Make sure you can cope with a tax hike
With the government facing a revenue shortfall, it’s likely that tax increases will be announced in the Budget next year. Martin Hesse reports on what you should do now to prepare for a reduction in your disposable income.
YOU NEED to prepare for the fact that, from March next year, it is likely that you will be paying more of your hard-earned cash to the government in the form of taxes and duties. Tax revenue is falling far short of expectations, and state spending is unlikely to be curbed in the near future.
The government has a delicate balancing act on its hands, because a point may be reached where increased taxes will have the opposite effect to what is intended, an issue alluded to by Finance Minister Malusi Gigaba in his medium-term budget speech a few weeks ago.
Kyle Mandy, tax policy leader at accounting firm PwC, says the government may be close to its limit in what it can extract from taxpayers through further tax increases.
He says at the last Budget, in February, a number of commentators, including himself, warned National Treasury and Parliament that the tax increases announced in the Budget, particularly on personal income tax, would likely push tax collection very close to the top of the Laffer curve, the point at which tax revenues are maximised and beyond which tax-rate increases actually result in a decrease in tax revenues.
TAX RATES AND REVENUE
Mandy says the Laffer curve (see graph) was developed by United States economist Arthur Laffer to illustrate the relationship between tax rates and the amount of tax revenue collected by governments.
“It suggests that, as tax rates increase from low levels, the revenue collected will increase. However, at some point, further tax-rate increases will actually lead to lower tax revenues as the disincentive effects of higher taxes begin to dominate,” he says.
“While Laffer’s primary objective was to illustrate that taxing any economic activity results in less of that economic activity and resultantly lower tax revenues, the Laffer curve also illustrates that higher tax rates result in a greater incentive for tax avoidance and evasion, which could also cause tax revenues to fall. In this regard, it is important to recognise that a tax system does not operate in a vacuum. It is affected by the social, economic, and political environment in which it operates,” he says.
The curve itself is not static. Mandy says: “Where taxpayers perceive a government to be corrupt, inefficient and wasteful, not delivering benefits to taxpayers or the broader citizenry, or when a country is going through tough economic times, the Laffer curve shifts downwards and to the left. This results in the tax system delivering less revenue at a lower maximum rate than in the absence of such conditions.”
He says there have been significant tax increases in the past few years, which saw the tax-to-grossdomestic-product (GDP) ratio increase from 24.5% in 2012/13 to 26% in 2015/16, primarily led by increases in personal income tax. Since then, the tax-to-GDP ratio has stalled at 26%, and it is “not unreasonable” to expect that the ratio for 2017/18 may fall below 26%.
“The stalling of the tax-to-GDP ratio comes despite significant tax increases in each of 2016/17 and 2017/18, which were expected to deliver R18 billion and R28bn of additional tax revenues respectively,” Mandy says.
Priya Naicker, the advice manager at Old Mutual Personal Finance, says although tax increases are generally considered not conducive to economic growth, the government may well deem them necessary to address the projected R51bn tax shortfall, the biggest revenue gap since 2009.
“If an income tax increase or rise in the VAT rate is announced in February 2018, your disposable income will shrink,” Naicker says. “Many South Africans will be forced to further tighten their belts in an attempt to make ends meet and avoid going into, or falling deeper into, debt.
“To prepare for this possibility, you should consider cutting back on spending, particularly on unplanned and unnecessary purchases. Now is the time to focus on reducing your debt and increasing your savings to ensure you are on track to achieve your financial goals (see ‘Reduce your tax burden while building a nest egg’).
“Being proactive and self-disciplined with your money is an essential stepping-stone to financial empowerment. Openly evaluate your expenses and have candid discussions with your family about money management.
“An objective professional, like a financial adviser, can help you evaluate your finances and empower you to make informed decisions. Partner with a financial adviser who can work with you to prepare for a potential tax hike and determine a realistic budget to ensure that you stay on track to meet your mediumand long-term goals,” Naicker says.