This week’s budget speech takes place in the context of renewed optimism for South Africa’s economic prospects, exemplified in recent rand strength. While business in many respects shares this optimism, it is also aware that much depends on the minister of finance’s ability to convince lenders, investors and the ratings agencies of South Africa’s commitment to fiscal consolidation in a manner least disruptive of economic growth.
The following are key considerations in respect of the 2018 budget:
The primary risk facing South Africa’s public finances in recent years has been the steadily-rising budget deficit and debt-to-GDP levels. Indeed, if National Treasury guarantees to state-owned entities (SOEs) are included, South Africa’s overall government debt is in excess of 70% of GDP – making a ‘debt trap’ difficult to avoid. This has been a feature of recent budgets, with about 13% (and rising) of current government revenue diverted towards debt servicing.
Stabilising, and ultimately reducing, debt-servicing costs are a precursor to further increases in social spending and reductions in poverty, inequality and unemployment in a sustainable manner. Further sovereign ratings downgrades are likely to be difficult, but not impossible to avoid and will depend on credible fiscal consolidation measures.
The dilemma: expenditure reduction vs revenue raising
In the immediate future, only two broad avenues to reach fiscal sustainability are available, namely reductions in government expenditure or increases in revenue (taxation). In reality, a combination of both is likely and necessary. Over the longer term, only economic growth can sustainably balance the dual requirements of sustainable public finances and pro-poor policies. Any increases in revenue therefore need to ensure that growth is not prohibited by excess taxation.
Government expenditure has been made possible in recent years by a steady growth in tax revenue, mainly in the form of personal income tax (PIT) at a rate in excess of GDP growth. However, problems are arising – tax collection has been falling short of forecasts and the budget will likely reveal a further significant shortfall in tax revenue (forecast in October to be just short of R51 billion).
Evidence is emerging that taxation is beginning to reach levels where further increases would be self-defeating, through the negative impact on economic growth and levels of compliance. In short, the emphasis in the budget should be on reducing expenditure, which should include the sale of non-core assets as part of the solution.
Notwithstanding, tax increases appear inevitable in the short term and in this regard increasing value-added tax (VAT) appears at the current juncture the least-damaging option.
However, business agrees that this is a regressive tax that disproportionately affects the poor. Therefore, compensatory mechanisms should be considered.
A 2% increase in VAT to 16% would yield approximately R40 billion. When combined with an increase in zero-rating for basic goods and increased social expenditure to compensate the poor, R30 billion could be raised through the increase in VAT to 16% which, when combined with other measures (including, for example, limiting fiscal drag relief in PIT), could address a significant part of the budget deficit.
Arguably, the biggest risk to achieving reductions in expenditure lies in the lack of control in spending by SOEs in recent years, with poor governance appearing the primary cause. Continued bailouts by Treasury for SOEs have undermined the credibility of fiscal consolidation measures and served to reduce the finances available for social spending. Of particular concern in this regard is Eskom, with government’s adherence to an outdated model of a vertically-integrated, State-owned monopoly electricity utility the primary cause.
Answers to the particular problem posed by Eskom (and other SOEs) need to be addressed according to economic rationale and whether they support national developmental goals. Consideration should therefore be given to a degree of strategic unbundling that encourages private sector investment. Policy also needs to support the fiscus – solving the problem of Eskom for example is impossible without the finalisation of a least-cost integrated resource plan.
As a general rule, government needs to exercise caution around policy pronouncements where costing has not been addressed. While business supports the objectives of a number of government programmes, including expanding access to tertiary education, National Health Insurance and Comprehensive Social Security, it is necessary to create the fiscal space for the delivery of such programmes.
Credible cost-benefit analyses should accompany any new (and even existing) fiscal commitment.
Non-performing government programmes should be terminated post-haste, and fruitless and wasteful expenditure eradicated.
In the near term, public sector wages present a major risk. While business is sensitive to under-pressure workers, any settlement in excess of CPI will inevitably have the effect of necessitating expenditure reductions elsewhere (e.g. social spending) or increasing revenue to self-defeating levels.
Support for growth
Business recognises that there is currently very limited fiscal space to support growth. However, long-term fiscal sustainability requires growth and options to consider, among others, include:
- Tax incentives for companies that demonstrably boost exports, create jobs, etc. where benefits can be shown to exceed the costs of the incentive;
- Support for high-potential sectors such as tourism through, among other measures, easing tourist visa requirements;
- Boosting access to broadband through a national digital strategy to enable South African firms to take advantage of the fourth industrial revolution; and
- Creating regulatory certainty for business in general, including reducing the regulatory burden for small business.
The 2018 national budget is critical and will necessitate tough choices on the part of government. Fiscal consolidation, through moderate revenue increases and expenditure reductions, holds the only prospect of sustaining government’s pro-poor, pro-growth policies over time.
Simply put, failure to get spending under control may result in an extended period of enforced austerity should South Africa be forced to seek a bailout. This would have devastating effects for all South Africans, but particularly the most vulnerable.
It is essential that this week’s budget displays the leadership necessary to balance the budget and create the conditions for growth, job creation and transformation.
Olivier Serrao is director of economic and trade policy at Busa.