Finance Minister Malusi Gigaba confirmed the much-anticipated increase in the value-added tax (VAT) rate from 14% to 15% in his maiden Budget speech to Parliament on Wednesday, describing the increase as “unavoidable if we are to maintain the integrity of our public finances”.
The hike was announced amid a R48.2-billion revenue shortfall for 2017/18, against a gross tax revenue estimate of R1.27-trillion. While slightly lower than the R50.8-billion projected in the 2017 Medium-Term Budget Policy Statement, the revenue gap was substantially higher than the R30.7-billion reported in 2016/17.
Government proposed closing the gap through a combination of tax hikes and expenditure cuts, while still accommodating the December announcement of fee-free higher education and training, which received a R12.4-billion allocation in the 2018/19 Budget. The policy would involve additional expenditure of R57-billion over the three-year Medium-Term Expenditure Framework period.
Gigaba acknowledged that the higher education funding mandate had posed a significant challenge to ensuring a balanced outcome, but said the choices made, including the VAT hike, were taken with a view to limiting negative impacts on growth and low-income earners.
The 2018 Budget outlined expenditure of R1.67-trillion for 2018/19, rising to R1.94-trillion by 2020/21.
The consolidated deficit would slip to 4.3% of gross domestic product (GDP) in 2017/18, a marked deterioration from the 2017 Budget target of 3.1% of GDP, announced by Gigaba’s highly respected predecessor, Pravin Gordhan, whose removal from Cabinet in March last year precipitated a downgrade in South Africa’s credit rating to junk.
The deficit is expected to fall to 3.6% of GDP in 2018/19 and 2019/20, before narrowing marginally to 3.5% in 2020/21. In the Medium-Term Budget Policy Statement (MTBPS) the deficit was expected to remain at close to 4% for the medium term.
“A narrower deficit, stronger rand and lower borrowing costs result in gross government debt stabilising at 56.2% of GDP by 2022/23. Net debt stabilises at 53.2% of GDP in 2023/24,” the National Treasury outlined in the Budget Review, which is released alongside the Budget.
Nevertheless, with national debt approaching R2.5-trillion, interest payments would continue to rise, from R170-billion in 2017/18 to R187-billion in 2018/19 and to R223-billion in 2020/21. The biggest item on the Budget remained the allocation for Basic Education, which would rise to R246-billion in 2018/19, or 16.5% of the Budget.
Government revised its growth projection for 2017 to 1%, from 0.7% in the MTBPS, and forecast that the economy would grow by 1.5% and 1.8% in 2018 and 2019 respectively. Growth is forecast to reach 2.1% by 2020.
In a context of a low-growth trajectory, the National Treasury admitted the tax hikes were “not desirable”.
“But the fiscal position is substantially weaker than it was at the time of the 2008 financial crisis, when South Africa had a gross debt-to-gross domestic product (GDP) ratio that was just above 26%. That ratio now stands at 53.3%. A failure to act now would lead to more drastic spending cuts and tax increases in future,” the National Treasury outlined in the Budget Review.
Gigaba added that both the tax hike chosen, as well as the expenditure cuts outlined, had been factored into the new growth forecasts.
VAT HIKE RESISTANCE
Although widely anticipated, the VAT increase would nevertheless face strong resistance from South Africa’s labour movements, as well as from certain opposition parties, notable the Economic Freedom Fighters, which perceive it as a regressive move that will affect poor households disproportionately.
Gigaba defended the decision, which he said arose following an assessment of potential adjustments to the three main tax instruments that contribute over 80% of revenue, being personal and corporate income tax and VAT.
“We have increased personal income tax significantly in recent years, particularly at the higher income bands, and our corporate tax is high by international standards. We have not adjusted VAT since 1993, and it is low compared to some of our peers,” Gigaba asserted.
The current zero-rating of basic food items such as maize meal, brown bread, dried beans and rice would limit the impact on the poorest households, the Minister added. Draft VAT regulations were also announced to cover foreign businesses selling electronic services to South African consumers.
