2021 Fiscal Framework & Revenue Proposals: National Treasury response to public hearings

Meeting report

National Treasury response to public comments

Mr Edgar Sishi, Acting Head: Budget Office, National Treasury, said the Department had grouped the main comments of the public hearings into different categories, which would make it easier to respond to the submissions.

Unlocking private sector investment was critical for economic recovery

• The private sector -- 70% of gross fixed capital formation (GFCF) -- was the lead contributor to investment.
• The positive effects of fiscal consolidation and the easing of electricity supply constraints could support a recovery in private investment.
• Shifting the composition of government spending from consumption to investment would support economic recovery and raise South Africa’s potential growth.

Reduction in corporate income tax (CIT) rate

• The Budget Review acknowledged that the CIT rate was not out of line with other African countries. However, it also states that the contribution of CIT to gross domestic product (GDP) in those countries was substantially lower due to tax holidays, tax exemptions, and investment allowances in those countries.
• Tax holidays reduce the tax base and create distortions between sectors, which was inequitable and negative for economic growth.

 Impact of lowering CIT on economic growth

• Multiple previous budgets had highlighted that government would like to broaden the base and potentially lower tax rates.
• To facilitate economic growth, the tax system needed to be as efficient as possible by minimising distortions and obstacles to investment, innovation and employment.
• The Organisation for Economic Cooperation and Development (OECD) 2010 had stated that corporate income taxes were the most harmful type of tax for economic growth, followed by personal income taxes and then consumption taxes, with recurrent taxes on immovable property being the least harmful.
• A growth-orientated strategy would be to reduce reliance on corporate income taxes and personal income taxes, and increase reliance on consumption taxes and taxes on immovable property, while removing incentives.

Effective tax rates for CIT

• For South Africa, the composite effective average tax rate was 27.1%, while the composite effective marginal tax rate was 9.8%.
• The first measure reflected the average tax contribution from an investment, while the second measure showed the extent to which taxation increased the pre-tax rate of return required by investors to break even.
• The second measure did not reflect the contribution from CIT, but was related to the investment return and was dependent on which sector one was referring to, which asset was being purchased and whether the investor was financing their investment with debt or equity, amongst other assumptions.
• A lower maximum effective tax rate (METR) was good, as it encouraged expansionary investments, but the annualised effective tax rate (AETR) was a better measure of how much revenue would be generated, so higher was better.

Increasing taxes on those with high incomes

Over the past six years, the government had introduced numerous measures to increase the tax paid by those with large incomes and the wealthy. These measures included:

• A 1 p.p. increase in all the personal income tax brackets, except the bottom bracket (2015/16) and a new top tax rate of 45% above R1.5 million (2017/18);
• An increase in the dividend tax rate from 15% to 20 % (2017/18);
• An increase in the capital gains tax inclusion rate from 33% to 40% for individuals, and from 66% to 80% for companies (2016/17);
• A higher tax rate for estate duty of 25% for estates above R30 million (2018/19);
• An increase in the ad valorem tax on luxury goods from 7% to 9% (2018/19);
• A new transfer duty rate of 11% for properties above R2.25 million (2015/16) and another new transfer duty rate of 13% for properties above R10 million (2016/17).

The budget does not extend the venture capital company incentive, which had provided tax deductions worth R745 million to high net-worth individuals in (2018/19).

Fiscus was becoming heavily reliant on personal tax.

Personal income tax as a share of GDP had increased from 8% in 2009/10 to over 10% in 2019/20. This was mostly due to tax policy measures to increase the personal income tax collections. SA’s personal income tax system was highly progressive and had tax rates and contributions that were comparable to high income countries. The 2021 Budget had provided a small amount of tax relief that mostly went to lower and middle income individuals, to assist households through the pandemic and to allow for a stronger economic recovery.

Increase in excise duties

In assessing the potential changes, National Treasury had considered the impact on revenue, behavioural change, illicit trade, and the potential social and economic harm from consumption of these products. The annual excise tax adjustment was calculated on the projected retail prices for the next fiscal year, or expected consumer inflation, whichever was the highest. It was also often based on the trade-offs within a fiscal framework, as was the case this financial year.

