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Taxes force start-ups underground

Teigue Payne

Statistics have shown a slump in the establishment of new businesses, but experts say they have just gone under the radar.

A 76% decline in the past five years in the officially recorded number of South Africans who are, at any one time, starting up new businesses does not necessarily mean that those businesses are not actually being started.

Although fewer businesses may be starting up because of recessionary conditions, most of the 76% fall is likely to be because more budding entrepreneurs are operating in the unrecorded informal sector, according to Adcorp’s labour economist, Loane Sharp.

This drastic decline—from 250 000 businesses being started up at any one time in 2001 to 58 000 in 2011, recorded in the Quarterly Labour Force Survey—might otherwise spell disaster for South Africa because small business hold the only real prospect of sustainable, large-scale job creation.

But it is another indicator of the general trend towards the “informalisation” of the South African economy. This, in turn, is a result of the overregulation of economic activity relative to South Africa’s development level.

Sharp said although many observers had been predicting a “youth spring” for South Africa because of the high levels of unemployment, this had not happened and was unlikely to occur because of the growth of the informal sector and its employment opportunities.

Sharp and Adcorp are well known for their controversial calculations, which indicate that South Africa’s informal sector is much bigger—and the economy overall is generally bigger—than Statistics South Africa’s figures indicate.

Both StatsSA and the other organisation that analyses post-apartheid statistics in South Africa, DataFirst, based at the University of Cape Town, have engaged in bitter debate in the media with Sharp on the size of South Africa’s informal sector, the percentage of unemployed and methodology in general.

Sharp said the essential difference in Adcorp’s methodology was that StatsSA and DataFirst relied on the questionnaires and surveys of StatsSA. Adcorp, where possible, checked other sources of data and extrapolated. The company apparently checks its projections on the size of the informal sector against cash demand and VAT collections (what should be received according to formal sources and what is in fact received), which highlights big discrepancies. Adcorp does this because it believes that people lie in questionnaires, especially when questions are asked that might affect their taxpaying status.

The huge discrepancies can be seen in the differences between, for instance, StatsSA’s data on the number of taxpayers and the South African Revenue Services’ figures (7.2-million against eight million) and StatsSA’s number of South Africans receiving social grants and the social welfare department’s figures (11.5-million against 15.2-million).

By these measures, Sharp said, a sample of South Africa’s leading statistics was about 28% undercounted. But the 76% decline in new business start-ups claimed would not be disputed by StatsSA because it came directly from its data.

A corroborating statistic is that the number of people operating a small business has declined by 400 000 from its peak of about 2.4-million in 2004, also directly from the same survey data. However, Sharp said the fact that so many small start-ups had perhaps gone “underground” indicated that the conditions for starting small businesses had deteriorated.

He speculated that this was primarily because of two factors:

  • Between 2003 and 2010, SARS offered a tax amnesty that netted many new taxpayers, including small businesses. The amnesty is now over and an additional burden of taxes has fallen on small businesses. Starting up underground is a way to avoid them.

  • Labour laws and regulations for small businesses have become particularly onerous. For instance, between 2004 and 2011 the number of cases dealt with by the Council for Conciliation, Mediation and Arbitration increased by 22%, from 128 000 to 156 000 a year. Sharp said the industry-wide extension of bargaining council wage agreements, typically reached between a handful of large employers and trade unions, also forced small businesses to pay higher wages, further prompting the option of going informal.

Sharp expects the informalisation of the economy to increase further, especially as more restrictive labour laws are likely to be implemented soon. He said such laws eventually had the opposite effect to that sought, resulting in less protection for labour and less unionisation, because informal workers had neither. The laws also encouraged lawlessness and undermined the ability to gain accurate statistics, which meant discrepancies would increase.

Heavy regulation builds a shadow economy
Two German experts on the informal, shadow or underground economy internationally, Friedrich Schneider and Dominik Enste, list the main factors in its growth in any country as high taxation, heavy regulation, rising labour costs, rising corruption and declining “tax morality”. All these factors are present in South Africa.

Working in the shadow economy may consist of a second job after (or even during) regular working hours, work by individuals who do not participate in the official labour market, work by people who are, for instance, on social security benefits and therefore not allowed to work in the official economy, professionals who do not declare all their income and so on.

It is thus not just basic businesses such as small spaza shops that operate in this economy.

An international survey for 1990 to 1993 on the size of shadow economies in various countries reflected that, as expected, in developing countries the percentages were much higher. Nigeria topped the international list with 68% to 76%, depending on the measurement method used, of shadow economy as a percentage of gross domestic product (GDP). By comparison, the United States, Austria and Switzerland, for instance, were at 8% to 10%. But the percentages in developed countries are likely to have increased since then because of rising taxation and regulation.

South Africa had a small shadow economy of 9% in 1989 to 1990, according to the experts. It was low for a developing country and was likely to be mainly because black enterprise was discouraged.

Adcorp believes that the figure is now 12% to 17%, still relatively low given South Africa’s level of development, probably because of the power of the formal sector in South Africa (for instance, banks are active in informal lending, making it difficult for stokvels).

StatsSA and DataFirst do not estimate South Africa’s shadow economy as a percentage of GDP, because it is unrecorded. But StatsSA’s official estimate of informal employment is 2.1-million people, against Adcorp’s 6.5-million.

According to StatsSA’s fourth quarter 2011 Quarterly Labour Force Survey, the informal sector lost 91 000 jobs compared with the fourth quarter of 2010. It compared growth in formal employment of 453 000 jobs in the same period.

Adcorp does not agree that this happened. The 15.2-million South Africans on social security (according to the social welfare department) are likely to have considerably boosted the shadow economy. This is because, the German experts point out, individuals receiving social welfare will often look for work only in the shadow economy, because they would be disqualified from welfare payments if they landed formal jobs.

Assuming that more small businesses in South Africa are starting up “underground”, the disadvantages for society are that employees are paid in cash, do not pay tax other than VAT and are not protected by statutory benefits.—Teigue Payne

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