Medium-term budget: Significant tax increases to compensate for slowing economy

As South Africa faces multiple unknowns, Finance Minister Pravin Gordhan presented a cautious medium-term budget policy statement, tailored for an economic environment which is “a challenging one, but not an impossible one”.

The unknowns are myriad. Will economic growth pick up, or slow? Is a credit rating downgrade forthcoming in December and, if it happens, how will it affect the South African economy? What unexpected demands might come forward, placing further pressure on tax coffers? And come February next year, will it be Gordhan delivering the budget speech?

The medium-term budget policy statement (MTBPS) is a government policy document that communicates to Parliament and the country the economic context in which the forthcoming budget will be presented, along with fiscal policy objectives and spending priorities over the three-year period.

Quite simply, the economy has slowed and so tax revenues have fallen short of expectations.
To plug the widening shortfall, spending must be further cut and tax must be raised.

Without a change in policy the expected budget falls are R36-billion and R52-billion in the next two years.

Following a series of expenditure cuts, the medium-term budget policy statement proposes a further R26-billion in reductions to the public expenditure ceiling over the next two years.

New proposed tax measures amount to R13-billion in the 2017-18 year. Combined with higher taxes signalled in the 2016 budget, total revenue increases amount to R43-billion over the next two years.

The higher taxes signalled in the 2016 budget comprised higher excise duties, an increase in the fuel levy, and other environmental taxes; adjustments to capital gains tax and transfer duty. Allowing for higher income earners to shift into a higher tax brackets would also contribute.

But in a press briefing on Wednesday Gordhan refused to be drawn on how more tax revenue could be raised. “We don’t discuss tax choices in the MTBPS,” he said.

With a great deal of pressure on the budget, Gordhan said spending will be sustained on core priorities and existing resources will be shifted to critical needs.

One priority is the funding of higher education.

The demand for free higher education has persisted, and since last month chaos has ensued at campuses across the country as heavy handed police have clashed with protesting students.

Allocations to post-school education and training are now be the fastest growing element of the budget, after debt servicing costs. Much of this growing budget has benefitted vocational colleges, and other training funds and entities rather than universities.

Still, Treasury said subsidies to universities grow at 10.9% each year and transfers to NSFAS grow at 18.5% Universities and students will now receive an additional R17-billion over the medium term.

In 2017, government will a fund fee increase at higher learning institutions, of up to 8%, for students from households earning up to R600 000 per year. The National Student Financial Aid Scheme will also receive significant top ups.

Speaking alongside Gordhan at a press conference on Wednesday, the Minister of Higher Education, Blade Nzimande, said he was happy about the allocations Treasury had signalled. He said the college sector needed to be up to four times larger than the university sector. He also said money alone would not solve the problem faced, such as poor throughput rates.

Gordhan said a number of technical proposals had been received the bets of which all suggested solutions that would complement limited state resources and already provided an indication of how some of the problems facing students which could be solved immediately.

The political context in which Gordhan presented his budget – try as he might – could not be ignored.

Seemingly trumped up fraud charges brought against the minister by the National Prosecuting Authority – in his role in granting early retirement for a South African Revenue Services official – are due to be aired in court next week. The charges have stoked fears that a more sinister plan to replace the minister, with an aim to loot state coffers, is at play.

Gordhan wished only to field questions related to the MTBPS, but injected a quip about possibly being in the job market sometime soon.

Flanking the minister at the briefing, deputy finance minister Mcebisi Jonas noted that political stability was paramount in order to foster investor confidence.

The MTBPS is the last opportunity for Gordhan to demonstrate to credit ratings agencies that South Africa is making progress and not deserving of a credit rating downgrade come December (when the agencies will reassess the rating).

A lower rating signals higher investment risk. This could prompt higher cost of borrowing for a country, as well as large capital outflows.

Drivers of growth remain a key concern. In the February budget, Treasury’s economic growth forecast for this year is 0.9% but in the policy statement is revised to 0.5% for the year – more optimistic than estimates by others such as the International Monetary Fund.

The budget deficit is estimated to continue on a narrowing trajectory and the gap will taper from 3.4% in this financial year, to 2.5% by 2019-2020. Total loan debt will remain under the key 50% threshold over the medium term, reaching 47.9% in 2019-2020.

Treasury is optimistic that economic recovery is emerging, as factors that were limiting economic growth are receding.

There’s been a slight rebound in commodity prices, drought conditions have eased and electricity constraints are no longer an issue.

This year growth of 0.5% expected according to Reserve Bank and Treasury projections. Next year an improved 1.3% of annual growth is forecast and growth of 2% and 2.2% are estimated for 2018 and 2019 respectively. Headline Inflation is expected to slow from 6.4%, as estimated for 2016, to 6.1% next year, and 5.9% in 2018.

The policy statement, however, shows National Treasury is also not counting out a number of other scenarios in which low growth persists.

The risk here is that South Africa could fall into a low-growth trap if fiscal consolidation is not balanced. In a low-growth trap low economic growth means lower tax revenues. Aggressive steps to stabilise debt and contain the budget deficit may bolster confidence but could undermine the economy.

National Treasury’s modelling indicates that if the trend rate of economic growth remains below 2% for an extended period, “government will not be able to sustain its current policy commitments.” Tough trade-offs will have to be made. Limited space to increase taxation cannot accommodate proposals, and large spending commitments, related to health, education, defence, social development, and infrastructure. 



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