TAX: IT’S NOT AS BAD AS YOU THINK
At a time when many corporates are taking immense strain, as reflected in the sharp weakness in corporate income tax collection, the surprising buoyancy of personal income tax provides some hope for the fiscus
here may just be room for a bit of an upside revenue surprise over the next few years. And, if so, there’s more likelihood that the National Treasury’s intended fiscal consolidation will be achieved.
That’s if an in-depth analysis of South African tax data going back more than a decade is correct. It suggests that there is more stability and resilience in the personal income tax (PIT) tax base, and greater buoyancy of income and real earnings in the economy, than the national accounts are telling us, and than many commentators believe.
That’s not to say South Africa is out of the woods. Though the PIT revenue and income trends show there is resilience in the economy, growth is still far too weak, which means the fiscus will remain under pressure until the rate of investment is boosted.
This is the view of former National Treasury deputy director-general Andrew Donaldson, now a senior research associate of the Southern Africa Labour & Development Research Unit at the University of Cape Town. It is based on his painstaking analysis of National
TTreasury and South African Revenue Service (Sars) data, adjusted for inflation and aligned with actual PIT revenue collection from 2011 up to the 2022/2023 tax year.
His analysis shows how PIT has continued to strengthen over the past decade while corporate income tax (CIT) has lagged behind as a source of tax revenue.
Between 2011 and 2023, PIT has climbed from about 7% to 9% of GDP and, as a share of taxable income, from 16% to 19%. Donaldson estimates that about a quarter of this increase has been due to a rise in personal incomes relative to GDP, with the balance attributed to a tightening of the screws by the taxman and shifts in the income distribution.
The overperformance of PIT over the past six months has been particularly stark when set against the sharp underperformance of CIT.
For the first half of the 2023/2024 fiscal year, PIT
collections were 7.9% higher, or R22bn more than the same period last year. This led the National Treasury to upwardly revise its PIT revenue estimate by R6.4bn in the recent medium term budget policy statement (MTBPS), even as it warned of a total revenue undershoot of more than R56bn, due mainly to a nosedive in provisional mining CIT.
“It does appear that the PIT tax base has proved remarkably resilient — and at a time when many commentators expressed concerns about narrowing at the upper end of the income distribution due to an ageing population and emigration,” says Chris Axelson, acting deputy director-general (tax and financial sector policy) at the National Treasury.
Donaldson’s analysis shows that despite growing slowly, and being interrupted by Covid, the number of taxpayers above the tax threshold has continued to rise to more than 7.5-million people now, against 7.4-million in 2019, 6.8-million in 2017 and 5.9-million in 2011.
But what is more striking — and “a real concern” to Donaldson — is the marked difference between the more buoyant 2011-2017 period and the period since 2017, when real growth in income and revenue has been much slower.
In the first period, taxable income grew by 8.7% a year; in the second by 5.2%. In real terms, PIT revenue grew by 5.1% in the first period, and by just 1.1% in the second.
Among taxpayers, the fastest-growing income group has been those with taxable incomes of between R730,000 and R930,000 a year (in 2022/2023 real terms). This group grew by 7.4% a year in the pre-Covid era (2011-2017) but slowed to 2.9% annual average growth in the 2017-2023 period. Over the past 12 years, it has almost doubled in size, growing from 192,000 taxpayers to 348,000.
The top earnings group — those with taxable incomes above R1.9m a year in real terms — is also the smallest, numbering just 117,000 individuals. It also grew quickly — by 5% in the pre-Covid era but then slowed sharply to post only 1.6% growth in the 2017-2023 era. It has added 37,000 new taxpayers over the past 12 years, an average of about 3,000 a year.
The slowest-growing income group has been at the bottom end, those with taxable incomes of between R100,000 and R250,000 a year. This group grew by 1% a year in the pre-Covid era but stagnated thereafter, according to Donaldson’s estimates. This may reflect low numbers of new entrants into the labour market at this level.
What Donaldson’s estimates show is that whereas income inequality widened somewhat over the 2011-2017 period, since then the growth of taxpayer numbers, and income, has been stronger in the middle-income groups that shoulder most of the tax burden.
