1992/93 financial years. This highlighted the increase share of corporate tax in overall taxation and the decrease in the contribution of personal income tax to overall tax in 2009/10. He asked how a balance could be achieved between the two types of taxation.

Mr Sogoni referred to the comment that macroeconomic stability was foundational, and asked if this meant that there was hope for South Africa to sustain its macroeconomic stability.

Mr Laubscher replied in general to all these questions. He noted that in the financial year 1992/93, government revenue increased by about 6%, whereas a decline of about 6% was recorded for 2009/10 in nominal terms. In 1992/93, personal income tax more than compensated for lower corporate tax and VAT revenue. Over the last few years, South Africa had received a substantial amount of personal income tax relief and corporate tax had been increased. As personal income tax was more stable than the more cyclical corporate tax, this had led to the overall taxation being more cyclical. He did not suggest that this was bad, but stressed that South Africa would  have to bear this in mind and plan for it.

In regard to the welfare state, Mr Laubscher was not proposing a cut in social security spending. If this was to be a priority for South Africa, it had to be balanced against the other priorities. He had the impression that the R7 billion increase in the child support grant was not yet reflected in the expenditure numbers. If this was a priority spending area, government also had to look at how R7 billion could be saved elsewhere.

Regarding a more manageable level for the wage bill, he suggested that he would like to see this below 50% of current payments. The closer that government could get to 40%, the better. This could not be done overnight. Approaching 40% was a very long-term objective. The fact remained that it was still high.

With regard to the developmental State, the established model originated in Asia, specifically Japan, South Korea and Taiwan, and had a very specific character in its original form. Perhaps South Africa should strive to define the developmental state. The Asian model had accepted the reality of competition and it aimed to make economies more competitive. This was done by targeting a smart State, rather than a bigger State. The Asian developmental State model also paid little attention to social needs. If South Africa wanted to include social needs in its developmental State model, government had to acknowledge the constraints that this would cause.

Regarding the tax burden, Mr Laubscher referred to a body of growth studies that indicated that higher taxation and a larger government was not good for a country's growth prospects. In terms of long-term growth, smaller governments were better for growth.

Mr Laubscher explained that dis-saving was essentially borrowing for current expenditure. The problem arose when capital expenditure was growing at a faster rate than current expenditure. Although the dis-saving was projected, the financing of current expenditure through borrowing complicated the current account situation.

In regard to the increasing wage bill, he replied that the current projections had the wage bill growing at about 6,6% per year over the medium term. If one saw this against an annual average inflation rate of about 6%, there was almost no real increase. Government then had two options: either it must have increases at less than the inflation rate to allow for more appointments, or fewer appointments had to be made.

Mr Luyenge noted that a climate change-related tax was being discussed, to be imposed on polluters, and asked what other options there were for taxation.

Mr Laubscher responded that the global warming taxes mentioned in the MTBPS were not intended as a tax to raise revenue, but were aimed at influencing decision-making on energy usage, especially by businesses.

Mr M Swart (DA) noted the number of vacancies and said that a number of these posts were funded but not filled. This resulted in roll-overs when the funded posts were not filled. He asked whether it would help to freeze the positions temporarily, to evaluate which of the posts were really necessary before filling them.

Mr Laubscher responded that freezing vacancies was not currently desirable. If this was done, government had to be circumspect about the possible negative impact on service delivery.

Mr Sogoni wondered what the positive effects of the higher public sector wage bill were. He suggested that this would positively contribute to higher tax revenue.

Mr Laubscher replied that the positives mentioned did apply. The real issue was that once the increase was given, it could not subsequently be withdrawn. The increased wage bill would then be built into government spending over the long-term. Spending of a more once-off nature was more beneficial, for example, something like a once-off bonus to pensioners.

Mr M Makhubela (COPE; Limpopo) referred to the complexity of the problem facing South Africa and the comment that there was a bumpy road ahead. He wondered whether South Africa could sustain the shocks.

Mr Laubscher replied that South Africa had shock absorbers. This was in the form of the surpluses generated under the countercyclical fiscal policy, but South Africa could not afford another shock. South Africa had to repair the cushion or surplus, in anticipation of future shocks.

The Institute for Democracy in Africa (IDASA)
Mr Len Verwey, Economist,  IDASA,  began his analysis by looking back at the key aspects of the 2009/10 Budget  presented in February 2009.  He noted the nominal non-interest spending increase of 16.8%, projected real GDP growth forecast of 1.4% and the projected budget deficit of 3.8%.

