SOUTH AFRICA’S FISCAL POSITION PRESENTATION AT THE CAPE TOWN PRESS CLUB 24 February 2015 Jannie Rossouw Head: School of Economic and Business Sciences University of the Witwatersrand 1

OVERVIEW Historical background and unanswered questions This presentation analyses: the fiscal cliff facing South Africa (x2) social assistance expenditure the remuneration of civil servants a proposal to raise government’s revenue by R44 billion, the additional income requirement to 2018 This presentation expands the findings Rossouw, Joubert and Breytenbach (2014) on the possible fiscal cliff facing South Africa 2

HISTORICAL BACKGROUND AND UNANSWERED QUESTIONS The budget is traditionally presented on Wednesday afternoon – reason? Government’s fiscal year runs from 1 April to 31 March annually The financial year of South African municipalities runs from 1 July to 30 June annually, although many poor municipalities are dependent on funding transfers from national government Tax year for individuals run from 1 March to 28/9 February annually since 1964 (previously 1 July to 30 June) 3

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 4

2012 ASSESSMENT: HOW BIG IS THE PROBLEM? *Estimates Sources:Estimates of National Expenditure 2012: as used in Joubert and Rossouw 2013, Breytenbach and Rossouw 2013, SA Reserwebank, Statistics SA [S.a.], own calculationsF

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 (2014/15) to (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 R129,5 bn (2015/16) and R137,6 bn (2016/17). This is equal to an average growth rate of 7,4% p.a. 6

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

8 GRANTS Source: 2014 Budget Review: 44

COMPENSATION ACCOUNT OF THE SOUTH AFRICAN GOVERNMENT 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 in 2014 – a very positive development 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 (reasons for difference on the next slide) Government cannot afford to an annual increase in civil service remuneration of more than one percentage point above the rate of inflation (and definitely not by 15%). Based on the above it might result in an increase of 21,2% (15% + 6,2%) 9

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%) Leveling-off in employment growth in itself is therefore not a sufficient condition to avert a fiscal cliff 10

Engle-Granger type econometric model Long term (cointegrated) plus short term (error correction mechanism, ECM) Macroeconomic, time series data 1990 to 2013 (24 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). FISCAL FORECAST 11

Variable (name in model)Assumption Money supply (RM3)Result as obtained from econometric model Disposable income (RYD) Expected nominal GDP (OECD GDP forecast* + 5,9% inflation) Prime interest rate (RPRIME)Inflation plus 3.0 percentage points Inflation (INFL)Actual average SA inflation rate for 2002 to 2013 GOVERNMENT REVENUE FORECAST: EXOGENOUS VARIABLES AND ASSUMPTIONS 12 * For the forecast period this model uses 3% per annum real growth, i.e. South Africa’s full- employment growth rate. However the MTBPS shows that this forecast is too high for 2014, 2015 and 2016 as Treasury expects this rate of growth on to be achieved only by 2017

The baseline analysis accepts that: – the take-up rate in social grants will increase for the next decade and then level out – the increase in government remuneration will be limited to 10,5% p.a. (6,9% general adjustment and 3,6% for “others”) – the economic growth rate will be 3% per annum The latter is problematic, as South Africa currently suffers “investment hesitation” owing to power supply problems and an uncertain policy environment An additional scenario, the effect of a 15% increase in civil service remuneration for 2015 to 2017, is also shown in the result below FISCAL FORECAST 13

RESULTS 14

This analysis still shows a fiscal cliff approaching, but further in the distance as in earlier research The size of Cabinet should be reduced with a concomitant reduction in the number of government departments and senior civil servants There is no scope for general annual civil service remuneration increases exceeding the rate of inflation plus 1 percentage point Notch increases are a contractual obligation FISCAL CLIFF AVERTED? 15

Promotions should be limited Civil service employment numbers should be contained with a moratorium on growth in civil service employment Structural changes in remuneration with larger increases for senior staff should be avoided Social grants cannot be increased to over more recipients FISCAL CLIFF AVERTED? 16

GOVERNMENT’S REVENUE NEEDS The 2014 MTBPS reports that government requires spending cuts of R25bn and additional revenue of R44 bn in the period to 2017/18 No firm proposals for cutting spending were tabled This implies new and additional taxes to raise revenue Opportunities for increasing revenue is very limited 17

Tax Revenue (Income source)Amount (R billion) % of subtotal Personal Income Tax335,9 33,8 Value Added Tax267,2 26,9 Corporate Income Tax198,9 20,0 Excise Duties*31,1 3,1 Fuel Levies47,5 4,8 Customs Duties50,3 5,1 Other** (e.g. Dividend tax, estate tax, gift tax, etc.)62,7 6,3 Subtotal993,7 100,0 Non-tax revenue20,9 Less: SACU-payments-51,7 Total962,8 GOVERNMENT REVENUE BY SOURCE 2014/15 – FISCAL YEAR * Specific plus Ad valorem excise duties** Balancing Item 18 Source: 2014 Budget Review: 132

