Does recovery include raising more taxes?

The Minister of Finance, Enoch Godongwana, is hard at work refining his 2022/23 National Budget Speech to be presented in February and alive to the numerous negative sentiments about the state of the economy - COVID-19 being one of the main culprits and weighing heavily on the minds of South Africans, and will likely continue to for a long time. In the third quarter of 2021 the official unemployment rate also accelerated by 0.5% to 34.9%, the highest it has ever been since the introduction of the Quarterly Labour Force Survey in 2008. This highlights the grave effects of COVID-19 on South Africa’s economy, which was already in a poor state prior to the pandemic. The economy also has to contend with electricity supply challenges and the dire state of many state-owned enterprises, as well as the ballooning public sector wage bill. 

These factors will without a doubt weigh heavily on the minister’s mind, but we expect that he will draw inspiration from the better-than-expected economic outlook, boosted by high commodity prices and improved mining production. The Finance Minister should be energised that progress is being made in charting a trajectory of fiscal consolidation and debt stabilisation to avoid a debt trap, which is now expected to materialise earlier, as the overrun in revenue receipts is directed to finance additional government spending. Improved revenue collection by the South African Revenue Service (SARS) underpinned by, among others, more economic activities and the rebuilding process happening at SARS spearheaded by the SARS Commissioner is expected to add to this.  

As the minister delivers the budget speech there are some key questions that he will have to consider:

What does recovery look like?

After positive news on improved economic activities together with better-than-expected revenue collection, the Finance Minister may just have some good news for parliament and taxpayers. If this recovery trajectory is sustained at the rapid pace seen recently, this could ease many uncertainties and headaches.

Can the government keep running a deficit?

It is well known that the government has been spending more than it earns, borrowing for social expenditure instead of infrastructure investment. The current total government debt is well over 80% of GDP, mostly due to the pandemic. The previous Finance Minister succinctly summed up the position when he said, “we owe a lot of money to a lot of people”.

While not a consensus view, it is widely accepted that for a country such as South Africa, as an emerging market, a debt to GDP ratio above 100% is perceived to be unsustainable. Last year September this ratio was projected to peak at well over 90% in the next three to four years, uncomfortably close to unsustainable levels. Thanks to higher-than-expected tax collections from corporate income tax and value-added tax, the ratio is now projected to peak at 88,9% of GDP, which is still high but better than what was projected.  

Is there a need to raise more taxes?

It was acknowledged in the 2021 Medium Term Budget Policy Statement, that tax increases over the recent past have had an adverse effect on growth rather than spending reductions, as the spending multiplier has declined. In this regard, National Treasury has also recognised that both personal income tax as a percentage of GDP as well as the country’s marginal tax rate are higher than other comparable countries. Therefore, there is acceptance that further tax increases are not desirable as they will negatively impact economic recovery. Instead, the focus is to broaden the tax base whilst lowering tax rates, a journey that is already under way – with the reduction of the corporate income tax rate from 28% to 27%, accompanied by a reduction of some tax incentives such as deduction of certain expenditures and utilisation of assessed losses.

Additionally, progress is being made in rebuilding SARS with the re-introduction of the Large Business Centre, and other units with special focus on High Wealth Individuals, auditing of offshore transactions and general anti-avoidance.