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KPMG: Budget 2014

30 January 2014 Deborah Tickle, KPMG

The 2014 annual Budget Speech will be presented by Minister Pravin Gordhan on 26 February 2014. The contents of the Speech, together with the State of the Nation Speech to be delivered by President Zuma on 13 February 2014, are considered to be critical in the run up to the general election that will be held later this year.

So the big question is: What rabbit is Minister Gordhan going to pull out of his hat this year to present a Budget that demonstrates that the funds will be available to meet the promises that government is, and will be, making to secure its position in the election?

To gain insight into government’s stated intentions for the country, one can refer to the National Development Plan (NDP) that was adopted last year. Many aspects of the Plan, however, require significant investment by the government, as well as the private industry. As one of the main ‘challenges’ set out in the NDP, job creation is critical in the government’s bid to address the funding challenge.

So, where will the funds for this investment come from?

The main sources of funds available to government are taxes and borrowings. The levels of debt raised by the government are running higher than previously anticipated, and this has resulted in South Africa’s status with the various ratings agencies being negatively affected. This has had a knock-on effect on our trade and currency. Consequently, increasing borrowings is not a good option for Minister Gordhan. Thus, we need to look at tax as an option to which the Minister will turn to fund next year’s government spending.

But is this a viable option?

Last year (2013 tax year), the ratio of taxes to Gross Domestic Product (i.e. the size of South Africa’s economy – it represents all the finished goods and services produced within South Africa within the year) was 25.3%. Although this figure increased to just over 27% during the height of the recession, international experience has shown that the ratio needs to remain around or below 25%. Thus, it is clear that in order to safely increase taxes, GDP, i.e the economy, needs to grow.

To make this clearer, the main sources of revenue to the government in the form of taxes are personal income taxes, corporate income taxes and VAT. Growing any of these sources requires that there be more taxes taken from individuals and companies.

Currently, there are 15.4 million registered individual taxpayers. In 2012 there were 13.7 million. However, only 5.9 million of these were required to pay tax and, of those 5.9 million people, 6.6% i.e. approximately 388 000 people (being those earning in excess of R580 000) paid 49.2% of all the personal income taxes. As one can see, even if one were to collect R100 000 more from each of those taxpayers, it would only provide Minister Gordhan with R3.88 million. Not very helpful when, based on projections given for the 2014 budget, he is likely to be looking for an additional amount of around R90 billion in the period starting 1 April 2014 to 31 March 2015, compared to the same period ending 31 March 2014.

Against this background, it is also important to understand that the proportion of the total tax bill paid through personal income tax in 2008/9 was 31.4%. Last year i.e. 2012/13 it was 34%. Individuals are thus already paying more than their fair share of the total tax bill through personal income taxes. In addition, people paying tax at the highest rate are paying 40% of their money over to the South African Revenue Service (SARS). This is already high when compared to global averages, which are generally less than 40%. Based on a KPMG survey, the global average is 31.87% and in Africa, for example, it is 29.77%.

Thus, the only way to increase the tax based on income from individuals is to increase the number of individuals paying taxes at a meaningful level. In order to do this, simply put, there needs to be more jobs; in order for there to be more jobs there needs to be employers (businesses) that need more people, or more businesses; to achieve that there needs to be the requirement to produce more goods and services; and to do that we need more people to be buying those goods and services i.e. more people in South Africa with money to spend i.e. more people with jobs.

The NDP tells us that, in affluent OECD countries, SMMEs represent 95% of the number of enterprises and 40-80% of the employment in manufacturing. South Africa’s labour policies are known to inhibit foreign direct investment. In South Africa, the public sector wage bill absorbs 35% of spending, compared with an average of 22% among emerging market peers (IMF report), and this needs to decrease. Thus, the jobs need to come from business and not the public sector.

As indicated above, many of the other NDP initiatives that would, in theory, provide more jobs, need money to get off the ground. Thus, the healthcare initiative, transforming urban and cultural spaces, and expanding infrastructure would all create jobs, but need money (collected largely in the form of taxes) to be implemented.

Could Minister Gordhan think about increasing the corporate tax rate? This could sound like an excellent proposal when one considers that the proportion of the total taxes paid by corporates in 2012/13 was only 19.8% as compared to 26.7% in 2008/9. Much of this decrease is, however, because of the recession and businesses being cut back or closing down.

As indicated above, one of the ways to achieve more jobs is to increase the number of businesses. An OECD multi-country study has found that a 1% increase in the corporate tax rate reduces inward investment (i.e. businesses setting up their activities in South Africa and thereby also creating jobs) by 3.7%! A reduction we can ill afford.

In addition, the global average for corporate tax rates is 24.08% and the average in Africa is 28.57%. This means that our corporate rate of 28% is currently in line, and to increase it may be detrimental to growing business and therefore jobs, and the consequent overall wealth of the individuals in South Africa. It is also important for Minister Gordhan to bear in mind that the current world trend is to decrease corporate tax rates, rather than increase them, e.g. the UK rate is being phased down to 20% by 2015.

It is also interesting to note that in 2012 there were 2.2 million registered companies, of which only 800 000 were liable to submit tax returns. Of these, a small proportion pay the majority of the taxes, and SARS has been diligent in making sure that those companies pay all their taxes, charging penalties wherever possible and changing laws to ensure that taxes can’t be avoided.

Increasing the VAT rate is a political ‘hot potato’ and therefore unlikely to be a viable option for Minister Gordhan in election year, even though it may be the most logical solution.

One of the arguments against increasing the VAT rate is that it is not a ‘progressive tax’ (such a system requires that poor people pay tax at a lower rate than wealthy people). In truth, though, what must be borne in mind is that VAT is payable on purchases of goods and services. In South Africa, essential subsistence goods (bread, milk, basic vegetables, etc.) have a 0% VAT rate applied. Other VATable goods and services have a 14% rate applied. Of note is that people who have more money are able to spend more on goods and services. Thus, more VAT is paid by people who have more money, which is, at least, ‘fair’.

Nevertheless, as indicated above, although there may be room for a 0.5% to 1% VAT rate increase in our economy (the global average rate is 15.59%, and the African average is 14.53%) this is unlikely to happen.

Thus, one can see the dilemma Minister Gordhan is facing.

As a consequence, I would suspect that this year, being an election year, Minister Gordhan will not increase any of the tax rates. He is likely to be relying on the extra VAT collections that should arise as a consequence of the new law that was announced last year but will come into effect on 1 April 2014, which will require that VAT be paid by non-resident companies like Amazon etc. on services, e.g. the download of books, music or movies, provided through the Internet. In addition, certain withholding taxes (e.g. on interest) will come into effect on 1 January 2015.

However, this may be a very short-term solution.

What is clear is that it is now more than a case of Minister Gordhan looking at what is out there and collecting taxes from those resources. Going forward, the Minister will be reliant on the country achieving its growth goals to be able to collect the taxes he needs, and these growth goals (see below) require the backing and implementation by the rest of government.

For a number of years now, Minister Gordhan has talked about the government working towards combatting ‘waste, inefficiency and corruption’ and, ‘preparing cost-containment instructions to limit wasteful expenditure’ (see the 2013 Medium Term Expenditure Budget Statement). He has also talked about the need for annual 5% growth in the GDP (see 2013 Budget speech) in order for him to be able to supply the funds projected in the Budget reviews, for the next three years. He has thereby indicated that he needs government to create the right environment for him to be able to do his job properly, and it is now becoming critical.

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