Taxpayers could be in for a shock announcement on Wednesday (22 October) when finance minister Nhlanhla Nene delivers his mini budget speech, warn commentators. Analysts point out that South Africa’s deficit will push Nene into a corner and make tax hike announcements either this week or at the next Midterm Budget in early 2015.
Odendall said that while there could be some feedback from the Davies tax committee on Wednesday, actual changes to tax rates are unlikely to be announced during the Midterm Budget. However there is no question that taxpayers are in for some additional squeezing in coming months.
“The Minister will have little option but to announce some bad news for taxpayers, whether it be this week or in February”, said Izak Odendaal, investment analyst at Old Mutual Wealth.
“Three tax changes appear to be on the table in the medium term. Firstly, Value Added Tax (VAT) exemptions may be eliminated. Currently, a range of fresh food items are VAT free, benefiting rich and poor alike. The blow to poorer households from this change could potentially be offset by increased social grant payments.
“Increased marginal tax rates for high income earners, or another form of wealth tax, are also a possibility. This will probably be more for symbolic than fiscal reasons, as high income earners are already stringently taxed, so there is little extra revenue Government can squeeze out of them.
“Finally, closing any remaining loopholes and tax avoidance schemes are likely to be on the cards. Particularly the practice by some companies of ‘offshoring’ some of their tax liabilities.”
Odendaal said there are four broad themes that will form the backdrop to this year’s Mini Budget:
Spending
As always, the Government has an extensive list of pressing areas requiring spending, including desperately-needed infrastructure upgrades, poverty relief and the daily requirements of education, health and safety.
But this year, other spending requirements also need to be addressed.
“The size of the Government’s wage bill is of particular interest, as it is such a politically sensitive area. Public sector unions have asked for 15% salary increases from next year, but the Minister has said that increases greater than inflation plus 1% would lead to job losses.”
Another urgent matter on the MTBPS agenda is Eskom‘s recapitalisation, which might be funded from the sale of “non-strategic” assets. This announcement will be keenly anticipated.
“Since Government has committed to a ceiling above which spending may not rise over the medium term, it becomes a matter of trade-offs between different spending priorities, both current and future. Implementation of the National Health Insurance programme might, for instance, be pushed out.
“Of course, while there is massive room for improvement in curtailing wasteful, unnecessary and fraudulent spending, that will not by itself close the budget deficit,” said Odendaal.
Slow growth
“To grow its tax take, Government relies on economic growth, yet economic growth has been most disappointing,” added Odendaal.
“At the time of the February Budget Speech, the National Treasury was expecting the economy to grow by 2.7% in real terms this year, and 3.2% in 2015. However, with protracted strikes, sluggish global growth and a squeeze on household incomes, the economy has faltered this year. Currently, The International Monetary Fund expects growth of only 1.4% this year and 2.4% in 2015, while the SA Reserve Bank’s most recent forecasts were for 1.5% and 2.7% respectively.”
Odendaal explained that, at the time of the February Budget Speech, tax revenue was expected to increase by 8.6% compared to the previous year.
“But five months into the current fiscal year, tax revenue is only growing by 6.9% compared to the same period last year. Tax revenue projections for the following two fiscal years (9.9% and 10.3% respectively) now seem very ambitious. Meanwhile, expenditure growth is running ahead of budget, which means the budget deficit is growing, rather than shrinking, which should be raising the alarm bells.”
Large deficits no longer acceptable
Markets are no longer tolerating large deficits, added Odendaal.
“As recently as four years ago, South Africa’s budget deficit was considered to be manageable by global standards. In 2010, following the collapse in tax revenue due to the recession, the US deficit was 9% of gross domestic product (GDP) and the UK’s at 8%. South Africa’s was only 4.5% of GDP.
“But since then, South Africa’s deficit has remained broadly the same around 4% of GDP while the other major deficit countries have made substantial progress. The US deficit will be smaller than 3% this year. South Africa had its rating downgraded by Standard & Poor’s this year, but even compared to our new BBB-rated peer group, the size of our budget deficit is starting to stand out.
“In other words, the global climate is less forgiving of our problems than it was a few years ago. The same is true for our massive current account deficit, but that lies outside the direct control of the finance minister.”
Odendaal says that the Government is well aware of the need to close the deficit, and the February Budget Speech included plans to this effect.
“But it has already fallen behind in those plans, and a capital injection for Eskom could put deficit reduction further behind target. This significantly increases the pressure on the Finance Minister.”
Trends are turning
Over the past few years, South Africa benefited from two big trends that now appear to be reversing.
“Firstly, the country received massive foreign capital inflows as global investors searched for higher yielding investments. With US interest rates set to increase next year, the global liquidity environment could become complicated (we have already experienced a taste of this with the surging US dollar over the past two months).
“This could raise borrowing costs for all local borrowers, including the South African government which borrows around R160bn per year. With interest payments the fastest growing item in the budget (and not far from over-taking welfare spending), we cannot really afford to borrow or roll-over debt at higher yields,” said Odendaal.
“The other major trend that has turned against us, is that global commodity prices are falling as Chinese demand for commodities has softened, while global supply is increasing as a result of the high real commodity prices of the past decade. This complicates our ability to export our way out of weak domestic demand. Lower commodity prices also limits government’s tax take from the mining sector.”
Next year taxpayers will see tighter fiscal and monetary policy, higher electricity tariffs, and sustained inflation of between 5% and 6%, pointed out Odendaal.
“The assumption that the economy will improve on 2014’s dismal performance thus rests almost entirely on an export recovery,” he says.
“Longer-term, the economy needs structural reforms along the lines identified by the National Development Plan, and specifically, a more flexible labour market, the professionalisation of the civil service, improved educational quality, and sustained infrastructure investment.
“The danger is that government could cherry-pick the ‘easy’ but expensive recommendations of the NDP, while ignoring the politically difficult but vital parts. Either way, the ‘fiscal space’, as former Finance Minister Trevor Manuel used to call it, has closed.
“We wish Minister Nene, who accepted the job at a very challenging and critical time, all the best.”