Savage fiscal consolidation a legacy of Zuma’s poison pills
Infrastructure spend will suffer most as Treasury is forced to resort to a VAT hike to balance the books
The first budget of the Ramaphosa administration was presented on Wednesday by a finance minister who was a poster child of the Zuma administration — and it highlighted the paradox at the heart of the speech. On the one hand, Cyril Ramaphosa’s ascent to the presidency holds out the prospect that SA will make the changes needed to alter its economic course, a prospect that has already boosted confidence and lifted growth forecasts off their earlier lows, making the budget ratios look somewhat better.
Arguably, too, the fact that there is now an administration in place that has political legitimacy – and Ramaphosa’s renowned negotiating skills – made it possible to opt for budgetary choices such as hiking the valueadded tax (VAT) rate, which Treasury officials had previously feared because of the popular protest they might trigger. On the other hand, this first budget of the new administration was all but crippled by the sins of the old. This was the budget that had to deal with the poison pill of free higher education that Jacob Zuma announced on his way out of the presidency in December.
And, as it turned out, that will cost SA at least R57bn over the next three years, making higher education the fastest-growing item of government spending, faster even than the ballooning cost of interest on government debt.
This budget had to accommodate that on top of the fairly savage exercise in fiscal consolidation it already had to undertake to rescue SA’s public finances from the legacy of the Zuma era.
It is a legacy of years of low economic growth and the erosion of state institutions, including the South African Revenue Service — a legacy that has seen SA’s public finances deteriorate to a level at which the public debt is headed for the R3-trillion mark, and two of the three ratings agencies have already junked us, while the third was on the point of doing so.
Against that background, the budget that was crafted was more decisive and savage than many might have expected. Crucially, it sent a clear message to ratings agencies and investors, as well as to the citizenry and to government itself, that government is serious about getting a grip on the public finances – a message entirely absent from Gigaba’s disastrous medium-term budget policy statement, when he was candid about the problems but offered nothing by way of solutions.
Gigaba announced tax hikes of R36bn and spending cuts of R85bn over the next three years – an unprecedented total of R121bn of fiscal consolidation measures – to address the huge revenue shortfalls and find the funding for free higher education. That helped improve the fiscal deficits for the next three years of the medium term from 3.9% to 3.6% in the first two years and 3.5% in the third. That’s still not good – the average deficit is 0.8 percentage points worse than the projections of a year ago.
Upwardly revised growth forecasts also helped improve the ratios: acting budget office head Ian Stuart says 70% of the improvement in the deficit came from consolidation measures, while 30% reflected higher GDP in nominal (money) terms.
Crucially, however, all this was enough to stabilise the ratio of government debt to GDP, which in October was set to get to 63% by the mid-2020s and just keep climbing, but now is projected to level out at 56% by 2023-24 – still high, but representing at least a return to government’s promise of fiscal consolidation.
The taxing and spending decisions reflect, in a way, just how much the legacy of recent years has constrained the choices Treasury could make in crafting the budget.
As Treasury deputy director general Ismail Momoniat put it, there was no way of meeting such a huge shortfall without dealing with one of the “big three” taxes – personal income tax, corporate income tax, and VAT.
Efforts to extract ever more from personal tax have run dramatically out of road after years of raising the burden on an ever-narrower base of high-income earners – Treasury budgeted to get R28bn of extra revenue in the current 2017-18 year out of the tax hikes announced last February, of which R16bn was to have come from personal income tax. Instead, however, this has fallen an estimated R21bn short of target.
Nor is it possible to extract more from corporate income taxes, which tend to be volatile at the best of times and lately have been performing poorly in an ailing economy.
With other countries slashing their corporate tax rates in a bid to become more competitive, SA is now an outlier in terms of its 28% corporate tax rate and overall corporate tax burden, says the budget review. That left VAT as the only real option – and while it’s often seen as more of a burden on the poor than on the rich, in SA’s case it is not that regressive because of the zero rating of staple foods and fuel, with as much 85% of VAT paid by the top 30% of households.
In any event, SA has long been out of line, particularly with developing countries, in its heavy reliance on direct (income) taxes as opposed to indirect taxes such as VAT.
This begins to change that mix, and there could be more hikes to come if government needs funding for a National Health Insurance system. In any event, the advantage of a VAT hike is that it brings certain revenue – and the boldness of the decision will do much to persuade rating agencies of SA’s seriousness about fiscal consolidation.
The mix of spending is much more of a concern, however, given that so much of government’s spending already goes on current items such as paying public servants and social grants, rather than capital investment that would lay down infrastructure and boost economic growth in the longer term. The spending cuts will make that worse, because higher education spending is really just another transfer to households – and because the most savage cuts are to infrastructure spending, which accounts for 47% of the R85bn in cuts. The toughest cuts have been imposed on provinces and local governments, which are meant to do much of the pro-poor and economically essential capital spending on items such as water or roads.
But higher education is a step change in spending for which the money has had to be extracted. And while the argument is that it will be a key step in changing life chances for young people from poor homes, one big problem with Zuma’s free-fee poison pill was that it was never the product of a proper, consultative policy process in which higher education was weighed up against other policy imperatives, with tradeoffs transparently faced and decided on.
Would students have called for free fees knowing this would end up having to be funded with a VAT hike and deep cuts to spending on water and sanitation infrastructure for poor people? With Ramaphosa in place, we have to hope that SA returns to the shaping of budgetary decisions through thoughtful consultative policymaking processes — including on the issue of how much SA should be paying its public servants.
There is the hope too that if he and his new team deliver on his promises of growth, investment and job-creating reforms, economic growth could surprise on the upside over the next three years and more – all of which would make the budget balancing act much easier.