National Treasury was concerned about illicit trade, and the additional allocation of R3 billion to the South African Revenue Service (SARS) to capacitate its enforcement would help address the impact of the illicit economy on the fiscus. The review process would assist in providing better forward guidance to industry on the level of excise duties that could be expected.

National Treasury was reviewing the short-term impact of the health promotion levy and would use these inputs to consider future amendments to the scope and rate of the levy.

Structural and cyclically adjusted primary deficits

In general, both the cyclically adjusted primary balance and structurally adjusted primary balance have been in deficit since 2009/10 trending with the weakening in economic growth. However, the structurally adjusted primary deficit was generally much larger than the cyclically adjusted primary deficit, except for 2017/18 and 2018/19, where there were small or no extraordinary payments that affected the structurally adjusted primary balance. The cyclically adjusted primary balance (CAPB) was notably weaker than the structurally adjusted primary balance (SAPB) because of the large state-owned companies’ (SOCs’) equity injections, especially in 2009/10, 2010/11, 2015/16 and 2019/20. Structural expenditure events weighed heavily on the deficit, so as these events were expected to decline over the medium term, the SAPB would improve markedly.

Why fiscal consolidation-fiscal metrics had deteriorated

South Africa faced severe economic challenges. Real GDP per person had been falling since 2013/14, meaning that the average South African was becoming poorer, despite high and rising fiscal deficits. Private and public investments were lower than at any time since 2005, having declined to 12.5% and 5.4% of GDP respectively in 2019.

South Africa had provided one of the largest fiscal responses to the pandemic among developing countries, and as a result, consolidated government spending had reached a record 41.7% of GDP, compared with 29.6% in 2008/09 To support households, businesses and the public health sector, the consolidated budget deficit had widened from 5.7% in 2019/20, to an estimated 14% in 2020/21.

While a temporary increase in spending was necessary to combat the spread and impact of COVID‐ 19, the medium‐term policy stance was focused on repairing the public finances the fiscal position, which was already weak before the current crisis, had deteriorated sharply, requiring urgent steps to avoid a debt spiral for several years, increasing debt‐service costs have exceeded nominal GDP growth a trend expected to continue over the medium term.

If this course was not reversed, the economy would not be able to generate sufficient revenue for the state to service debt Were that to occur, government would lose the ability to control debt and debt‐service costs, as investors conclude that lending rates do not adequately compensate them for risk, leading to greater currency volatility and a protracted capital flow reversal.

Why Fiscal Consolidation- Fiscal Multipliers.

The 2020 Medium Term Budget Policy Statement (MTBPS) had noted that over the past decade, increased government spending had failed to promote growth. Since 2008, real spending growth had averaged 4.1% annually, well above annual real GDP growth of 1.5%. Despite high levels of expenditure, supported by increased debt accumulation, growth had not recovered to pre‐ 2008 levels.

Recent research in South Africa concluded that spending multipliers were positive, albeit generally smaller than 1. The Reserve Bank estimated that the fiscal multiplier declined from 1.6 to less than zero between 2009 and 2019 as South Africa approached its fiscal limits.

In general, infrastructure investment multipliers tend to exceed consumption spending multipliers. The literature shows large negative multipliers from revenue increases, suggesting that South Africa’s growth slowdown over the past five years may be related to rising taxes.

This implies that a large fiscal consolidation to narrow the budget deficit and stabilise debt, complemented by the implementation of structural reforms, was more likely to support economic growth than continued spending funded by higher borrowing and taxation.

Fiscal strategy

South Africa’s fiscal challenge was to balance the immediate need for support to the economy during the pandemic, with ongoing efforts to close a large, pre-existing budget deficit. In this context, the fiscal strategy aimed to:

• Narrow the deficit and stabilise the debt to GDP ratio, primarily by controlling non-interest expenditure growth.
• Provide continued support to the economy and public health services in the short term, without adding to long term spending pressures.
• Improve the composition of spending, by reducing growth in compensation while protecting capital investment.

Response to fiscal rule proposal

One option would be to introduce a debt ceiling. However, the ceiling level must be sufficiently ambitious without requiring an implausible fiscal adjustment. A debt ceiling rule should be accompanied by additional fiscal rules to provide operational guidance.

These rules should take into account the macroeconomic volatility, the finer technical issues in their creation and adherence, and the developmental needs of the country. Government debt should act as a shock absorber, and debt should adjust over time towards a long-run target.

