By Jac Laubscher, 11 March 2014
There is an indirect link between the budget and the NDP, which depends on the policies developed and implemented by each government function and department to achieve the NDP. In other words, by definition it is impossible to bring the budget in line with the NDP without accepting the relevant policies.
The implementation of the NDP should not be supported only by the expenditure side of the budget, but also by the revenue side. The tax structure has major implications for incentives and disincentives in the economy and should encourage the “correct” behaviour in order to attain the NDP’s objectives.
With regard to the expenditure side of the budget, the first question is what the size of the government should be. The NDP foresees the private sector being the key player in the attainment of its objectives, while it also highlights the need for government effectiveness and efficiency. The NDP thus definitely does not foresee a large government; in fact, the NDP makes a plea for a debate on Government’s role in the economy. This plea probably has its origin in fundamental differences within the government on this issue.
As far as the current size of the government is concerned, consolidated government expenditure accounts for 33% of GDP and the budget envisages only a slight reduction. The comparable figure for South Africa’s peer group is approximately 18%; actually, the magnitude of government spending in South Africa is more comparable with that in developed countries. Likewise the resultant tax burden, which is expected to amount to 26,5% of GDP by 2016/17, far exceeds the 13,2% average for middle-income countries.
If the rest of the public sector (for example public enterprises such as Eskom) is also taken into account, the government’s stake of the available resources in the economy increases to approximately 40% of GDP. This certainly leaves no room for further increases given the proven negative relationship between the size of the government and economic growth when a threshold of 15% to 20% of GDP is crossed.
In their research on the relationship between growth and government size, Antonio Afonso and Joao Tovar Jalles of the European Central Bank found, for example, that (i) the size of the government has a negative effect on economic growth, (ii) that the lower the quality of a country’s institutions, the greater this negative impact, (iii) that government consumption expenditure is consistently prejudicial to economic growth, and (iv) that fiscal rules (in other words institutionalised fiscal discipline), especially with regard to spending, are beneficial to economic growth.
Proponents of a larger role for Government in the economy should realise this does not mean more resources will magically be mobilised, but merely means a shift of available resources from the private sector to the public sector. For this shift to have a positive effect on economic growth it will have to be accompanied by higher productivity, which is highly unlikely.
The second question is to what extent Government’s spending priorities already reflect those of the NDP. As far as this is concerned, it is significant that because education is the NDP’s first priority it is already receiving the largest share of the available funds (22% of total non-interest expenditure). Here it is solely about the effectiveness of application.
As far as the NDP’s second priority is concerned, namely job creation, expenditure on economic services amounts to 12,6% of non-interest expenditure compared to 65,8% on social services. In many instances the expenditure on measures to support economic activity is spot-on in principle, but the allocated amounts are too small to make a significant difference. A drastic shift in expenditure will therefore be required to even come close to achieving the NDP’s vision of higher economic growth as the means to attain its objectives.
The scope for reprioritising government spending to be better aligned with the NDP without increasing total expenditure is further limited by the high wage and salary bill (nearly 40% of non-interest expenditure) and the ever-increasing government debt and resultant interest burden (9,7% of total consolidated expenditure). In order to make more resources available for the implementation of the NDP the public service will have to be downscaled judiciously and the debt burden will have to be reduced much more quickly than is currently envisaged.
This brings us to the tax structure.
The NDP sees higher economic growth of between 5% and 6% per annum as the basis for achieving its objectives. As mentioned previously, it considers the private sector to be the key role player in the attainment of higher growth. The NDP’s vision is also that the issue of poverty should be addressed by people’s ability to personally improve their circumstances, to develop and to grow stronger.
This implies a tax structure that promotes and rewards hard work and enterprise.
The first guideline for such a tax structure is that indirect tax is preferable to direct tax, in other words that tax on expenditure is better than tax on income. Among other things, this would have a more positive effect on saving, and the NDP does envisage an acceleration in South Africa’s savings rate to 25% of GDP compared to the current approximately 13%. At present, tax on income and profits contributes more to government revenue that does indirect tax.
A second guideline is to keep tax on profits as low as possible in order to promote entrepreneurship and enterprise. Lower tax on companies makes it easier to establish and grow a business by lowering the profitable investment threshold.
The contribution by company tax to the government’s total tax revenue increased between 1994 and 2008 by 10 percentage points while that of individuals decreased accordingly. However, the recession in 2009 and the ongoing problems in the mining sector have reversed this trend temporarily.
The fact that the relative tax contribution by companies has increased in spite of a reduction in the head line rate from 40% to 28% indicates that the effective rate has risen as a result of the deductibility of specific expenses having been abolished. The question is whether this has not been taken too far.
The 2014 Budget Review provides estimates of the value (in terms of tax sacrificed by the government) of deductions from taxable income up to and including 2011/12. According to the Review the value of deductions from tax on companies amounted to 2,3% of the total tax sacrifice in 2011/12 compared to 40,6% in the case of personal income tax. Research and development and strategic industrial development together enjoyed only 0,5% of the benefit.
One could contend that the tax structure supports the government’s current focus on social expenditure. However, if South Africa wants to shift the emphasis in favour of economic growth, the tax structure will require a fundamental review. One can only hope that the Davis tax committee will come to the same conclusion.
Aligning the budget with the NDP is therefore no easy task. It will necessitate the exclusion of any sacred cows from government finances. The risk of the implementation of the proposed national healthcare system having such a huge impact on future budgets that it could potentially overshadow any other initiative, already exists.
Health expenditure already accounts for 13% of total non-interest expenditure and even only a 50% increase in health expenditure (a conservative assumption) will represent an increase of 2% of GDP.
Consequently there is only a slight possibility that the objectives of the NDP will be achieved within the set time frame.