UPDATE ON South Africa’s fiscal CLIFF Presentation ON 4 March 2015 TO THE STANDING AND SELECT COMMITTEES ON FINANCE OF PARLIAMENT ON THE 2015-BUDGET Jannie Rossouw Head: School of Economic and Business Sciences University of the Witwatersrand Fanie Joubert Senior Lecturer: Department of Economics University of South Africa Adèle Breytenbach

OVERVIEW This presentation analyses: the fiscal cliff facing South Africa (x2) social assistance expenditure the remuneration of civil servants This presentation extends the findings of Rossouw, Joubert and Breytenbach (2014), published in the academic journal, Tydskrif vir Geesteswetenskappe on the possible fiscal cliff facing South Africa.

Introductory summary This research defines South Africa’s fiscal cliff as the point where civil service remuneration plus social grant expenditure equal government revenue. By 2012 it was clear that the South Africa was heading for a fiscal cliff with social assistance expenditure and the remuneration of civil servants exceeding all government revenue by 2026 if historic growth trends continued. Based on trends between 2008 and 2012, not even tax increases to raise revenue could have averted the problem.

Social ASSISTANCE: COST AND NUMBER OF RECIPIENTS LEVELING OUT   Source: 2014 Budget Review

SOCIAL GRANTS: SUBSEQUENT DEVELOPMENTS It seems that growth rate in this expenditure item is levelling out, but it still requires careful monitoring: Trends are concerning and confusing (e.g. an expected decline in child support grants after 2020 vs talks of increasing qualifying age to 23?) Number of grant recipients expected to increase from 16 052 000 (2014/15) to 17 300 000 (2017/18). This is equal to an average growth rate of 2,5% p.a., which shows continued uptake of social grants. Social grant expenditure expected to rise from R120,9 bn (2014/15) to R130,1 bn (2015/16) , R140,0 bn (2016/17) and R149,0bn in 2017/18 (2015 National Budget Review). This is equal to an average growth rate of 7,2% p.a.  

GRANTS   Source: 2014 Budget Review: 44

PUBLIC SERVICE EMPLOYMENT IN south africa The number of employees in the public sector (central plus provincial government) increased at a steady rate of some 2,6% per annum between 2008 and 2014. Employment growth in the civil service levelled off since 1 April 2014 – a very positive development.

Public SeRVICE employment Central government Provincial government Total* Percentage change (y:y) 31/03/2005 369 500 823 677 1 193 117 31/03/2006 385 441 860 580 1 246 021 4.4% 31/03/2007 407 489 889 652 1 297 141 4.1% 31/03/2008 405 805 938 173 1 343 978 3.6% 31/03/2009 418 879 967 740 1 386 619 3.2% 31/03/2010 410 051 1 006 793 1 416 844 2.2% 31/03/2011 427 281 1 047 990 1 475 271 31/03/2012 443 199 1 075 515 1 518 714 2.9% 31/03/2013 454 757 1 084 197 1 538 954 1.3% 31/03/2014 454 096 1 116 404 1 570 500 2.0% 30/06/2014 455 701 1 118 748 1 574 449 n/a 30/09/2014 454 701 1 1120 207 1 574 772 0,07% (annualised) *These figures do not include local authorities, nor other public-sector enterprises Sources: Breytenbach and Rossouw, 2013, SA Reserve Bank, Statistics SA [S.a.]

Compensation account of the south african government Average annual adjustment (general increase) between 2008 and 2014 was 6,9% (inflation plus 1 percentage point). Actual annual average increase in remuneration expenditure between 2008 and 2014 amounted to 13,1% per annum. Difference of 6,2 percentage points requires analysis.

Compensation account of the south african government An analysis by Breytenbach and Rossouw (2013) shows that the increase in the government’s compensation account since 2008 is attributable to: Annual general adjustment (6,9%) accounted for by: Inflation (5,9%); and additional general annual increase (1%) Balance of 6,2% (13,1% - 6,9%) accounted for by: structural changes in public service compensation, more senior staff members appointed from outside owing to more government departments and larger compensation increases for senior staff (2,6%); notch increases and promotions (1%); and growth in public service employment on national and provincial levels (2,6%)

Compensation account of the south african government Government cannot afford an annual increase in civil service remuneration of more than one percentage point above the rate of inflation (and definitely not by 15% plus additional demands). Based on the above a general adjustment of 15% will result in an increase of 21,2% (15% + 6,2%) Leveling-off employment growth in itself is therefore not a sufficient condition to avert a fiscal cliff

Compensation account of the south african government An individual who earned R528 000* per year in 2013/14, paid R127 348 income tax after primary rebate.  Given a raise of 6% during 2014/15 fiscal year to adjust for inflation, compensation increases to R559 680.  PIT on this will be R140 091,80 (after rebate).  This is equal to an increase of 10% in his/her tax burden.  This illustrates that tax increases will result in demands (why can these not simply be requests?) by civil service trade unions for large remuneration increases to compensate for higher direct taxes and lower take-home pay *Random amount chosen by authors

FISCAL FORECAST Engle-Granger type econometric model Long term (cointegrated) plus short term (error correction mechanism, ECM) Macroeconomic, time series data 1990 to 2014 (25 observations) 2-Step model with money supply (M3) feeding into government revenue (REV) Velocity of money dynamic: Variables including change in price level, disposable income and interest rates (Gould & Nelson, 1974).