RAISING REVENUE The three main sources of tax revenue are personal income tax, company tax and value-added tax (VAT), which should therefore be the focus of a revenue-raising exercise In the calculation of an increased tax burden a 10% elasticity in the reduction of the tax base owing to the increased tax burden is assumed. Examples of reductions are people working less in response to higher income tax, people driving less in response to increased fuel prices and people spending less in response to increased VAT rates. Proposals: The introduction of two additional marginal tax brackets: 45% for taxable income above R1 million per annum and 50% for taxable income above R2 million per annum VAT increased by 1 percentage point from 14% to 15% Company tax increased to 30% Increase excise duties and fuel levy by 10% Assume that other (e.g. dividend, estate and gift taxes) can be increased to yield an additional R1 billion per annum Other: SACU payments more than revenue from custom duties? 19

Taxable Income (R)Rate of Tax (R) 0 – % of taxable income – R % of taxable income above R – R % of taxable income above R – R % of taxable income above R – R % of taxable income above R – R % of taxable income above R – R % of taxable income above R and aboveR % of taxable income above R MARGINAL TAX RATE STRUCTURE WITH TWO PROPOSED EXTRA BRACKETS (ASSESSMENT 2014/15) Tax Rebates PrimaryR SecondaryR7 110 (persons 65 and older) TertiaryR2 367 (persons 75 and older) 20 Source:National Treasury, own calculations

Revenue/income sourceAmount before adjustment (R billion) Proposed adjustments Additional Income Reductions (Elasticity effects) Revised additional income Amount after adjustment and reductions (R billion) Personal income tax 335,9 Marginal rate adjustments 7,5-0,86,7342,7 Value-added tax (VAT) 267,2 Rate adjusted to 15% 19,1-1,917,2284,4 Corporate income tax 198,9 Rate adjusted to 30% 14,2-1,412,8211,7 Excise duties* 31,1 10% extra 3,1-0,32,833,9 Fuel levies 47,5 10% extra 4,8-0,54,351,8 Customs duties 50,3 Paid over to SACU 0,0 50,3 Other** (e.g. Dividend tax, estate tax, gift tax and non-tax revenue) 62,7 Assumed additional R1bn 1,0-0,10,963,6 Subtotal 993,7 N/a 49,7-5,044,71038,3 Non-tax revenue 20,9 N/a 20,9 SACU -51,7 N/a -51,7 Total 962,8 N/a 49,7 -5,044,71007,5 ADJUSTED GOVERNMENT REVENUE BY REVENUE SOURCE *Specific plus Ad valorem excise duties. **Balancing item 21 Source: 2014 Budget Review: 132, own calculations

FINAL REMARKS AND CONCLUSIONS A fiscal cliff has not yet been averted but it is further in the distance than indicated by earlier (2014) research There is no scope to grant 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 Moratorium must be placed on growth in civil service employment numbers, promotions, larger increases for senior officials and new senior appointments from outside Social grant expenditure must be contained The room for raising extra income through increased taxation is very limited 22

FINAL REMARKS AND CONCLUSIONS Limiting government expenditure is preferable to the raising of taxes Given South Africa’s own fiscal needs, it is clear that this subsidisation of South Africa’s SACU partners can no longer be afforded 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 23

QUESTIONS/DISCUSSION Selected References: Breytenbach, A. & Rossouw, J ’n Ontleding van vergoedingsneigings in die Suid-Afrikaanse staatsdiens, 2005 tot Tydskrif vir Geesteswetenskappe. Jaargang 53:4. Desember. Business Day “Gauteng education MEC moots exemption of teachers from income tax”. Available on: news/18780-gauteng-education-mec-moots-exemption-of-teachers-from-income-tax.html. [Downloaded on: 14 July 2014] Joubert, S. J. & Rossouw, J Lewensstandaard: ’n Ekonomiese perspektief op lewensgehalte in Suid-Afrika. Tydskrif vir Geesteswetenskappe. Jaargang 53:1. Maart. Rapport Mei Republic of South Africa Budget Review National Treasury: Pretoria Republic of South Africa Estimates of National Expenditure February. Republic of South Africa. National Treasury: Pretoria Republic of South Africa Budget Speech. Minister of Finance (Mr Pravin Gordhan). 27 February 2013 Rossouw, J., Joubert, S. J. & Breytenbach, A 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 24