He then highlighted the divergence between these projections and the MTBPS figures. Growth had become negative from the Budget projection of 1.4% to -1.6%, tax revenue had declined from R740.4 billion to R657.5 billion, expenditure had increased from R834.3 billion to R841.4 billion and the deficit had increased from 3.8% to 7.6%.

The key aspects of the MTBPS 2009 were that recovery was expected to be slow, and that the public sector investment would drive this recovery. Notably, tax revenue was projected to recover more slowly than growth and as a result the deficit would also stay large.

The commentary on the risks to public finances over the medium-term highlighted the likelihood of a higher-than-anticipated debt stock as a share of GDP. A graph was used to illustrate this point and this showed the debt stock as a share of GDP approaching 50%. Additionally the debt servicing costs were projected at 3.2% of GDP by 2013. This figure was between R99 billion and R100 billion, or 9.5% of 2012/2013 consolidated expenditure and an average annual increase of 18.1%. Mr Verwey queried the realism of growth forecasts and revenue forecasts if further problems should occur, and was wary of the possible entrenchment of a higher deficit culture.

Discussion
Mr N Koornhof (COPE) referred to several allusions that that South Africa was closely linked to the world's fortunes. He asked for the presenters' opinion on whether this was true and whether South Africa would recover at a comparable rate to the world's recovery.

Mr Koornhof pointed out that construction driven by the 2010 Soccer World Cup would come to an end by the latter part of 2010. He asked if this would have a negative impact on the economy.

Mr Verwey replied that clearly South Africa was closely linked to the world economy, in that the crisis affected South Africa quite strongly and negatively. In regard to the question whether South Africa would recover as quickly, he pointed out that household debt was one of the main constraints to South Africa's relative rate of recovery. Two positives on the horizon for 2010 were World Cup spending and tourism, and the lag effect of easing in monetary policy working its way into the economy. These two positive effects may last into 2011. These effects were difficult to quantify, so broadly South Africa's recovery would be slower. The MTBPS also appeared to incorporate that thinking.

Mr Ramatlakane asked for a further explanation of the projection that government borrowing would be in the region of 50% by 2012. He asked what would be characterised as a good level of borrowing (borrowing to GDP ratio) and whether borrowing for infrastructure spending was a good thing. He also asked what a good split was between borrowing and investment.

Mr Verwey replied that the MTBPS projection was 41,1% by the end of 2013, and there was reason to think it could go beyond 50%. At this stage it was not possible to know. These were assumptions. There was the danger of a gradual incremental increase toward the 50% mark. This was not an alarmist statement, but rather it pointed out that the gradual effect debt overhang had to eclipse other spending, and also pointed to the subtle effects of how investors regarded the level of debt and made their investment decisions based on that. The world was not necessarily fair to developing countries who were perceived as having debt and the range of social challenges similar to those that South Africa faced. South Africa probably could not sustain a debt level comparable to developed countries. In the end, a good level of borrowing would be one that was manageable and that did not eclipse other spending or put the balance of payments under pressure. He said that the question on infrastructure was difficult to answer, since much of the social infrastructure was done through the main budget and the economic infrastructure was done through the State Owned Enterprises (SOEs). This was akin to comparing apples with oranges.

Dr George referred to page 12, paragraph 2, of the PIMS Budget Paper 5, regarding the changes to the Budget process arising from the recent enactment of the Money Bills Amendment Procedure and Related Matters Act, which had stated:
   "Finally, until recently the constitutionally-required legislation setting out the procedure for Parliament to amend the budget had not been enacted. In one sense, therefore, submissions made to Parliamentary Committees lacked real force, as recommendations made by civil society could not be adopted by the committees in their engagement with the budget. The 2009 Money Bills Amendment Procedure and Related Matters Act provides Parliament with strong powers to amend the budget, and should therefore also have a positive impact on participation. From a broad fiscal governance perspective, the aim is not to have a proliferation of amendments simply because an Act now exists which allows them, nor should the risks of amendment from an under-capacitated Parliament be underestimated. But the fact that legislation grants Parliament amendment authority as a final recourse should result in more weight being accorded to its deliberations on the budget, and its oversight hearings. This is a positive development, particularly given the increased emphasis on value for money by government."

He asked Mr Verwey to expand on this commentary.

