Mike Haworth
Reflecting back on the 2016 budget and looking forward to 2017, notwithstanding South Africa’s turbulent political climate, there is cautious optimism around the 2017 budget.
According to Jannie Rossouw, head of the University of the Witwatersrand’s school of economic and business sciences, as far as the 2017 budget is concerned, only two issues really matter. The first is who will be the minister of finance, and the second is how extra revenue will be raised.
“There is a reasonable expectation that Pravin Gordhan will be the minister of finance when the budget is presented, which is of particular importance, as South Africa will not experience a credit risk downgrade while he remains finance minister,” claims Rossouw.
“Credit risk agencies understand that a downgrade while Gordhan serves as finance minister, will give President Zuma reasons to dismiss Gordhan. The effect of a downgrade will be a massive increase in the country’s borrowing costs (borrowing of government debt).
“It was announced in the October 2016 Medium Term Budget Policy Statement that the South African government requires an additional R28-billion in tax revenue for the 2017/18 tax year to keep the deficit before borrowing within a reasonable limit.
“The big focus of the budget will therefore be on raising revenue and the important issues become matters such as the types of taxes to be increased. Issues that come to mind are a possible VAT increase (or not, given the impact on the poor), higher personal income taxes, a possible introduction of a wealth tax and then sin taxes.
“There is also pressure for a [possible] wealth tax, so it will be interesting to see whether this is introduced as a new form of taxation. Given the need to raise revenue, it follows that South African taxpayers should brace themselves for a larger tax burden,” says Rossouw. “South Africa can move from a fiscal cliff to a fiscal plateau if the growth of social grants, civil service employment and the salaries of civil servants can be curtailed.”
Extraordinary challenges
In the 2016 mid-term budget speech, Gordhan cautioned against expectations of finding straightforward answers. He said: “The budget process, every year, is a reminder that we face many difficult questions [including] how to make further progress in housing, clean water and sanitation for all, create equal access to health care, accelerating job creation and small enterprise development and how to expand access to further education and advance our technology capabilities.”
He further explained that the economic environment this year was unusually difficult and brought with it other “extraordinary” challenges.
“Slow economic growth means that employment has declined over the past year [2016]. Many businesses are in difficulties and households are struggling to make ends meet. We have been acutely aware of the depth of these stresses, and the diverse interests and expectations of South Africans who need work, want to study, seek opportunities in their careers or businesses and for their families.
“All of us have expectations of government, of the economy and indeed of our political system. We expect delivery. We expect change for the better. We expect progress in South Africa. Above all, we expect a better future for our children — particularly through education.”
Education and regulation
When dissecting the proposed sugar tax, for example, to come into effect in April 2017, there are concerns that the anticipated R4-billion in public revenues from this will be driven into the fiscus, rather than used for education about the impact of sugars and lifestyle diseases such as cancer, obesity and diabetes. As welcome as the tax revenue might be, it would thus become just another consumption tax.
Data from the UK and the US has shown the supposed health benefits of this tax have proven negligible. Coupled with this are South Africa’s current draft tax laws, which give little to no incentive for companies to actually comply.
“The sugar tax will be an excise tax,” says Mike Haworth, investment strategist at Sasfin Wealth. “Excise taxes are selective on products in terms of coverage, discriminate in intent and often have some form of quantitative measure linked to the tax liability. The proposed sugar tax will be at a rate of 2.29 cents per gram of sugar, based on the current product-labelling framework. This rate roughly equates to a 20% tax for the most popular soft drink, Coca-Cola, averaging 35g/330 ml.”
Haworth says this new tax creates a plethora of fresh issues such as labelling, advertising regulations, administrative complications, tax evasion, job losses, product substitution and more.
“Inevitably there will be debate as to whether all sugars are equal. For the full health benefits to be achieved, a sugar sweetened beverages (SSB) tax will need to be part of comprehensive and integrated approach to address obesity and its related diseases. If it is an isolated intervention, the sugar tax will be judged to be discriminatory.
