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Execution and consistency is key this time around – Budget Speech 2022!

By Nazrien Kader – Head of Tax at Old Mutual

Recent good news relating to tax collections overshooting the medium-term budget projections provides Minister Enoch Godongwana with a little breathing room as he prepares to deliver his inaugural National budget presentation on 23 February 2022. South Africans have a right to be cautiously optimistic.

Revenue Collections: Sustainable or not?

With economists optimistic that revenue collections will exceed the budget projections by between R220 billion and R250 billion – which is significantly higher than the R 120 billion pencilled in in the medium-term budget statement – the real question is how much of this increased collection is sustainable? The biggest contributor to the overrun is company tax which for the year up to December 2021, increased from 17.1% in the 2020/21 fiscal year, to 22% in the year to December 2021. All indicators are that this was largely driven by the higher commodity prices, which is unlikely to be sustained over the medium term due to the cyclical nature of the commodities cycle. As we see commodity prices retreating from their highs of 2021, it would be prudent for Minister Godongwana to treat any corporate tax excess as ‘windfall gains’ to be used to reduce borrowing requirements rather than to fund future expenditure.

Even though corporate tax collections increased significantly, it is notable that it remains the smallest contributor to the pie, with personal income tax retaining the lead at 34%. VAT followed second at 24%. (Other indirect taxes made up the remaining 10% of collections).

Overall, I remain sceptical: the predicted revenue overrun must be seen in the context of the material deficit of R483 billion budgeted for the 2021/22 fiscal year (Revenue of R1351billion and Expenditure R1834billion). This budget deficit as a percentage of GDP is expected to reduce to 5.8% for the 2022 fiscal year from an initial estimate in the February 2021 budget of 9.3%. Whilst we can all agree that directionally, this is good news, we can also agree that the budget deficit remains too high.

Notwithstanding these increased tax collections, the current trajectory of South Africa’s debt to GDP ratio is still upwards. The medium term budget projected the net debt to GDP ratio to increase from a projected 66.2% in 2021/22 to 75% in 2024/25. As a consequence of the ever-growing debt burden, debt service costs continue to rise as a percentage of the overall government spend, crowding out other spending priorities, such as social development expenditure (such as, spend on education, housing, health and security and the like).

Latest GDP projections by the South African Reserve Bank suggest that GDP should recover by 4.8% for 2021 (bouncing back from the Covid-induced low of 2020) followed by a substantially lower 1.7% for 2022. The lower GDP growth expected in 2022 would result in a tempering of the stellar revenue growth performance in 2021.

Pressure on Government spending from all sides

In his medium terms budget speech, Minister Godongwana signalled that spending will remain restrained over the medium term.  Risks to this commitment include the push to make the Social Relief Distress Grant permanent (or to temporally extend the grant until a decision on whether to make the grant permanent or not is made). From public discourse, it seems fairly certain that Minister Godongwana will be pressured to at the very least extend the Social Distress Grant.

Other barriers include the public sector wage increases which is highly dependent on negotiations with unions (including the Constitutional Court challenge to the (non)implementation of the 2018 agreement). Of significance is that in 2021 a ‘one year agreement’ was concluded that increased wages by 1.5% plus a cash payment. With inflation currently running at 5.9%, a similar agreement may be difficult to negotiate. The medium-term budget showed an increase of just 1.5% in the baseline for wages.  The implementation of the National Health Insurance Scheme remains a dream. National Treasury hinted that there was a lack of capacity within the health sector to fully implement National Health Insurance in the medium term. Bailouts of state-owned operations remain on the horizon.

It has also been made clear that funding for the extension of the Social Distress Grant or significant increases in the public sector wage bill have not been factored into the medium-term budget forecasts.

To increase taxes or not to increase taxes? That is the question

Minister Godongwana, like those came before, would possibly be exploring the ‘Top 5 channels’ available to fund expenditure being (1) a general increase in taxes through new taxes and/or increase in existing tax rates, (2) a budgeted increase in the budget deficit, (3) a more efficient Revenue Authority to bolster tax collections and clamp down on tax avoidance, (4) phased in plan to reduce spending and (5) arguably the  most sustainable and preferred, being sustainable economic growth.

Projections in the medium-term budget did not hint at any tax increases for the next three years. With  South Africans taxpayers earning the title of “highly taxed” and income tax increases in recent years seeing diminishing returns, it is inconceivable that there would be an increase in the headline income tax rates. That is not to say that the “usual suspects” are safe – lower than inflationary adjustments or worse, no adjustments for bracket creep, super-high increases in “sin taxes”, more than inflationary adjustments to fuel taxes and the like, are guaranteed. With the petrol price at record highs, Minister Godongwana is possibly hoping that the red-hot-oil price-cools to provide him some room to increase fuel levies.

Corporate taxpayers are watchful: Will Minister Godongwana follow through on the reduction in corporate tax rates from 28% to 27%, as announced in the 2021 budget? The world is a very different place now with major economies looking to increase corporate tax rates to shore up their fiscal position that has been devastated by the Covid crisis. In any event, the reduction in the South African corporate tax rate would come with a sting in the tail for corporate taxpayers, as its implementation is linked to other amendments such as the ring-fencing of interest deductions and limitation on use of assessed losses in a tax year. Rumours are rife that Minister Godongwana may shock by increasing the VAT rate from 15% to 16%, to fund the Social Distress Grant if it is made permanent. Would he be so brave to reduce the corporate tax rate and increase the VAT rate in one year?

A message of fiscal discipline

Increasing the budget deficit would weaken National Treasury’s message of fiscal discipline to the capital markets and rating agencies. Revenue collection overruns do provide some room to the to manoeuvre in this respect. Recent news from the South African Revenue Service would suggest that Commissioner Edward Kieswetter’s turnaround strategy at SARS is gaining momentum with some strides being made in clamping down on tax evasion and tax fraud. The tangible impact of increased collections from SARS anti-tax corruption and policing of tax compliance cannot go unnoticed.

Shifting focus away from effective, sustainable service delivery does not have to be the answer. More can be done to curb fraud, wasteful expenditure and build a more efficient and effective public service. South Africans are hopeful that with the publication of initial parts of the Zondo Commission report, we will now see some action from the National Prosecution Authority, to quickly catch the “big fish” that have in the past – and in some cases continue to – loot South Africa. (The PPE scandal is a case in point).

Execution. Execution. Execution

To a self-confessed “armchair observer” of the national budget, surely we cannot tax our way out of the fiscal hole that we find ourselves in? Whilst options may be fewer and counting, a laser focus on implementing a strategy to free up the economy, to stimulate growth sounds like the only sustainable plan. Execution on its famed economic recovery plan is hotly awaited. There are flickers of some hope. Whilst Eskom is seen as the single biggest risk to our economy (now that hopefully the worst of the Covid crisis is behind us), a step in the right direction was Government raising the licensing threshold for embedded electricity generation from 1MW to 100MW. After being delayed for many years, the migration to digital broadcasting is also finally underway which would free up spectrum for other uses. The auction of digital spectrum to cellular networks seems to be off the starting line, after numerous court challenges, with a promise of lower communication costs.

These initial steps are welcome but a lot more is needed to really kick-start South Africa’s morbid economic growth. We await President Ramaphosa’s state of the nation address and Minister Godongwana’s  national budget presentation with much trepidation but this time, not without hope.