Budget 2019: Government cannot spend itself out of a hole

President Cyril Ramaphosa
President Cyril Ramaphosa

Eskom’s debt is the immediate issue that Treasury needs to deal with, but there are few – if any – viable options that wouldn’t hurt our pockets, writes Azar Jammine.

Confirmation by President Cyril Ramaphosa in his state of the nation address last week that government would support Eskom’s balance sheet, while it may have been unavoidable to prevent an immediate debt crisis, has serious implications for the budget, which is set to be delivered by Finance Minister Tito Mboweni on Wednesday.

An Eskom default on its debt would ripple through the entire book of government loan guarantees to state-owned enterprises, which stood at a total of R462 billion last March, probably prompting an instant downgrade of the sovereign credit rating and a dramatic increase in debt servicing costs, which we can little afford.

Bitter as the pill may be – the recapitalisation of Eskom is expected to come in at a minimum of R100 billion, or an instant 2% increase in the debt-to-GDP ratio – there is no option but to swallow it.

Quite how this will be financed is the big poser for Mboweni, and may lie behind the proposal announced in the ANC’s election manifesto to introduce prescribed assets for pension funds.

This would be a hugely unpopular move considering low levels of confidence in the governance of state-owned enterprises and the recent damaging revelations about the Government Employees’ Pension Fund manager, the Public Investment Corporation.

But it is also pretty clear that tax increases of any kind to fund the Eskom bailout would be not only equally unpopular, but probably counterproductive.

As it is, there has been a shocking decline in tax assessments in recent years in personal and company tax, indicating the encroachment on revenue of the Laffer curve effect – the point at which an increase in tax rates produces a decrease in tax collected instead of a commensurate increase.

Personal income tax rates for the middle- and upper-income brackets has increased sharply – by an effective 2% to 3% a year – through the effects of a sharp increase in the top marginal tax rate from 41% to 45% in the 2017/18 financial year and bracket creep as National Treasury has chosen not to adjust tax rates to keep pace with inflation.

The impact of this on disposable income of the wealthy can be seen in steeply falling sales of luxury car brands such as Mercedes, BMW and Audi, which are traditionally more resilient in a downturn.

Some of this may be attributable to emigration, but there is clearly also a high level of resistance to tax increases, which is having an effect on revenue, and another increase may prove even more pernicious.

This effect is also visible at the lower end of the spectrum.

For example, consecutive above-inflation increases in excise tax on tobacco have produced a R1.94 billion decline in revenue over two years instead of an expected increase.

The Treasury’s estimation of tobacco excise tax income has also been badly off for the past two years and the gap between expected and real tobacco excise income was an astonishing R1.65 billion in 2016/17, which increased to R1.71 billion in 2017/18.

This indicates that consumers are becoming far more sensitive to price as they feel the pinch of declining disposable income and are switching to cheaper products – mainly, in the case of smokers, illicit cigarettes selling for as little as R10 a pack, compared with the minimum R17.85 tax due on a pack of 20.

Increasing tobacco excise tax, as government has implemented by more than inflation each year over the past few years, will most likely lead to a further drop in actual revenue collected, whereas our modelling predicts that revenue would stabilise if the tax rate was kept the same.

This is as clear a case as one can get for government to stop doing what’s demonstrably not working and focus instead on tax collection from manufacturers of illicit cigarettes who have not bothered to pay up for years.

That leaves VAT as the most viable lever to increase revenue, but one that government would be extremely reluctant to use – especially in an election year.

Of course, there is another way to improve the deteriorating tax buoyancy and simultaneously return government’s balance sheet to relative health, and that is to eliminate the extraordinary leakage we have witnessed over the past decade.

There is at least R8 billion there for the taking from illegal cigarette makers, not to mention back taxes owed by these companies that have been growing their businesses on the back of rampant tax evasion.

Over and above the effect of a limping economy, the sheer scale of destruction that the lack of capacity the SA Revenue Service (Sars) had to collect taxes under former commissioner Tom Moyane has clearly profoundly affected tax buoyancy.

Rebuilding Sars’ capacity – a task that has, thankfully, already begun – would go a long way towards plugging the gap.

So would weeding out corruption in the state, enabling government to do more with less.

Gestures such as foregoing the traditional state of the nation address banquet dinner, while more symbolic than a substantial saving, also set the tone for greater government efficiency.

Indications are that this effect is beginning to manifest itself in government expenditure, which has increased by just 4% in the first nine months of the financial year.

Continuing to curb government spending while increasing efficiency could certainly free up funding to stabilise the fiscus without increasing personal and corporate taxes and excise duty.

If people start seeing that there is action being taken against the perpetrators of state capture and corruption, they will be more inclined to believe their hard-earned taxes will be properly spent and will be less likely to resist the efforts of Sars to collect them.

However, it is too early for this belief to truly take root and it will also be some time before Sars is properly back on its feet.

In the meantime, any tax increases other than VAT will most likely further erode tax buoyancy, not improve it.

Jammine is director and chief economist of Econometrix

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