Once the debt target had been set, expenditure ceilings could be calculated that were consistent with the rule. The risks of setting the target and not achieving it were high, given persistently low economic growth and major unresolved extra budgetary pressures. For example, if government were to move Eskom debt on to its balance sheet, the rule might require major fiscal adjustments.

The proposals would need accompanying institutional reforms. These could include the introduction of a new fiscal law to be passed in Parliament, in order to make it binding. The law must include escape clauses for extraordinary unforeseen events (e.g., a multi-year recession). There should also be a fiscal policy council/review panel, consisting of independent experts, academics, and the Parliamentary Budget Office, tasked with providing independent commentary, and a biennial review of the target.

How Budget 2021 supports economic growth.

Mr Sishi referred to fiscal sustainability, and said an increasingly unsustainable fiscal outlook acted as a drag on economic growth. Budget 2021 presented an improved debt to GDP outlook relative to the 2020 MTBPS, which should take pressure off interest rates, reduce crowding out, and improve investor sentiment.

Short term support to the economy would require funding for crucial health and employment interventions to support the economic recovery. This would include:

• Three-month extensions of the special COVID-19 social relief of distress grant and the Unemployment Insurance Fund’s (UIF’s) Temporary Employer/Employee Relief Scheme (TERS), and funding for the public employment initiative and for provincial hospitals in 2021/22.
• Up to R10.3 billion provided for the vaccine rollout for the current year and over the next two years.
• The contingency reserve increase from R5 billion to R12 billion in 2021/22, given uncertainty around vaccination campaign costs These interventions did not add to longer term expenditure.

Government would not implement the additional tax revenue measures announced in the 2020 MTBPS -- R5 billion for the next year, R10 billion per year in the following two years, and R15 billion in 2024/25.

The composition of spending would reflect infrastructure investment growth over the medium term, despite large expenditure reductions. After interest payments, capital transfers and capital payments grow fastest. Budget 2021 also provided funding for key infrastructure reforms related to the Infrastructure Fund.

Use of IT systems in procurement

A review of supply chain management (SCM) technology in the public service confirmed that fragmented systems undermine the effectiveness and efficiency of the procurement function. It was also noted that amongst the estimated 56 different technologies employed at the national, provincial and local government levels, very few examples of SCM information and communication technology (ICT) modernisation could be identified.

Inefficiencies in procurement were often related to a duplication of effort and costs relating to high volume/low value transactions and manual processes. International studies had shown that considerable savings in administrative costs and process efficiency could be achieved by automating SCM processes, and could also improve audit outcomes within organs of state.

Conclusion

Budget 2021 strikes a difficult balance between providing immediate support for the economy and shoring up the country’s public finances. The medium term fiscal policy focuses on:

• Extending temporary support in response to COVID 19.
• Narrowing the budget deficit and stabilising debt.
• Exercising continued restraint in non-interest expenditure growth while improving the composition of expenditure.

Returning the public finances to a sustainable position would require ongoing restraint in expenditure growth and implementation of structural reforms to support economic growth.

The current fiscal strategy reduces growth in the Compensation Bill and decreases the share of spending on public service wages over the medium-term, while sustaining small real spending increases on other items.

Significant risks remain for the economic and fiscal outlook.

Chairperson Carrim thanked National Treasury for the presentation, and asked the Committee secretary if all the stakeholders were present. Because of time constraints and the number of stakeholders that needed to ask questions, they needed to be cognisant of time when asking questions.

Discussion

Public Stakeholders

Dr Fanie Joubert, from the Fiscal Cliff Study Group, said National Treasury talked about debt consolidation over the next three or four years, but what if another global crisis happened within that period?  What steps were Treasury putting in place to mitigate this risk? He asked if Treasury was compliant with debt to GDP levels, which should be stabilised at 90%. How would National Treasury stabilise and lower the debt to GDP levels.

Ms Busi Sibeko, Researcher, Institute for Economic Justice, asked to what extend National Treasury had actually assessed the impact the 2021 budget would have on the progressive realisation of human rights. Treasury had not responded on the fact that the budget hinged on it winning the case on the wage bill, and it was problematic for it to assume it would win the case. The information on corporate taxes was based on outdated information. What would National Treasury do to re-evaluate this? She said the per learner spend had declined significantly, and this trend would continue over the next three years. She asked what the implications of this decline were.