Government revenue forecast: Exogenous variables and assumptions Variable (name in model) Assumption Money supply (RM3) Result as obtained from econometric model Disposable income (RYD) Expected nominal GDP (OECD GDP forecast* + inflation) Prime interest rate (RPRIME) Inflation plus 3.0 percentage points Inflation (INFL) Actual average SA inflation rate for 2002 tot 2014 was 5,9%. An inflation rate of 4.3% was used for 2015 and from 2016 5,9% per annum was used * Growth forecast for 2015 is 2,0% and 2,5% for 2016, thereafter this model uses 3% per annum real growth, i.e. South Africa’s full-employment growth rate, obtained from the OECD.

FISCAL Forecast The analysis reports three scenarios, based on the revenue forecast obtained from the model: Scenario 1: Social assistance: Actual and budgeted figures until 2017/18. Thereafter growth at a rate of average inflation plus 1 percentage point to take into account the growth in number of recipients Public service compensation: Actual and budgeted figures until 2017/18. Thereafter annual growth equal to inflation of 5,9% plus 1 percentage point (general adjustment) plus 3,6% (notch increases, promotions, structural changes) = 10,5% p.a.

FISCAL Forecast Scenario 2: Social assistance : Same a scenario 1   Social assistance : Same a scenario 1 Public service compensation: Actual figures until 2014/15 After 2014/15 annual growth at: a rate of average inflation of 5,9% plus 1 percentage point (general adjustment) plus 3,6% (notch increases, promotions, structural changes) = 10,5% p.a. Plus once off increase of R4,0bn (“other adjustments”) in 2015/16

FISCAL Forecast Scenario 3 (agreeing to trade union demands:   Social assistance: Same a scenario 1  Public service compensation: Actual figures until 2014/15 2015/16: Adjustment of 18,6% -- 15,0% general adjustment + 3,6% (notch increases, promotions, structural changes) Once off increase of R45,0bn comprising: Increase in housing allowances: R40bn (R2 100 x 12 x 1,574 million) Increase in GEMS contribution: R5bn 2016/17 +: Growth at a rate of average inflation of 5,9% plus 1 percentage point (general adjustment) plus 6,2% (notch increases, promotions, structural changes, new appointments) = 13,2% p.a (more of the same)

Public Service COMPENSATION (R billion) R bn  Actual + budget Actual + scenario 1 Actual + scenario 2 Actual + scenario 3 2007/08 195.0 2008/09 232.5 2009/10 273.1 2010/11 309.9 2011/12 346.0 2012/13 375.0 2013/14 411.3 2014/15 445.3 2015/16* 479.5 496.1 573.1 2016/17* 509.6 548.1 648.2 2017/18* 539.6 605.7 733.1 2018/19 ? 596.3 669.3 829.2 Sources: SA Reserve Bank, Statistics SA [S.a.], own calculations

RESULTS: Scenario 1 Sources: Authors’ own calculations

RESULTS: Scenario 2 Sources: Authors’ own calculations

RESULTS: Scenario 3* Fiscal cliff by 2030 * Graph capped at 100%. Any ratio higher than this will clearly be unsustainable Sources: Authors’ own calculations

Summary of RESULTS * Graph capped at 100%. Any ratio higher than this will clearly be unsustainable Sources: Authors’ own calculations

FINAL REMARKS AND CONCLUSIONS Scenarios show that expenditure on social expenditure and civil service remuneration as percentage of government revenue continue to grow, but at a slower pace than before. A fiscal cliff has not yet been averted but it is further in the distance than indicated by earlier (2014) research. Social grant expenditure must be contained. A moratorium must be placed on growth in civil service employment numbers, promotions, larger increases of senior officials and new senior appointments from outside to contain remuneration growth at inflation plus 1 percentage point.

FINAL REMARKS AND CONCLUSIONS There is no scope to grant general annual civil service remuneration increases of more than the rate of inflation plus 1 percentage point. An increase of 15% can simply not be afforded as it will push South Africa over the fiscal cliff – it will be fiscal suicide. South Africa suffers “investment hesitation” owing to power supply and policy uncertainty, thus impacting negatively on the economic growth rate. A lower growth rate will change these assumptions considerably as it erodes growth in the tax base, with the fiscal cliff moving closer. Limiting government expenditure is preferable to the raising of taxes.

Questions/discussion Selected references: 2015 National Budget Review. 2015. National Treasury: Pretoria Breytenbach, A. & Rossouw, J. 2013. ’n Ontleding van vergoedingsneigings in die Suid-Afrikaanse staatsdiens, 2005 tot 2012. Tydskrif vir Geesteswetenskappe. Jaargang 53:4. Desember. Business Day. 2014. “Gauteng education MEC moots exemption of teachers from income tax”. Available on: http://www.salabournews.co.za/index.php/component/content/article/70-labour-news/18780-gauteng-education-mec-moots-exemption-of-teachers-from-income-tax.html. [Downloaded on: 14 July 2014] Joubert, S. J. & Rossouw, J. 2013. Lewensstandaard: ’n Ekonomiese perspektief op lewensgehalte in Suid-Afrika. Tydskrif vir Geesteswetenskappe. Jaargang 53:1. Maart Rapport. 2014. 11 Mei Republic of South Africa. 2014. Budget Review 2014. National Treasury: Pretoria Republic of South Africa. 2014. Estimates of National Expenditure 2014. 26 February. Republic of South Africa. National Treasury: Pretoria Republic of South Africa. 2013. 2013 Budget Speech. Minister of Finance (Mr Pravin Gordhan). 27 February 2013 Rossouw, J., Joubert, S. J. & Breytenbach, A. 2014. Suid-Afrika se fiskale afgrond: ’n Blik op die aanwending van owerheidshulpbronne. Tydskrif vir Geesteswetenskappe, Jaargang 54 No. 1: Maart. SA Reserve Bank: Various sources