Why Is The Budget Speech Important?

Will our new Finance Minister continue the growth drive of his predecessor or focus on cutting expenses instead?

If government is raising its revenue, which avenues will it use: income tax, consumer tax or special levies?

Which expenses will enjoy priority and will government continue to borrow to fund these expenses?

And, most importantly, how do these changes affect your pocket?

Click here to view our panel of experts explain the jargon around the Budget Speech, and give their views around what you can expect from Finance Minister Nene on 25 February 2015.

Tax structure and growth objective should be aligned

Tax changes, guided by the recommendations of the Davis Tax Committee are likely to take centre stage when Minister Nene reads the National Budget on 25 February 2015. The Minister indicated in October 2014 he would be looking for additional revenue of R12 billion in 2015/16 and R15 billion in 2016/17 (from enhanced tax collection efficiency and changes to tax policy).

It has become popular to guess which taxes are likely to be increased (and by how much). The list of possibilities is long, even though a 1% hike in the VAT rate alone would more than meet the Minister’s objective for the coming fiscal year.

But, before we draw up a list of possibilities, we should bear in mind tax policy cannot be determined in splendid isolation of broader economic objectives. To this end the Medium Term Budget, October 2014, notes that in addition to enhancing the progressive nature of the tax system the “short and long-term implications for growth and job creation will be a key consideration” in setting tax policy. This statement highlights the conflicting objectives and wishes the National Treasury must deal with. On the one hand, fairness dictates South Africa’s tax structure should be progressive. This suggests taxing higher income earners more. On the other hand, poverty cannot be reduced unless the economy grows fast. This requires less emphasis on taxing income.

South Africa needs growth of 5% and more to reduce the unemployment rate and poverty meaningfully. But, the country has a low level of savings (little more than 14% of GDP), which is insufficient to fund the level of investment required to grow the economy fast.

In order to align itself with the growth objective the tax structure should be supportive of investment. It would also be helpful if savings are encouraged, or at the very least, not discouraged. This calls for higher taxes on spending and lower taxes on income. Taxes on spending (indirect taxes) restrict consumption in favour of savings. Taxes on income reduce the incentive to work, save and invest.

But, currently, South Africa’s tax structure is skewed towards direct (income) taxes, which contribute more to government revenue (around 55% in 2014/15) than indirect taxes.The tax regime affects private business investment decisions by impacting the return on capital. A decline in the company tax rate or an increase in incentives (for example accelerated depreciation allowances) decreases the user cost of capital and increases the incentive to invest.

Currently, there is a dearth of private sector investment spending in South Africa, because the marginal rate of return on capital is too low. Indeed, the current outlook for fixed investment spending heading into 2015 is a concern.

And, even though the Treasury is on track to meet its consolidated Budget deficit target of 4.1% for 2014/15, there is a marked deterioration evident in company tax revenue due to the weakening of the company income tax base (company profits). Note, earnings (profits) of companies listed on the JSE are not representative of profits growth for the total economy. The advance in profits for the total economy has been markedly weaker than for JSE listed companies in recent years.

But, government total revenue has held up relatively well because of an increase in the personal income tax base (worker compensation). The problem is the buoyancy in the personal income tax base can’t last if company profits and private sector fixed investment remain weak.

What can the Treasury do? The bold move is to skew the mix of taxes towards indirect (consumption) taxes. This implies tax changes in Budget 2015 should, ideally, be more heavily weighted towards increases in the VAT rate, the fuel levy and / or adjustments to sin taxes in excess of inflation. An increase in the VAT rate would be widely unpopular since the tax is viewed as regressive (higher income groups spend a smaller percentage of their income on consumption than lower income groups). But, this can be addressed by zero-rating goods on which lower income groups spend most of their income. Indeed, given the current exclusions and zero-ratings already applicable, VAT may not be regressive after all. But, that is a matter for econometricians to debate.

If we don’t get this shift in the tax structure, then, at the very least, private businesses will be looking towards government to stick to its fiscal consolidation path – no matter how difficult. Fiscal policy should dovetail with monetary policy. A sound fiscal policy helps contain the risk of higher future inflation and, together with a lower government debt level, would help to keep borrowing costs low.

What about savings? We know the Treasury is seeking ways to boost savings. This is one of the factors driving government’s intention to reform retirement savings. The imminent introduction of tax-free savings accounts is another intervention, which is useful since taxes on savings lower the return on savings (and hence the incentive to save). The proposed scale of the tax-free savings accounts is rather limited, though, and it remains to be seen whether this merely encourages a substitution effect (shifting savings around).

Viewed more broadly, the issue is government has been dis-saving. That means it has been borrowing to fund current expenditure. The good news is that if we stick to the Medium Term Budget Policy Statement, October 2014, government’s current balance (the difference between current income and current expenses) shifts into a surplus in 2015/16. This implies the government is no longer dis-saving and intends borrowing to fund capital expenditure, but not consumption.

Overall, the extent to which government sticks to its fiscal consolidation path and the way in which it structures taxes will have an important bearing on South Africa’s growth outlook and, ultimately, the economy’s ability to deliver lower unemployment rates.

When all is said and done, and the dust has settled post Budget Day, it seems likely we will be saddled with a higher tax burden. The National Treasury has indicated it needs to increase taxes, because the economy is growing too slowly. We should be looking at the issue the other way around.