Optimism around political change, but fiscal environment still tough

 

South Africa has been gripped with a renewed sense of optimism amid indications of political change, rand strength and an improved economic outlook, but the country’s fiscal situation remains challenging.

National Treasury is under pressure to introduce a package of tax hikes and austerity measures in the upcoming budget without stifling economic growth. Below are five tax questions that will be of interest on Wednesday.

1. Has the fiscal position deteriorated?

Lullu Krugel, chief economist at PwC Africa, says South Africa’s fiscal environment is tough and will probably remain so for some time.

PwC expects the budget deficit to reach about R250 billion, close to 5% of GDP during 2018/19, compared to the Medium-Term Budget Policy Statement (MTBPS) number of R203 billion (4.3% of GDP).

Krugel says it would be very difficult to introduce significant spending cuts in this year’s budget, and it will be important to take steps that ensure fiscal stability and transparency going forward.

Kyle Mandy, tax policy leader at PwC South Africa, says there is a sense that the tax revenue numbers are slowly turning a corner.

The MTBPS projected that tax revenue would fall short of the budget estimate by almost R51 billion in 2017/18.

“We expect that at the very least the downwardly revised forecast will be met and possibly will be slightly better when we get to the final analysis come the end of March,” Mandy says.

PwC currently estimates that the final outcome will be closer to R50 billion.

But there are some serious fiscal challenges, he adds. Finance minister Malusi Gigaba will be looking to introduce R30 billion worth of tax increases – R15 billion that was previously penciled in and an additional R15 billion “revenue-enhancing measures” as per the presidency’s instructions in the wake of the MTBPS. This number does not include the funding of free higher education or start-up costs associated with the National Health Insurance.

The table below sets out PwC’s projections of possible gross tax increases:

Source: PwC

2. Will personal income tax be increased?

Personal income tax as a proportion of GDP has been on an upward trajectory since the global financial crisis. There is growing concern about the relatively small tax base and the economic impact of further personal income tax hikes. There is also a risk that further increases may not result in additional revenues due to a deterioration in compliance.

Mandy says in the current environment there is limited scope for further personal income tax hikes.

PwC does not expect the introduction of a new super tax bracket for high-income earners or that tax rates will be increased. However, Treasury may still collect a sizeable portion of revenue by taxing inflationary salary adjustments (fiscal drag).

He expects Treasury to provide some fiscal drag relief – particularly for lower-income earners. Hence, it would probably only collect between R5 billion and R8 billion in additional revenue through fiscal drag.

“If you are a low- or middle-income taxpayer, we don’t expect that you will see much in the way of damage coming from the budget insofar as taxes on individuals are concerned.”

High-income earners will likely bear the brunt of the additional taxes – largely through limited fiscal drag relief and potential other measures – an increase in the capital gains tax inclusion rate and reform to the taxation of trusts and estate duty.

3. Will the VAT rate be increased?

Due to concern about the rising burden of individual taxpayers – at 10% of GDP it is now back at a level last experienced in 1999/2000 – the bulk of additional tax revenues will need to be raised from VAT, Mandy argues.

A one percentage point increase in the VAT rate to 15% would raise roughly R22 billion in additional tax revenues.

However, to make such a step palatable, the government would have to provide relief to lower-income earners through the personal income tax system and by increasing social grants.

Mandy estimates that government would have to spend about R5 billion of the R22 billion on increased social spending to make a VAT hike more politically feasible.

“Unfortunately, we don’t think we have a choice this year. We’ve kicked the VAT can down the road for a number of years now and this is a bullet that we are going to have to bite, despite the opposition that is likely to come from certain quarters,” he says.

4. Will a wealth tax be introduced?

Although the Davis Tax Committee (DTC) is investigating the merits of a wealth tax, its report has not been released publicly.

Mandy says various forms of wealth taxes are being considered, ranging from an annual net wealth tax to land taxes and national taxes on land and buildings, but he does not expect an annual net wealth tax to be introduced. Some DTC members are not in favour of it.

While there are strong theoretical arguments in favour of a land tax, there are also a number of practical challenges from a South African perspective.

“The trouble though with all of these things is that they are not a short-term fix. So even if they were announced in this year’s budget it could only ever be an announcement to the effect that there is an intention to introduce such a tax.”

It would require at least a two-year period to write and introduce the legislation and for the South African Revenue Service to update its systems accordingly, he says.

5. Will Moody’s be satisfied?

Krugel says Moody’s was the first credit rating agency to provide South Africa with an investment grading and has also been the most forgiving.

While it arguably had good reason to downgrade South Africa last year, it refrained from pulling the trigger.

The agency’s methodology also differs slightly from those of S&P and Fitch. It looks at the country’s balance sheet and although South Africa doesn’t look particularly healthy, it seems that it believes the country can meet its obligations.

Krugel says current political developments will likely play a big role in the March decision.

“All things being equal – given that the situation has really improved, that the outlook has improved, definitely sentiment has improved – if we play the next couple of weeks right, I don’t think Moody’s will downgrade us.”

 

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