1. 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

3. 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.

4. 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.

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

7. 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 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.

8. GRANTS
Source: Budget Review: 44

9. 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 April 2014 – a very positive development.

10. Public SeRVICE employment
Central government
Provincial
government
Total*
Percentage change (y:y)
31/03/2005
31/03/2006
4.4%
31/03/2007
4.1%
31/03/2008
3.6%
31/03/2009
3.2%
31/03/2010
2.2%
31/03/2011
31/03/2012
2.9%
31/03/2013
1.3%
31/03/2014
2.0%
30/06/2014
n/a
30/09/2014
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.]

11. 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.

12. 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%)

13. 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

14. 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 R   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

15. 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).

16. 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 ,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.

17. 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.

18. 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

19. 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)

20. 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

21. RESULTS: Scenario 1
Sources: Authors’ own calculations

22. RESULTS: Scenario 2
Sources: Authors’ own calculations

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

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

25. 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.

26. 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.

27. Questions/discussion
Selected references:
2015 National Budget Review National Treasury: Pretoria
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: [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