Chairperson Carrim informed stakeholders that they still had a chance to submit a summary by 17:00 today.

Prof Corne van Walbeek, Director of REEP: School of Economics, University of Cape Town, said there was a false dichotomy between health and economics. Excise taxes were often presented as harmful to the economy and industry, which was not true. By increasing the excise tax, there would be at least two wins -- on the one hand, it would do good for public health, and on the other hand there was an increase of revenue. There were arguments being made that it could lead to massive job losses, but based on studies from other countries and South Africa, it would not lead to massive job losses. An increase in excise tax would in the long run be good for the economy.

Ms Sharon Smulders, Project Director: Tax Advocacy, Institute of Chartered Accountants, said Mr Sishi had given a brutally honest presentation of where the country was currently heading, which was quite frightening. She agreed with him on corporate tax, and said the base needed to be broadened and rates needed to be brought down. Government was spending more than it had, and this was a policy choice, but she wondered what this would lead to. She said expenditure was going down in sectors such as health, policing and social development, which was a concern, and Treasury was still not cutting the wage bill. If the wage bill could not be cut, then the government would need productivity for the amount of money that the country was spending, but there was no accountability on productivity from the public servants. There was not enough accountability from government, and nothing was being done to fix this. There also needed to be more accountability for the misappropriation of funds.

Ms Beatrie Gouws, Head: Stakeholder Management & Strategic Development, South African Institute of Tax Practitioners, said she agreed with lowering the corporate tax rate to make South Africa more competitive. Personal income tax was tapped out, and in order to manage this with current legislation one had to make changes within the parameters of the business that was running. She said they were willing to work with Treasury to find common ground.

Mr Greg Smith, Senior Manager: Corporate & International Tax, PriceWaterhouseCoopers (PWC), said there was a lot of debate around corporate income tax, and people should not lose focus. The aim was to broaden South Africa’s base. Treasury had announced an initiative to review incentives, and this must be seen as a measure that would incrementally increase tax revenues. The objective was not to get less money from corporations. He understood the issue of excise duties. These industries had been under massive pressure over the last year and had suffered huge revenue losses.

Dr Sharon Nyatsanza, Project and Communications Manager, National Council against Smoking, said when looking at the current crisis, the government needed to ask how ready it was for the next crisis and if the recovery plan was sustainable. She said tobacco control supported and did not hurt the economy. There was no intention from Treasury to move to World Health Organisation (WHO) recommendations that tobacco taxes should be 75% of the retail prices. There needed to be bolder movements towards preventing tobacco, alcohol and other harmful products from burdening the health budget.

Dr Yussuf Saloojee, Executive Director, National Council against Smoking, wanted to make a quick comment. He said it had been in 1997 that a former Finance Minister announced that tobacco taxes would make up 50% of the retail price of tobacco, and in the 23 years since then the Treasury had stuck to this rule stubbornly. If one looked at what had happened in South Africa, the illicit trade had increased dramatically during this period, so clearly Treasury was following a policy that did not work. If one compared South Africa’s tobacco prices to international standards, it was in the bottom tier. There were other countries with much higher taxes on tobacco and much lower levels of smuggling. There needed to be more tracking and tracing, stricter enforcement and rooting out corruption.

Mr Ernie Lai King, of 1Road Consulting, said the emphasis should be on the recovery of the economy, but there needed to be a realisation that one could not tax one’s way to prosperity. When combative measures were being put in place, Treasury should just make sure that it did not combat everything, including those aspects that were desirable. The law as it stood rendered the taxpayer very powerless. Disputes on tax refunds could take a very long time.

Mr Matthew Parks, Deputy Parliamentary Coordinator, Congress of South African Trade Unions (COSATU), said COSATU’s position was quite clear, and they agreed with National Treasury that current debt levels were not sustainable. On the other hand, the government did not appreciate that unemployment levels were pushing past 50%, and 10% of the budget was lost every year to corruption and wasteful expenditure. The economy was also in its worst recession. He said cutting the wage bill would put a strain on government’s relationship with labour, and this could lead to a massive brain drain and loss of skills within government.

