07:46 pm
22 October 2016

To meet financial commitments, SA can’t cave in to populist demands

Even draconian tax hikes will not be able to save SA from going over the looming fiscal cliff if recent expenditure trends continue unchecked.

This was the blunt warning made in a presentation to a joint sitting of the select and standing committees of finance in parliament last week by Prof Jannie Rossouw, who heads the school of economic & business sciences at Wits University.


Rossouw and Unisa researchers Fanie Joubert and Adèle Breytenbach estimate that free tertiary education for all would add an extra R33-billion a year to government expenditure.

Even if government responded by instituting two new personal income tax brackets, including hiking the 41% marginal tax rate to 45% on income over R1-million/year and taxing earnings over R2-million/year at 50%, they estimate it would yield only R6.82-billion a year more in tax revenue — a drop in the ocean compared with the amount required.

The presentation built on a previous paper by Rossouw, Joubert and Breytenbach, “SA’s fiscal cliff: A reflection on the appropriation of government resources”, published in SA’s Journal of Humanities last year.

Their definition of what would constitute a fiscal cliff in the SA context is “that point where social grant expenditure and civil service remuneration will absorb all government revenue”.

This differs from the meaning in the US, where the term is typically used in reference to the “debt ceiling” — a legislated ceiling on the borrowing capacity of the federal government.

In their published paper, the SA researchers show that social grants and civil service wages will consume all government income over the coming decade if the expenditure trends observed from 2008-2009 to 2011-2012 are allowed to continue unchecked. Even unthinkable tax increases — like instituting a 72% marginal tax rate (a level used in the early 1970s) on taxable income above R2-million/year — would be unable to do more than delay the process by a year or two.

In parliament last week, Rossouw presented two scenarios: one in which SA tumbles over a fiscal cliff by 2035 and a second in which expenditure on social grants and wages is more contained but still rises from 54% now to 60% of state spending over this period.

In scenario one, “More of the Same”, the researchers assume that government bows to political pressure to raise the age of child care grant beneficiaries from 18 to 21 and make old-age grants available to all over the age of 60. Both reforms have been proposed by various cabinet ministers in the past few years. The researchers estimate that together these reforms would cost the fiscus an extra R31-billion/year.

In addition, social grants are assumed to increase at the same average rate as in the past, rising annually by one percentage point above inflation.

At the same time, they assume that civil service remuneration will continue to rise at the rate recorded between 2008-2009 and 2011-2012. During this time it grew by 13%/year owing to wage increases, notch and structural adjustments and annual average employment growth of 2.6%.

If these trends persist, they find that SA would find social grants and public service wages consuming 100% of government revenue by 2035, assuming no real tax changes are made.

“SA cannot afford an extension of social grants, and the current public servants’ wage agreement is unaffordable,” says Rossouw. “Allowing these trends [to go] unchecked and allowing an extension of social benefits leads to the fiscal cliff.”

However, the researchers show that SA can move from tumbling over a cliff to reaching a plateau if populist choices can be avoided. Such a future is sketched out in scenario two, dubbed “New Beginnings”.

In this scenario, the researchers assume that social grants are not extended to additional categories of recipients. Grants increase by the budgeted amounts until 2017-2018 and after that by one percentage point above inflation. Civil servants’ wages rise by the budgeted figures until 2017-2018 and thereafter grow by 10.5%/year.

There is no further growth in civil service employment.

“This scenario shows that SA can reach a fiscal plateau, but that this plateau is at too high a level and that changed behaviour is necessary,” says Rossouw.

To be fair to national Treasury, the period of study the researchers extrapolate from (2008-2012) is coloured by the large fiscal stimulus government employed during that time in response to the global financial crisis. A large part of this stimulus went towards raising the rate of public sector remuneration and employment.

Since the introduction of an expenditure ceiling in 2012, however, Treasury has shown commitment to keeping spending in check. The spending ceiling has not only been maintained for the next three years but strengthened through the introduction of a new fiscal guideline that requires that spending remain stable as a share of GDP in the absence of new taxes.

To achieve this in the context of low growth will require a steep slowdown in spending from previous years, with main budget noninterest expenditure growing at just 0.9% in 2016-2017 compared with rates averaging close to 7% of those from 2008-2012.

On the other hand, Treasury was unable to prevent the conclusion of an outsize public service wage settlement this year that will push compensation growth to 8.2%/year over the next three years and cost R64-billion more than budgeted for. To accommodate it, Treasury has forced a hiring freeze on all departments and drawn down R41-billion from SA’s contingency reserves.

Lefika Securities economist Colen Garrow likens this action to “cash-strapped consumers who liquidate their life annuity policies to maintain their standard of living”.

Sanlam economic adviser Jac Laubscher asks “if the minister of finance could not hold the line on the public sector wage agreement, how is he to succeed in persuading parts of government to reduce their staff numbers?”

There is no alternative to disciplining government expenditure if SA is to avoid a trajectory of continuously rising government debt and debt-servicing costs, he adds. “As difficult as it may be, the public sector wage bill will have to be reduced — the SA government has dug itself into a hole that only it can dig itself out of.”

Treasury was unable to comment at the time of going to press. However, budget documents stress that accommodating the public wage deal means there is no new money to fund new policies.

It is clear from the alacrity with which government agreed to a university fee standstill that the rest of the cabinet does not appreciate this.

The idea that taxes can simply be raised to fund such generosity is well and truly punctured by the analysis of Rossouw and the others. Their paper should be compulsory reading for all parliamentarians.

This article first appeared in the Financial Mail