What to expect from Pravin
Budget 2017: Hard truths to face
The severity of SA’s fiscal squeeze is going to hit home when it is made clear that the country has reached its financial limits
For a while now finance minister Pravin Gordhan has been tightening the screws on taxpayers and government spending, while trying to plug revenue shortfalls with savings by reprioritisation and by running down the contingency reserve.
These measures have taken SA only so far. After five years of disappointing growth, national treasury has emptied its box of fiscal tricks, and only hard choices remain. The 2017 national budget is where the rubber hits the road.
The message Gordhan is likely to emphasise when he tables the budget on February 22 is that SA has reached its fiscal limits and that everything must be done to rebuild confidence and bolster fixed investment, on which growth depends.
Unless Pravin Gordhan stays, the actual numbers in the 2017 budget will count for little
But he will be faced with the near impossible task of trying to raise confidence while simultaneously announcing severe tax hikes and spending cuts.
In so doing he will have to tread a fine line between fiscal probity and fiscal austerity. The International Monetary Fund
has warned SA that more aggressive fiscal consolidation, though it might bolster investor and business confidence, could prove self-defeating if it causes growth to retreat further.
But Gordhan cannot afford to raise SA’s budget deficit targets even slightly, as the repeated slippage, though small, suggests that SA is losing its grip on fiscal sustainability.
According to treasury’s medium-term outlook, the consolidated budget deficit (at present running at about 3.4% of GDP) is now expected to decline to 2.5% only by 2019/2020 — a year later than previously foreseen; net loan debt, which was supposed to stabilise at 46.2% in the 2017 fiscal year, is now expected to stabilise at 47.9% in 2019/2020; while the goal of achieving a primary surplus has also had to be pushed out a year.
Any further disappointment in SA’s debt dynamics could spell currency, bond yield, ratings and short-term interest rate trouble.
At an absolute minimum, Gordhan will have to stick to the lowered spending ceiling announced in October by cutting
the bloated public sector wage bill, wastage and corruption.
But spending restraint on its own will not be enough.
A year ago, Gordhan managed to balance the books without resorting to draconian tax hikes. He relied mainly on making above-inflation increases to a wide range of indirect (consumption) taxes and providing impartial relief for fiscal drag. Personal income tax (PIT) hikes were avoided.
But after the economy’s disastrous performance last year, Gordhan announced in October that to prevent further fiscal slippage, expenditure would have to be cut by an additional R26bn over the next two years and taxes raised by another R43bn.
This will require more than the usual slew of tax increases.
No further fiscal slippage allowed, and personal income tax increases are probably inevitable
Prof Jannie Rossouw, who heads the School of Economic & Business Sciences at Wits University, has, with other researchers, estimated that even if government institutes two new personal income tax brackets, including hiking the 41% marginal tax rate to 45% on income over R1m/year and taxing earnings over R2m/year at 50%, it would yield only R6.82bn more a year in tax revenue.
A one percentage point increase in the Vat rate, on the other hand, would raise about R22bn in additional tax revenue in the first year. This would make it the closest thing SA has to a magic bullet in addressing the deteriorating fiscal outlook.
The consensus view among economists, however, is that while national treasury is reconciled to the inevitability of raising the
Vat rate, the politicians are not. This is because Vat is seen as a highly regressive tax (it hurts the poor the most), making any move to raise it political suicide for the party in power.
The Davis Tax Committee has recommended that if government did feel compelled to raise Vat it would have to institute pro-poor measures to soften the impact on lower-income groups.
Sanlam economic adviser Jac Laubscher calculates that if all social grants were simultaneously increased by 1% (which would amount to overcompensating for a one percentage point rise in Vat) it would cost the state about R1.5bn. So the net gain from such a Vat increase would still be a whopping R20.5bn to the fiscus.
This would be enough to almost close the tax gap. But if Vat is not raised, increases in wealth-related taxes (like dividends tax and estate duty) as well as PIT will be unavoidable.
If the bulk of the required additional revenue is to come from PIT, Laubscher estimates that an increase of at least two percentage points in marginal tax rates will be needed.
The problem is that SA’s effective PIT burden has risen sharply in recent years as fiscal drag relief has fallen short of fully compensating for the effects of inflation, and all personal tax rates were already upped by one percentage point two years ago.
Old Mutual Investment chief economist Rian le Roux’s main concern is that once a government lifts the tax anchor, it takes the pressure off politicians to contain spending and to engage in pro-growth reforms. It would be a dangerous move in a country where much of government doesn’t appear to see the need to cut spending, and growth is dwindling.
The risk for future years is that a more politically pliable finance minister than Gordhan might resort to major tax increases, which would further reduce growth.
“If this, especially milking already-highly taxed higher income groups, becomes a trend, then skills and capital flight become really risky realities,” says Le Roux. “This is something the economy simply cannot afford.”
Treasury understands that the only sustainable solution is to broaden the tax base. This means raising the growth rate to generate more income, more profits, more taxpayers and more tax revenue.
Unfortunately, there is no indication that the rest of government really understands the low-growth environment it is in. National health insurance, a national minimum wage and the nuclear build all remain on the table in irrational defiance of SA’s true economic and fiscal position.
Previous budgets have asserted government’s willingness to undertake structural reform to remove the impediments to growth, but with very few results. So any growth plan outlined in the budget will be taken with a heavy pinch of salt.
This contrast between the fiscal plans set out by treasury and the wayward conduct of much of the rest of government has become a feature of recurrent budgets.
In the end what really matters is that treasury continues to be headed by a credible person to inspire confidence, champion pro-growth reforms and enforce spending restraint.
Unless Gordhan stays, the actual numbers in the 2017 budget will count for little.