Mr Matt Johnston, Parliamentary Engagement Manager, Organisation Undoing Tax Abuse (OUTA), said the problem was not funding, but rather spending, in South Africa. The wage bill could not be the primary catalyst to curtail spending, and not enough emphasis was being put on higher earning individuals -- people who underperformed and who had been responsible for financial mismanagement. It could not be a blanket approach, so how would this process be differentiated? There were fundamental qualitative issues that national Treasury could not necessarily do -- who would address them? Parliament and its Portfolio Committees needed to do more, because National Treasury could not do everything. He asked if National Treasury could comment on the fuel levy which had been increased last year.

Mr Lawrence Mbalati, Programmes Manager, Healthy Living Alliance (HEALA), said he would be very brief and had only one question. He asked if National Treasury had a timeline for evaluating the Health Promotion Levy (HPL). Treasury had explained the process that led to the HPL and this study was long overdue.

Committee Members

Ms P Abraham (ANC) said it had been eight years since the start of fiscal consolidation and any impact assessment would show that South Africa’s fiscal position had not improved. She asked for National Treasury’s comments on whether this had worked so far. The inherit danger of budget 2021 was that it hinged on dealing with compensation, and this could have an undesirable outcome. What were Treasury’s thoughts on this matter?

Co-chairperson Maswanganyi welcomed National Treasury’s responses on the submissions submitted by stakeholders. He said GDP growth had fallen far behind and had not kept up with the population growth rate. This lower rate of economic growth had reduced government spending power and undermined the state’s spending ability on social and economic programmes. This matter had been raised consistently by all stakeholders and needed to be attended to. Treasury would have to come back to the Committee and set out how they would implement the recovery plan announced by the President.

Chairperson Carrim said in the first quarterly report back from Treasury, National Treasury could make the presentation rather than make the Committee wait. Members could consider this in their report.

Response

Mr Dondo Mogajane , Director-General, National Treasury, welcomed the comments and submissions received from the different stakeholders. Treasury took this process very seriously. The issue of vehicles was a small yet important issue -- the government needed to look into using locally manufactured vehicles. Critical issues had been raised, and Treasury officials would give further information on them. He said Treasury worked in a complex environment and had to work with other departments and also provincial treasuries. The responsibilities of Treasury were clear, but it could only do so much.

Mr Chris Axelson, Chief Director: Economic Tax Analysis, National Treasury, said it would be very useful to have a discussion on some of the tax and financial sector issues. It was important for the Committees to have the right perspectives before National Treasury presented its bills to them. Treasury would take many proposals into account when making tax legislation and changing tax rules and laws. It was focused on bringing down tax leakages. On the issue of corporate tax, it was necessary to lower the rate to make South Africa more competitive. There was a perspective in South Africa that high net worth individuals were not being taxed enough, but this was not the case. The issue was that wealthy individuals had the capacity to structure their finances in a way which enables them to pay less tax. SARS was trying to incentivise people to avoid tax avoidance.

Mr Sishi said Treasury appreciated the comments made today. He said the biggest issue raised was the wage bill, and this concern was shared by Treasury. From a policy perspective, it was the right choice to seek a shift to items of expenditure that required investment. This was not without risk, and Treasury had identified the wage bill as the second biggest risk to the fiscal outlook. Budgeting was about difficult choices, and this budget had been incredibly difficult. The choice in terms of composition of expenditure was an important one. The alternative to not making the shift was obvious -- the money would have to come from other areas, particularly infrastructure, Treasury recognised it was a risk and it was within its risk assessment. He would refer Members to the assessment Treasury had been making over a number of years, which in the current budget review was in chapter three. Treasury could write a report on the assessment of the consolidation, but simply put, for over a decade government had been spending more than it had to spend.

Chairperson Carrim said there were a lot of specific questions Treasury officials had not responded to. He suggest that it respond to them in writing, They could not be left unanswered, as the Committees needed to make a decision on its reports and there was protocol that was meant to be signed as part of a WHO tobacco protocol. This was just one example of unanswered questions. The Committee would send the questions to Treasury so they could respond to writing. He said Treasury’s responses had been too general, and it would be helpful to give in-depth answers to some of the questions that were specific.

The meeting was adjourned