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Why did the Minister of Finance propose a tax increase?

There is no doubt that a VAT increase would lead to unwelcomed price increases, except on key zero-rated items like basic food stuffs and fuel.

The proposal to increase VAT was clearly informed by South Africa’s heavily constrained fiscal situation – debt has rising from around 25% of GDP 15 years ago to over 75% of GDP – the country is moving ineluctably into a fiscal crisis. We are moving into a deeper debt trap, in which more and more resources have to be used to pay off our national debt.

There are increasing spending demands – social grants, wages, services, State owned company bailouts, which have made it likely that taxes will have to be raised, or spending on other items cut and crowded-out.

The essential compromise of the rejected budget was that it would allow increases in permanent expenditures on condition that provided permanent increases in revenue. And it was not prepared to budget on the hope of possible efficiency gains, reduced corruption or wished for growth.

In recent years, SA has attempted to deal with the fundamental imbalance between public spending and tax revenue problem with a range of short-term strategies – reneging on public sector wage agreements, tapping into the rising value of the GFECRA gold reserves, fudging how the Eskom bailout is recorded in the budget, possibly now tapping funds into the well-funded public sector pensions, but none of these strategies deal permanently with the fundamental fiscal imbalance that the country is facing.

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Why a VAT increase?

VAT, PIT and CIT all effective in raising revenue
After zero-rating of basic goods VAT is not particularly regressive
But PIT and CIT impact more negatively than VAT on economic growth and welfare

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What will be the impact of the decision to delay the budget?

In the short-run – the budget will have to be reworked to get support from the GNU parties - if not higher taxes, then what spending will have to be cut in order to balance the budget, or should we continue to increase public debt?

In the longer run, it will be important to restore the credibility of the budget process – it will be very disruptive and costly if the delaying of budgets becomes the new normal. South Africa’s risk premium will likely go up, the cost of borrowing will rise, and the challenge of growth and job creation will be even harder to achieve.

Macroeconomics theory talks about the tendency of political systems towards ‘fiscal deficit bias’, as politicians prefer to increase spending and lower taxes even when economic conditions do not warrant it. For use the budget process was managed very tightly by National Treasury – now there is a risk that this model will be replaced by a more overtly politicised model.

A key question at this critical moment is whether South Africa’s GNU and broader civil society will be able to show the kind of leadership and economic insight required to overcome the current impasse in a manner that sets the economy up for a new wave of growth and job creation.

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South Africa’s failing growth model

SA’s Growth has been low (negative GDP per capita growth) for large periods of past decade

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South Africa’s failing growth model

Economic growth is failing because:
The state has become less effective – resources wasted and siphoned off, and infrastructure has decayed
There has been de-industrialisation in the face of import pressures and loss of competitiveness in electricity provision, logistics, technology, skills, etc.
Policies (such as education, energy, mining, etc.) have not been forward-looking and have not been designed to guide the country through a period of global transitions, such as, ongoing energy, digital and geo-political transitions
For example, a well managed energy transition could boost SA growth and competitiveness:

an energy platform is needed that allows manufacturing activity to be more competitive through access to reliable, lower-cost, lower-carbon energy
upstream and downstream investments should be planned around this new energy platform, to maximise local manufacturing and services spin-offs, such as, battery components, renewable energy components, metal components, transformers, cement components, financial products, etc.

But, incumbents and vested interests continue to push the energy transition off track

Instruments such as the Integrated Resources Plan, investment frameworks for private sector investment in generation and transmission infrastructure, are highly contested and are not fully aligned with the economy’s need for increased competitiveness.
This is further evidenced by proposals to extend for a further 10 years the life of coal plants earmarked for closure, by Eskom’s tendency to extend its market power and block competition
These powerful interests will need to be confronted if proper alignment between energy policy, industrial policy and growth policy is to be achieved.

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What else must be done to boost economic growth?

To achieve inclusive growth - the budget should be understood to play key roles in

redistribution
pre-distribution, and
growth

Income Redistribution is mainly about progressive taxation and social grants - with South Africa’s post-redistribution inequality significantly lower than market income inequality

Pre-distribution requires that we create more opportunities for higher productivity participation in the economy – through access to quality public education and health services, through land reform and improved spatial planning and public transport

To accelerate growth will require more of the following from the budget:

Increased levels of infrastructure investment which is being crowded out of the budget

PPP models to make use of private sector balance sheets, for example, to lift investment in electricity infrastructure and rail infrastructure

Tax incentives or concessional finance may be required to advance industrial policy and encourage investments in industrial activities where South Africa can be competitive and integrate into global production chains as we have done with the automotive sector, should create fiscal space to promote investment in mineral-beneficiation linked battery investments, or manufacturing of solar and wind components for an African and wider market, etc.

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Summary of key points

We must prioritise strategies to grow the economy again after more than a decade of low growth

Fiscal sustainability is a necessary, but not sufficient, part of creating a positive investment environment for both public and private investment.

Fiscal sustainability is needed along with effective state capacity, and a number of other key policies, such as, industrial and trade policies, and improved performance of the country’s energy and logistical systems.

What the attempt at tax increases tells us is that after more than a decade of low growth, South Africa’s fiscal position has become fundamentally unsustainable – despite attempts to reign-in spending, spending pressures continue to rise and permanent spending obligations are exceeding revenue.

Accelerated growth is a way out of this imbalance as it would increase tax revenues and allow for increased public spending

But a sustained period of accelerated economic growth is not easy to achieve – it will require:

rebalancing and reprioritisation of public spending on infrastructure so that it does not continue to be crowded out by welfare and current spending (this in a context where many are impoverished and excluded and dependent on grants),
co-ordinated and forward-looking economic policies - industrial, mining, agricultural, trade, education, etc.
contestation with vested interests opposing structural changes in the economy (where these interests are powerful and well-entrenched)