Praise for Pravin, but things are looking bleak for the economy

Only faster economic growth can take the pressure off SA’s strained public finances and overburdened taxpayers

SA’s lethargic growth rate has placed immense pressure on the country’s public finances, resulting in a R30bn revenue shortfall that has forced treasury to double down on measures to curb the build-up of debt.

The past year is the first since 2009/2010 that tax revenues have not kept pace with economic growth. This has created a huge hole in the budget and cast a cloud over the future pace of revenue collection.

But such is the esteem in which finance minister Pravin Gordhan is held that he received a standing ovation before and after delivering his budget speech in parliament.

Praise even came from opposite sides of the ideological divide. Julius Malema’s EFF loved Gordhan’s message of economic transformation, while the rating agencies were comforted by the budget’s adherence to fiscal discipline.

But all the cheering should not distract from the fact that the 2017 budget reveals just how fiscally constrained SA has become. Most alarming is that the buoyancy of tax revenue (its responsiveness to economic growth) has nosedived over the past year — and it appears that treasury is unsure why.

To accommodate the revenue slowdown — SA’s steepest decline since the global financial crisis — the expenditure ceiling will be reduced by R26bn over the next two fiscal years while taxes will be raised by R28bn in 2017/2018.

Since these adjustments were announced in the October medium-term budget policy statement, there are no new shocks for the markets to digest from the budget, other than the form that the new tax measures will take.

This includes the creation of a new top personal income tax bracket of 45% for taxable incomes over R1.5m/year, very little relief for fiscal drag, and an increase in the dividend withholding tax rate from 15% to 20%.

Investec Asset Management’s Nazmeera Moola says as there were only 75,000 individuals earning above R1.5m in 2015, this measure is likely to raise only about R4.4bn for the fiscus. Treasury’s official documents put this number slightly higher, at 103,000 people. Either way, with the base small at the high end of income distribution, the room for further tax hikes is very small.

By contrast, the “limited adjustment” for bracket creep will rake in an additional R12.1bn.

“The upshot is that every single income taxpayer is affected and paying the price of SA’s slow growth and inefficient expenditure,” says Moola. “This will certainly constrain consumption growth in 2017.”

The Budget Review concedes that continuing to raise the personal income tax burden could have negative consequences for growth and investment. It also appears to prepare the ground for a Vat hike down the line.

“If growth does not accelerate over the medium term, it may be necessary to adjust consumption taxes,” the Budget

Review says. “The least economically damaging means of doing so would be to increase the Vat rate, which is low by global standards.”

As ever, the budget hangs together because it assumes an automatic upswing in economic growth in the future.

Treasury has not changed its forecast that economic growth will recover from about 0.5% in 2016 to 1.3% this year, 2% in 2018 and 2.2% in 2019. This is only slightly more optimistic than the prevailing Reuters consensus.

But even with faster growth and projected fiscal consolidation of R154bn (from 2015/2016 to 2018/2019), treasury hasn’t been able to avoid a small amount of fiscal slippage.

The consolidated budget deficit is still intended to come in at -3.4% of GDP in the 2016/2017 fiscal year, as announced in October, narrowing to -3.1% next year. But net loan debt will now stabilise at 48.2% in 2020/2021 – a year later, and 0.3 of a percentage point higher than before.

The goal of achieving a primary surplus has also been pushed out a year to 2018/2019. In general, when the primary balance (revenue minus noninterest spending) is in surplus, the debt-to-GDP ratio can be expected to fall.

Moola says: “While there will be some disappointment in the revenue slippage and increased issuance, we believe the budget should be enough to retain SA’s credit rating through June 2017 — provided there are no major personnel changes at the finance department and that growth continues to improve as forecast.”

Michael Sachs, head of treasury’s budget office, stresses that SA’s underlying fiscal fundamentals have steadily improved. For a start, the primary deficit halves as a share of GDP in the current year, and will even move into surplus over the medium term.

This improvement in the primary deficit is a clear statement of intent, says Sanlam Investment economist Arthur Kamp. “It is also a remarkable achievement in a low-growth environment with an excessive unemployment rate and rising demands on state resources.” But Kamp points out that an ideal, lasting fiscal adjustment is one where a government cuts consumption spending, boosts infrastructure investment and limits tax increases to taxes on consumption.

“We’re not doing any of that,” he says. “If you increase the dividend withholding tax, you reduce the return on savings and, in an economy with a dearth of savings,

you frustrate growth.”

North-West University Business School economist Raymond Parsons makes a similar point, arguing that about two-thirds of the fiscal consolidation appears to be coming from tax measures and only a third from spending restraint. Parsons warns that unless renewed growth boosts tax revenues, a more aggressive tax policy could ultimately prove self-defeating.

Of course, part of the problem is that the SA Revenue Service (Sars) has fallen far short of its collection targets. Gordhan admitted during a prebudget press briefing — from which Sars commissioner Tom Moyane was notably absent — that he was worried about the shape of revenue collection.

Gordhan said he had met Sars senior executives four times in recent weeks to discuss tax administration. While the lack of trust between Gordhan and Moyane is a matter of public record, the feud hasn’t appeared to affect revenue collection — until now.

The Budget Review states explicitly that given rising public concerns about corruption, wastage and inefficiencies in service delivery, citizens’ willingness to contribute tax can’t be taken for granted.

Responding to speculation that either he or his deputy, Mcebisi Jonas, may soon be replaced, Gordhan said: “It is in the interests of a generation of South Africans to come that you don’t mess with the national treasury and Sars.

“It can take many years to build a solid institution, but it takes very little time to mess it up.”

Asked to comment on the possibility of Brian Molefe, the disgraced former CEO of Eskom, as a potential replacement, Jonas said “political deployments that fly against all rational thinking” had complicated the task of growing the economy.

Besides the heightened uncertainty around revenue collection, the Budget

Review cites several other risks to SA’s public finances. These include:

Policy changes made without consideration of the budgetary consequences, like those related to higher education;

Infrastructure projects that are poorly designed and not effectively delivered;

Financial imbalances related to water and electricity charges;

The public-sector wage bill increasingly crowding out other areas of spending;

The risks posed by mismanaged state companies; and Rising debt service costs. Debt service costs will climb from R146bn now to R197bn by 2019/2020. These costs remain the fastest-growing item in the budget, diverting critical resources from frontline services. In fact, for every R1 collected in tax, 13c must be diverted to service debt.

To rein in debt and accommodate new priorities, such as higher education, large adjustments have been made to spending plans.

National, provincial and local government must together take a combined haircut of R18.4bn, or 0.4%, off baseline budgets over the medium term.

But after the deaths of more than 100 psychiatric patients as a result of cost-cutting by the Gauteng health department, treasury is painfully aware of the budget execution risks as it expects departments to make do with less.

“As much as we believe there’s waste and inefficiency that can be corrected in response to pressure, that doesn’t mean that wrong decisions won’t be made,” says Sachs.

“If they plan with care, they can avoid seriously compromising service delivery. But if they are rash and determined to protect the wrong things, they can make mistakes.”

With the system under immense pressure, SA’s fiscal position will not improve significantly unless growth can be reignited beyond 2%.

SA needs to develop “a national obsession” with growth, Gordhan exhorted. And not just any growth, but inclusive, transformative growth that has the broadening of economic opportunities as its main goal.

The Budget Review is careful to make a distinction between narrow transformation that benefits only a wellconnected elite, and the creation of jobs and opportunities that would lift the masses out of poverty.

“Growth without transformation would only reinforce the inequitable patterns of wealth inherited from the past,” it says. But, it adds, “transformation without economic growth would be narrow and unsustainable”.