An economy ‘bubbling away’
So what explains the surprising PIT buoyancy in an economy which is battling to grow, and is there room for further upside surprises?
According to Sars, there are many reasons why PIT has been so buoyant, including annual increases in employee income that exceed wage inflation, incentive scheme payouts, the upward mobility of taxpayers into higher income brackets, and improvements in taxpayer compliance.
Of course, there has been a policy element behind the rise in PIT revenue too, including years when there was insufficient
adjustment for fiscal drag, the 1 percentage point shift up in tax rates in 2015/2016, the introduction of a new 45% tax rate in 2017/2018, the move to keep the maximum deductible retirement contribution constant, as well as making below-inflation adjustments to medical scheme credits.
All these measures have contributed to higher PIT revenue and higher numbers of people above the tax threshold.
As far as 2023 goes, the authorities are not yet able to track the micro-data for in-year numbers (most PIT taxpayers file only in July of the following year), so it is difficult to determine an exact reason for the higher collections just yet.
But their best estimate, based on sectoral and interim tax administration data, is that higher PIT collections are mainly attributable to a sustained recovery in earnings, higher bonus payments and vesting share incentives from employers, especially in the financial sector. In other words, bankers have been having a very good year.
But to what extent can this resilience be expected to continue?
Donaldson says the “surprising buoyancy” in PIT revenue reflects resilience in household and personal income and that this is part of a slow but extended postCovid recovery phase, supported by broader job creation in business services, changing patterns of household consumption, and small business activity.
He estimates that taxable income has grown as a share of GDP from 45% in 2011 to almost 47% in 2023. Sure, there has only been 0.4% real taxable income growth over the 2017-2023 period (against average real GDP growth of 0.5% over the same period), “so it’s not as if the economy is booming,” he concedes, “but it’s not a dead economy either”.
Sars commissioner Edward Kieswetter makes a similar point. While tax revenue net of refunds is what matters for overall fiscal management, he argues that gross tax revenue (GTR) actually says far more about what is happening in the economy.
Over the year to date, GTR is up 4.5% year on year, in line with the February budget estimate and current expectations that the economy will grow by 4.3% in nominal terms in 2023.
At a GTR level, the financial services sector has grown by 6.5% year on year, community services by 8.6% and the wholesale/retail sector by 5.3%. Moreover, gross VAT is up R14.7bn over the year to date, the gross fuel levy is up R7bn, and gross PIT is up R4.9bn relative to February’s estimates.
This, Kieswetter says, is “evidence of an economy that is actually bubbling away quite well except for corporate profits”. And the latter is not a reflection of the state of the general economy, he insists, but largely because of the constraints imposed on electricity supply and the national logistics system by Eskom and Transnet, which have slowed production in mining.
Donaldson goes so far as to predict a likely recovery in CIT and VAT over the remainder of the fiscal year and into 2024, as household debt levels have stabilised, inflation has moderated and as load-shedding begins to ease.
Kieswetter is more circumspect. He thinks the Treasury’s MTBPS adjustments, in slashing R56.8bn off the revenue line, take “a balanced view” of taxes that underperformed in the first half of the year, such as provisional CIT payments and VAT, vs those that overperformed, such as PAYE, trade taxes and the fuel levy.
Certainly, he expects to have a much better gauge once the December provisional CIT outcomes are known, particularly with respect to payments from the mining sector.
The R56.8bn predicted revenue undershoot is driven mainly by the Treasury’s expectation that CIT collection will continue to be poor over the rest of the fiscal year due to the collapse in mining sector profitability. This has been driven by weaker global demand for mineral commodities, softening commodity prices, and severe electricity and logistics constraints that have hobbled mining output.
Over the year to date, provisional mining CIT has fallen by R24.6bn or
55.4% relative to the same period last year. The total CIT shortfall is expected to be R35.8bn relative to the amount budgeted for in February.
Another key factor contributing to the current revenue shortfall has been the size of VAT refunds, with R29bn paid over the year to date — R21.5bn more than the same period last year.