Mr Verwey replied that this alluded to some of the points contained in the book, Parliament, the Budget and Poverty in South Africa: A Shift in Power. The fundamental point was that South Africa had a shortage of analytical capacity to begin with, particularly research support for parliamentary committees. Parliament had been given strong powers to amend the budget and this was constitutionally required and politically correct, and he fully agreed with this move. However, the quality of research support that Parliament had at its disposal would determine the quality of the engagement. This was a risk to the engagement. If Parliament was to amend the budget, it would have to be focused on adding value. There was a tendency in this regard for legislatures to have looser fiscal policy. An under-capacitated legislature might not get the appropriate advice. Amendment overload was a risk, as was the risk of highjack. The latter risk concerned the people who most often presented to the Finance and Appropriations Committees, and whose views were heard more often and this could also affect the quality if Parliament's engagement.

Dr George stated that while he agreed with the comments on the benefits of smaller government, it would require political will and the space to cut out the bureaucracy. He wondered whether it was possible for government to do this.

Mr Mashile asked how far investors could be stretched, in terms of increasing corporate tax, before disinvestment began.

Mr Verwey replied that it was not really possible to determine the tax rate that would lead to disinvestment, because companies considering investing South Africa did not only look at this tax rate. They looked at growth prospects and also at crime levels and labour legislation, when deciding where to invest. A country could have a high tax rate yet would still be attractive if efficient government spending led to economic growth.

Mr Laubscher added that the nominal corporate tax rates were now in line with global standards. Although he agreed that investors took other factors into consideration, it was worth nothing that the corporate tax rate, as a percentage of GDP, was high. This indicated that the effective tax rate was on the higher side compared to other countries. He could forward the exact figures to the Committee.

Mr Mashile asked whether the view that the Rand was overvalued was from the export or import perspective.

Mr Laubscher replied that he did not look that at exclusively from either the imports or exports side. There were various models for judging the value of a currency. The standard way used Purchasing Power Parity (PPP). It was expected that a country's currency would depreciate or appreciate according to the inflation differential with its trading partners, over the long-term. South Africa's inflation rate was higher than that of its trading partners, so it was to be  expected that the South African currency would depreciate over time, in line with that differential. There were periods where there were deviations, as in the current Rand value. Looking only at the current inflation differential, he noted that it would normally be expected that the rand would be much weaker than it had been. This was the reason for his statement that the Rand was overvalued.

Mr Mashile noted that his understanding had been that taxes were the primary way for the State to collect revenue. In light of this, he asked what Mr Laubscher meant when he stated that taxes were used to change behaviour, as there seemed to be a contradiction.

Mr Laubscher replied that he made this comment specifically in the context of the environmental taxes. It was clearly established that government needed to perform certain functions and, in order to do this, needed revenue, regardless of whether it was also specifically seeking to affect behaviour. Generally, the way that taxes were structured created incentives, and these incentives could influence behaviour. The environmental taxes were aimed specifically at reducing the carbon footprint and they were not introduced with the primary goal of raising revenue.

Mr Mashile referred to the recent service delivery protests and said  these showed that much still needed to be done to meet the country's social demands. Meeting the social needs would require high levels of spending. The recessionary conditions would not change the demand for services.

Mr Verwey responded that it was difficult to say whether problems with government performance were problems of money or problems of management. The assumption that more money was needed was a point that needed more robust discussion. There was evidence that there were problems with using the money that was available, in addition to problems arising from shortage of finances. The way forward would involve better management, which would require better oversight.

Mr Mashile responded that in several areas, the Minister's thinking appeared to be different from that of the economists. He asked whether the Minister's statements or academic sources informed the economists' responses to the MTBPS.

Ms Dlamini-Dubazana stated that all economic models were complex and the developmental State policy had worked well for the ANC up to this point. Sanlam was one of the biggest companies in South Africa. She asked if an effective partnership with Sanlam was possible, so as to promote the societal aspirations. Parliament was of the opinion that the developmental State was the best model. She expected Sanlam to highlight the advantages, disadvantages and the way forward based on the developmental State and the MTBPS.

Mr Laubscher responded that one of the main elements of the Asian developmental State model was close co-operation between the public and private sectors. In Japan, it was normal for people to move freely between working for the public and private sectors. He questioned whether this was possible for South Africa. In Japan, there was virtually no corruption because there were competent, dedicated, professional people on both sides that made the model work. He could not commit on Sanlam's behalf but the spirit in which they interacted in the past had always been co-operative.

Mr T Mufamadi, Co-Chairperson, recalled Mr Laubscher's statement that the term”developmental State” had been used loosely of late. Mr Laubscher also appeared to conflate the concept of a social democratic state with the concept of a developmental democratic state. These two concepts seemed distinct to him. Tied to this, Mr Laubscher had referred to high taxation, almost at the 30% level, and advocated reductions in government expenditure. He asked how this agenda could be related to the role of the developmental State where the State could lead development. The Co-Chairperson referred to the high-income social democracies, such as Sweden. Their taxation level was very high and this was used to fund their welfare programmes and social security network. The presenters were asked to comment on these points.