“A package of measures, including education and regulation and tobacco control, would have to follow. The SSBs form part of a convenience food offering which has become an integral part of an urban lifestyle where infrastructural constraints have dictated a growing convenience imperative. This means that consumer will have to switch to alternatives of the same or similar foods.
“The new sugar tax will disproportionately affect the lower, and to a lesser degree the middle-income groups, as it will push up inflation on non-alcoholic beverages, but its weight is only 1.91% in the consumer headline inflation basket.
“Companies affected include sugar producers and bottlers and the tax might well affect their earnings, and ultimately, the economy.”
Economic transformation
Undermining the key message expected in the 2017 budget speech — post President Jacob Zuma’s State of the Nation Address emphasising radical economic transformation — is how feasible this actually is, particularly in the light of South Africa’s high inflation rates.
“The middle class is affected more by rising or falling inflation than the higher income group, but the low-income group is the most sensitive to accelerating or decelerating inflation, because of the high proportion of food and transport costs in their expenditure mix,” says Haworth.
“It is our view that headline consumer inflation will fall significantly in the second half of 2017 and the first half of 2018, due the high base set in 2016, the current strengthening of the rand and assumed non-recurrence of drought conditions and a relatively stable international oil price.”
Haworth explains the main implication of inflation is the degree to which it impacts real household disposable income, with nominal income growth expected to be around 7%-8% in 2017. However, he says that should the expected headline inflation decelerate sharply, this will provide some relief in real disposable income.
“This relief is likely to be offset by higher income taxes and inflation increases in utility tariffs and licences. These tariffs are set on a steep sliding scale, which impacts the middle and higher income groups the most. Importantly, if the headline inflation decelerates as expected, the South African Reserve Bank is likely to respond by lowering its benchmark repo rate, which would provide interest relief to indebted middle-income households.”
Ultra-slow economic growth
Haworth believes the focus of the budget will be fiscal consolidation to control the trajectory of public debt to GDP, meaning that the budget deficit must be progressively lowered over the medium-term.
“This is a difficult task given the ultra-slow economic growth,” he says, “and given this, the fiscal consolidation will continue to take the form of higher income taxes and discipline to adhere to their main budget expenditure ceiling target over the medium term.
“Popularist pushes for National Health Insurance and free tertiary education cannot be afforded in the current low economic growth environment and heavily skewed personal income tax revenues.
“Also in the current low economic growth environment, National Treasury has minimal probability of success of rapid, radical economic transformation without severely impacting the activity and capacity of the economy, with fiscal consolidation fundamentally slowing aggregate economic growth.”
Haworth says increasing regulation, while understandable as a long-term objective, is strangling economic activity and undermining business confidence, both of which are structurally lowering the potential output growth in South Africa, which the South African Reserve Bank currently estimates to be 1.5% per annum.
“The drive for “radical economic transformation” dictates a major dislocation of current economic activity that is likely to structurally undermine economic growth in the short and medium term.
“If the economy was deregulated [and] the political environment stabilised to become more predictable, then confidence and private sector investment would return, enabling the economy get to growth rates of 5% per annum. At these high growth rates, transformation of the economy would take place naturally and every able-bodied person in South Africa would need to be employed to support the higher growth rate.
“We see personal taxes as being the main driver of tax revenue increases. The higher excise duties, sin and sugar taxes, are effectively higher VAT in another form. We do not see an increase in VAT though National Treasury may warn that it will be increased in 2018.
“The commodity price rally is expected to boost mining tax revenues that will provide some extra revenue to company taxes. Economic growth is expected to be marginally higher, which could lift company tax revenues slightly.
“Beyond these tax increases the fiscal consolidation will have to be balanced by slower expenditure growth. This is very difficult in an urbanising country where more and more police, nurses, teachers and utility maintenance people are required,” concludes Haworth.