Sars attributes this mainly to increased capital expenditure on embedded generation and a general increase in input and fuel costs claimed by VAT vendors, driven by the inflationary environment. Rand depreciation has also increased the cost of imports and the related VAT input values claimed as deductions.
Capacitating Sars
Axelson agrees with Donaldson on the strength of PIT collections but is not convinced that this will translate into higher CIT and VAT collections. He also points out that though PIT outcomes have been stronger than expected in recent years, “that doesn’t mean there aren’t underlying vulnerabilities ”— not least the constraint imposed by the very high unemployment rate.
In addition, he says that in a downturn, the impact on CIT and VAT are immediate, while the potential impact on PIT could take longer to materialise given, for instance, that wage adjustments and layoffs are subject to various dispute resolution mechanisms.
On the other hand, the Treasury concedes that since the 2021 budget, it has
considerably underestimated actual PIT collections. It is even considering reviewing the cautious PIT buoyancies pencilled into the MTBPS, which are more conservative than the actual outcomes of previous years.
The Treasury is also considering reviewing its assumptions regarding the relationship between formal sector wage bill growth and PIT growth. It downgraded the relationship in the late 2010s, but Axelson recognises that the correlation may have declined due to administrative issues at Sars at the time.
Either way, the fact that the Treasury expects the economy’s wage bill to grow by 6.9% vs projected inflation of 4.6% over the medium term is certainly positive for the PIT outlook.
Kieswetter also credits the revenue compliance push by Sars for having bolstered PIT growth.
He estimates that between April and September 2023, targeted Sars compliance activities yielded R118.4bn (almost 15% of net revenue collections). This represented year-on-year growth in compliance-related revenue of R26bn or 28%.
His optimism about the sustainability of tax revenue rests partly on the headway Sars continues to make in this area as well as on the opportunity presented by the size of the tax gap (the gap between the actual tax paid and what is legally owed to Sars).
A number of studies, including Sars’s own research, put the tax gap at R200bn-R300bn.
“I think that, given current levels of compliance, the growing informal economy, high levels of tax crime, corruption, as well as aggressive tax planning, the actual undercollection is likely to be well over R300bn,” says Kieswetter. “In addition, the size of outstanding debt owed to Sars is more than R250bn.”
He has long argued that collecting the taxes due to the fiscus is the most effective way to improve the public finances and, therefore, that funding Sars adequately, to ensure that it is modernised and appropriately capacitated, is the most effective way to improve the country’s fiscal integrity.
He vows that Sars will continue to pursue its compliance programme and “will leave no stone unturned” to improve on the MTBPS revenue projections.
Growth is ‘far too weak’
Despite its positive message regarding the resilience of PIT, Donaldson’s analysis shows the economy’s growth momentum remains very sluggish compared with the pre-Covid period.
In the longer run, South Africa’s low economic growth rate and high unemployment rate (even though the latter has moderated of late) will remain a concern for the growth of PIT as well as overall revenue collection.
“The economy is not only underperforming in terms of real growth,” says Kieswetter, “but the potential growth rates of the economy are also constrained to the extent that the supply of electricity hampers economic activity and, more so, fuels inflation ... The result is tighter monetary policy, with higher interest rates for longer, diminishing disposable income and consumption taxes.”
In addition, he points out that rising fiscal debt and higher related financing costs are imposing an additional burden on the public purse, as well as constraining capital investment that would otherwise have grown the tax base and tax revenue.
In short, though South Africa’s tax base continues to grow, with most of the tax burden being carried by the large middle-income layer, the rate of growth has slowed significantly in the past few years in line with the stumbling economy, putting pressure on the fiscus.
The real solution is faster growth because this would allow the tax base to grow faster organically without the need for new or higher taxes that will further dampen economic activity.
“While the PIT revenue and income trends show there is still resilience in the economy, growth is still far too weak,” says Donaldson. “It’s time to take steps to boost investment and strengthen the recovery economic growth will take care of the country’s fiscal consolidation and debt challenges over time.”
Until then, improving tax compliance (as opposed to instituting new taxes) will remain one of the most efficient ways to improve South Africa’s fiscal integrity and ensure its long-term sustainability.