SA's public finances have run into a brick wall

THE RECENT Medium-Term Budget Policy Statement (MTBPS) (or should we say fiscal scenario sketch?) has attracted a lot of interest for the alarming note it struck.

Some commentators welcomed the frankness of its assessment of the state of South Africa’s public finances and the risks involved, while others deplored the negative note thereof in the belief that it invites further downgrades to South Africa’s credit ratings.

One may well ask what has changed so fundamentally since the tabling of the National Budget in February this year to warrant such a drastic change in tone, or is it a typical case (as one often finds with the appointment of a new corporate chief executive) of getting the bad news out first so that things can only improve from there on and one can then claim credit for righting a ship that was keeling over.

However, regardless of one’s opinion on the questions raised above, it cannot be denied that South Africa’s public finances have run into a brick wall (as has been clear for some time already).

In a previous commentary I expressed the view that the problem stems mainly from the expenditure side of the budget, with government expenditure having increased by 5% of GDP from 2007/08 onwards without enhancing the growth potential of the economy and the tax base.

The appointment of a special committee of ministers to deliberate on ways to reduce government expenditure serves as confirmation of this observation.

This is not to say that the revenue shortfall (projected to amount to R51bn in 2017/18) is negligible, but it is not the root of the problem.

As pointed out previously, it is disingenuous to solely blame the weakness in the economy (and the international economy, for that matter) for his outcome after all, nominal economic growth has remained fairly buoyant, with higher inflation compensating for lower real growth. It is therefore valid to question SARS's capabilities when it comes to collecting revenue to support the national budget - a matter that is increasingly being raised.

However, the question may well be asked whether it is advisable to cut back on government expenditure at a point in time when South Africa is struggling with weak momentum in the economy. Will this not worsen the economic slump and make it even more difficult to revive its fortunes?

I am inclined rather to see the proposed reduction in government expenditure as part of the structural reforms needed to get the economy back on track. The jump in government expenditure after 2007 to 2008 did not enhance the growth potential of the economy, indicating that cutting back will likewise at most cause a temporary knock to consumption expenditure.

In view of the current lack of capacity in government, for pragmatic, if not ideological, reasons it would be better to move more resources into the hands of the private sector.

What should the ministerial committee’s priorities in cutting back expenditure therefore be?

A good starting point will be to drastically reduce the size of the rather bloated cabinet South Africa is saddled with, including reversing the politically motivated proliferation in government departments (e.g. Economic Development and Small Business Development) under the Zuma administration.

I am not for one minute suggesting that this will resolve the expenditure challenge, but it will send a strong message regarding the seriousness with which the South African government is approaching the matter and enhance its credibility. Reducing the number of government departments will furthermore have the concomitant benefit of simplifying policy coordination.

Secondly, reducing government expenditure inevitably implies reversing the surge in the public sector wage bill that occurred after 2009, another of the unwelcome legacies of the Zuma administration.

The fact that the National Treasury saw fit to add a special section dealing with compensation in the public sector to the MTBPS, with additional information being made available on its website, is an important signal that it regards this issue as a game breaker in its effort to rein in government expenditure.

As stated in the MTBPS, “In South Africa’s constrained fiscal environment, rising compensation budgets increasingly crowd out other expenditure, including the complementary inputs required for public servants to execute their functions effectively.”

Although government has succeeded in stabilising the size of its workforce since 2011 to 2012, only a minor reduction in the headcount has so far taken place, not to mention notch increases and promotions that put employees on higher salary scales without necessarily increasing their productivity.

For example, the MTBPS tells us that in 2013 to 2014 all clerks were upgraded from level 1 - 4 to level 5, and from level 5 to 7.

It will furthermore be unacceptable if the efforts of the committee of ministers to reduce government expenditure were negated by the outcome of the upcoming wage negotiations. The habit of granting public servants above-inflation increases on top of the automatic notch increases the majority of civil servants receive will have to come to an end. Automatic notch increases will either have to be scrapped or incorporated into wage settlements.

It is untenable for public sector wages to continue increasing at a higher rate than those in the private sector, which accounts for the majority of taxpayers. By implication, tax rates will have to increase in the long run to finance the transfer of purchasing power from private sector workers to public sector workers. This also applies at the level of local government.

However, the biggest challenge for the ministerial committee is to come to grips with the need to do more with less, viz. to deliver the same services at a lower unit cost. For example, it is often said (as again in the latest MTBPS) that social spending will be protected from any cuts in government expenditure.

Fair enough, but then the cost of providing social benefits (education, health, social grants, etc.) will have to be reduced, inter alia by the more judicious use of technology.

One should nevertheless not underestimate the difficulty of reducing the wage bill in labour-intensive functions/departments, as spelt out in the MTBP’s discussion of compensation in the public sector. Perhaps the best approach would be to completely scrap low-priority functions (or privatise them) rather than emasculate critical functions.

It will also be the task of the ministerial committee to convince the cabinet that there is no room for new policy initiatives. As the MTBPS acknowledges, any new initiatives will have to be met by increased taxation, either through increasing existing tax rates or through a broadening of the tax base by the introduction of new taxes.

Here the work of the Davis Tax Committee is crucial to ensure that any changes to the tax system do not further undermine the growth potential of the economy. It is ironic that at the time of the establishment of the Davis Committee it was emphasised that it was not the purpose of the committee to raise taxes to close the gap in government funding!

In the current environment of continued reporting of extreme waste in public expenditure, whether in the form of unauthorised expenditure, manipulation of tender processes, or outright corruption, taxpayer morality is already recognised to have deteriorated. Needless to say that any increase in the tax burden will go down like a lead balloon.

  • Jac Laubscher is economic adviser for Sanlam Limited. Opinions expressed are his own.

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