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Crucial budget needs to go bigger on tax and spending cuts to meet contraction targets

17 February 2017Johann Els, Old Mutual Investment Group
Johann Els, Senior Economist at Old Mutual Investment Group.

Johann Els, Senior Economist at Old Mutual Investment Group.

The upcoming Budget will be a critical one given there is no more room for the upward revision of deficit targets as seen over the last few years. As a result of the current slow growth environment, the tax increases and expenditure cuts set in October’s Medium-term Budget have to be adhered to if Treasury is to deliver a positive Budget. This is according to Senior Economist: Old Mutual Investment Group, Johann Els, who points out, however, that, given that the current fiscal year is running about R5 billion short of target, Treasury will have to go beyond the tax and expenditure targets set in October requiring an even tighter Budget.

Els says that the Medium-term Budget last year set out targets of R20 billion for expenditure cuts and R28 billion for tax increases in order to achieve the R48 billion contraction target needed for the Budget. “With the current fiscal year running R5 billion short, due to slower tax growth and slight over-spending, they will need to go bigger on tax increases and expenditure cuts this year to make this up,” he says.

“Whether or not they actually do take these necessary steps remains to be seen, but it will be a very big positive if they do as it will be a departure from the historical trend.”

Els highlights that the rating agencies will be watching this very closely. “Treasury sticking to the 3.1% Budget deficit target they set in October in the Medium-term Expenditure Framework is one of the crucial issues they will be considering in the decision on SA’s sovereign rating,” he explains.

Els says that they will also be keeping an eye on the actual mix of tax increases introduced by the Budget. “For example, if they decide to increase VAT, this would be viewed as a significant step in the right direction. While most economists are skeptical about the prospects of an actual VAT hike, there is increasing talk of a 0.5% VAT hike, which would contribute R10 billion to the Budget, although I still think the probability of this falls below 50%, despite the market and currency strength that such a move would bring,” he says.

A VAT increase is a notoriously unpopular political move among lower income groups, particularly during an election cycle. Nonetheless, Els believes that the chances of a VAT hike are still better than this time last year given the increased pressure that Treasury is under. “If they were to raise the VAT rate, they can still sell such a move politically by, for example, raising the top marginal rate by more, by increasing social grants, zero rate more food stuffs or even introducing a much higher VAT rate on luxury goods,” he says. “While a varied VAT rate structure is not favoured by Government, it can still be done.”

The fact that growth is picking up marginally, the improvement of the global economic environment, and stabilising employment numbers are all positive factors for the tax take or growth, according to Els. “The risk of tax increases in this year’s Budget is that, while we know that hikes will happen across the board, we don’t want Treasury to become too reliant on tax increases over the prioritising of expenditure cuts. We need them to focus on both, but expenditure cuts are more challenging given that public sector wages, social grants and interest payments make up 60% of the total expenditure budget. So where do they cut if they cannot easily cut these components?” he says.

Els believes that the risk of rising taxes hurting the economy through downward pressure on SA’s currently improving growth can be avoided through a suitable mix of taxes. “If the tax increases come in at the top level, as we expect they will, then the impact on the man in the street won’t be as severe,” he says.

“So yes, while a 2% VAT hike would be painful, a 0.5% increase could be manageable in terms of impact on the consumer. And if, as we expect, the mix means hiking the top marginal tax rate, which includes the wealth or rich taxes such as capital gains tax and dividend taxes, then we don’t expect the economy and consumer to be put under increased pressure. Of course there will be tax hikes such as fuel levy and excise increases, but these will be the normal increases we see every year.”

Els says that in order to meet the Ministry’s tax target of R28 billion, other tax options, in addition to those already mentioned, include an increase in estate duties, securities and sugar taxes. He does not expect the much-talked about Wealth tax to be implemented in the short term.

“A tighter Budget is key when it comes to SA’s policy mix as it could give the SA Reserve Bank the room that they need to be able to cut interest rates as we still expect them to in the second half of this year,” he explains. “At least some of the tax pain expected from this Budget will be negated by lower inflation and interest rates - but the bulk of the tax pain will be at the top end.”

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