As with all previous tax decision, no prior consultations taken place with labour or business on the changes, but there would be follow-up discussions with stakeholders, where Gigaba would outline how 80% of the VAT increase would affect higher-income earners rather than the poor.
The increase in the VAT rate emerged as the main measure taken for raising an additional R36-billion in 2018/19, with the other tax measures including:
• Bracket creep, facilitated by below-inflation adjustments to the top four personal income tax brackets, with greater relief for those in the lower income tax brackets.
• An increase in the excise duty rate on luxury goods from 7% to 9%.
• A higher estate duty tax rate of 25% for estates greater than R30-million.
• A 52c/l rise in the levies on fuel, made up of a 22c/l for the general fuel levy and a 30c/l increase in the Road Accident Fund Levy.
• And increases in the alcohol and tobacco excise duties of between 6% and 10%.
Gigaba also announced that the proposed carbon tax, the Bill for which was before lawmakers, would be introduced from January 1, 2019, but said the initiative would not be used to raise revenue, but to change the behaviour of greenhouse-gas emitters. Meanwhile, the health promotion levy, which taxes sugary beverages, would be implemented from April 1, 2018.
The 2018 Budget also included expenditure reductions of R85-billion over three years and the expenditure ceiling was revised down marginally from what was presented in the October MTBPS.
About R53-billion of this amount has been cut at national government level, including large programmes and transfers to public entities, the Budget Review states. At sub-national level, conditional infrastructure grants of provincial and local government have been reduced by R28-billion.
“The medium-term spending reductions are necessary to ensure a sustainable fiscal trajectory, but they will have a negative impact on the composition of spending. About 47%, or R39.7-billion, of the R85-billion in spending reductions consists of cuts to capital transfers. Goods and services, a category already reduced in previous budgets, will be cut by R16.5-billion. Current transfers will be reduced by R27.4-billion, offset by allocations to the Department of Higher Education and Training.”
Talks on a new public-service wage agreement were still in progress and posed a risk to the fiscal framework. The National Treasury warned that any agreement locking in salary increases that exceeded consumer price index inflation would make expenditure limits difficult to achieve.
The consolidated wage bill increased rapidly from 32.9% of spending in 2007/8 to around 35% in 2017/18, which according to an Organisation for Economic Cooperation and Development study made South Africa’s government wage bill one of the highest among its developing-country peers.
“Government is working to ensure that the current wage negotiations process results in a fair and sustainable agreement,” the Budget Review states, adding that, to avoid breaching their compensation ceilings, national departments were being directed to carefully manage headcount.
The other key risks to the fiscal outlook related to the contingent liabilities of State-owned companies (SOCs). Government’s guarantees to public entities stood at R466-billion, while its exposure, defined as the total amount of borrowing and accrued interest made against the guarantee, stood at R300-billion.
“To respond to unanticipated economic and fiscal developments, a R26-billion contingency reserve has been set aside over the medium term,” the National Treasury announced.
A contingency reserve of R8-billion in 2018/19, R8-billion in 2019/20 and R10-billion in 2020/21, was outlined, to allow for uncertainties associated with the economic outlook, the finances of state-owned companies and other spending pressures.
In addition, government would pursue asset sales as a way of creating new sources of revenue, to support those SOCs in need of recapitalisation.
Government had identified 195 000 State-owned properties that it planned to sell and which could realise R40-billion for the fiscus. It could also sell a further stake in telecommunications group Telkom, in which it retained a 39% interest.
Asked whether the tax hikes and expenditure cuts would be sufficient for South Africa to avoid a further downgrade to its credit rating, Gigaba expressed optimism, arguing that the Budget would be further proof that South Africa was serious about dealing with the domestic constraints to growth.
He added that it would also prove that government stood ready to make the “tough choices” required to stabilise its finances and avoid a debt trap.