Mr Laubscher felt that his statement on the developmental State being a difficult model had created a red herring and was diverting attention away from the MTBPS. The social democratic developmental state was not his term; but it was a term used by the Presidency, specifically used repeatedly by Mr Joel Netshitenze. As he had previously said, the standard developmental State model originated in Asia (Japan, South Korea and Taiwan). The Presidency inferred that South Africa was not going that route and would add social democratic aspects to the existing model. The best comparison to what South Africa aimed for was the social democratic developmental State in France.

Regarding the term being used loosely, he noted that "developmental State" was coined by Chalmers Johnson in a research study on the Japanese economy. It was now used to refer to all kinds of things and it was necessary that each person using the term should be certain on what was meant by it. He got the impression that "developmental State" was used in the context of government expenditure to uplift the poor and provide social protection and this was not part of the original developmental State model. Government had to be clear about what the goals were and how they would achieve them.

It was quite clear that there was no fixed model that could be taken from elsewhere and applied to an economy. South Africa had to use its own strengths, weaknesses and conditions to devise a plan for a South African model. This model could contain elements of the Asian developmental State and European social democracy but South Africa had to enhance this and live with the outcomes.

Regarding the reduction in government expenditure, he did not mean that this should be done immediately. It would be rather unwise to do so in the current economic environment. He meant to suggest that the overall size of government debt should be reduced over time. South Africa had experienced a jump from 31% (expenditure/ GDP) in 2008 to 35% in 2009. This was unintentional. It was not planned and this was illustrated by the fact that there was no policy decision to raise the expenditure to the present level. The MTBPS stated the intention to bring this down over time and this was the essence of counter-cyclical policy – that it was possible to deviate for a short period and then come back to the norm.

Mr Verwey replied that it was both socially and politically problematic to cut social spending. With reference to Sweden and the Scandinavian countries, he noted that these were countries with high levels of income equality and they had already addressed many of their social challenges, compared to South Africa. Given South Africa's social challenges, it would be very difficult to cut spending. Although it was difficult to model the qualitative impacts of South Africa's social challenges, they should be acknowledged, as they impacted on the economy. The social, political and economic realms interacted very closely.

With regard to the developmental State debate, he noted Peter Evans' concept of "embedded autonomy" to characterise the developmental State. This was a State that was embedded in society to provide a map informed by the preferences of society, but that was also autonomous in order to avoid the problems of rent seeking, corruption and strong lobbying, all of which were not in society's best interest.

Mr Mashile asked Mr Laubscher's opinion whether the increased expenditure was not related to the accelerated service delivery goals of the previous administration's policy of "Business Unusual". He wondered whether these statements did not imply heightened expenditure.

Mr Laubscher responded that government expenditure in the Budget for 2009/10 was projected at 33,7%. This was already an increase over the 2008/9 estimate of 31,3%. The 33,7% was set to be reduced to 32% by 2011/12. This meant that the increase to 35% in the MTBPS 2009 was not planned in the Budget, but was rather an outcome of the economic circumstances. There was no reason to think that the increase was a change in policy, and this was his interpretation of the numbers.

Mr D Montshitsi (ANC) responded that the resources government ploughed into the economy contributed to growth because they contributed to delivery and increased the numbers of role players in the economy. Government would then be able to recoup taxes from the increased numbers of economically active people. He agreed that government might not have planned for the 35% but plans were in place to reduce this over the medium term. He felt that the expenditure increase was largely due to external factors, such as commodity prices.

Mr Laubscher agreed that the increased expenditure was largely out of government's hands. The small amount of over expenditure was a positive, but it was a pity that 90% of that expenditure was the result of an unplanned increase in wages and salaries. This could have been avoided if government stuck to the Budget.

Mr Verwey stated that it would be a pity if this became the focus of debate, because government expenditure, as a ratio of GDP, was just one way to measure government spending. Looking specifically at the ratio, it consisted of a numerator (government expenditure) and a denominator (GDP). The smaller the denominator, the larger the ratio, and vice versa. Spending had generally stayed in line with what was intended. Inflation was not a factor here, because it would affect the numerator and denominator equally. This was not an inflationary issue, but it was a matter of the size of the denominator of GDP. As the economy recovered, GDP would be bigger and the ratio would automatically be reduced. This was not a policy issue, simply a matter of the fact that GDP had become smaller because of the economic contraction.

The meeting was adjourned.