The good news is that there will be a sufficiently large revenue overrun to allow finance minister Enoch Godongwana to beat his -7.8% 2021/2022 consolidated budget deficit target by a good margin, and safely extend the R350 social relief of distress (SRD) grant for 12 more months without having to raise taxes.
Moreover, he will be able to revise upwards his deeply conservative nominal GDP growth and revenue targets for the coming fiscal year. And, if commodity prices remain well supported by the global recovery, the economy could potentially deliver another (smaller) revenue overrun in 2022/2023, allowing the consolidated deficit to fall back below 6% slightly ahead of schedule.
It’s not a bad position to be in, and it will relieve pressure from SA’s credit ratings for at least another year. But is it sustainable?
For how long can the National Treasury keep funding the extension of the R50bn SRD grant — and its inevitable expansion into a permanent basic income grant (BIG) — out of windfall commodity revenues without raising taxes? And will SA’s fragile growth momentum, and progress towards debt stabilisation, stall when it is forced to do so?
Several economists say that as the commodity rally invariably fades over the medium term, the budget deficit could become sticky around -5.5% to -6.5% of GDP, given the pressure to introduce a BIG in a slow-growing economy with widespread resistance to tax hikes.
The International Monetary Fund (IMF) is even more pessimistic. In its annual report on the SA economy, released late last week, it projects that the growing interest bill and demands from state-owned enterprises (SOEs) and public servants will keep SA’s fiscal deficit high, above 7% of GDP. It expects the debt ratio to keep rising from just under 70% of GDP now to almost 78% by 2023.
But the overwhelming consensus is that a BIG poses the biggest risk to SA’s public finances.
"We all know that funding the SRD grant on a sustainable basis is near impossible," says Citi economist Gina Schoeman. "But we all know [the government] can’t take it away."
She predicts that because SA is both "a procrastinator and complacent", it "will be kicking the can down the road on this issue for a very long time".
"What we should be thinking about," says Schoeman, "is what the SA tax system will look like in 10 years’ time. Will there be enough people to keep relying on personal income tax [PIT] or a wealth tax, given the potential exodus of high-income individuals and corporates? That’s the type of thinking that needs to go into [any discussion] on social grants — how do you fund it sustainably over time in an economy that is unlikely to grow?"
Wits University adjunct professor Michael Sachs believes continuing with basic income support may well be necessary to secure Ramaphosa’s re-election at the 2022 ANC conference, and victory for the ANC in the 2024 general election. It may even be "a contract on which the sustainability of democracy depends".
This means the budget will probably have to accommodate a structural increase in spending of at least R50bn-R100bn a year, or about 1% of GDP, over the medium term.
We all know that funding the SRD grant on a sustainable basis is near impossible. But we all know [the government] can’t take it away
— Gina Schoeman
While SA may be able to accommodate this in the short term, it would be "foolish" to rely on the continuation of supportive commodity prices and easy global monetary conditions, says Sachs in a recent essay published by the research initiative Econ3x3, which is linked to the University of Cape Town.
"These [supportive] factors enable SA to continue along a clearly unsustainable path, and the political leadership is determined to make hay while the sun still shines," he adds.
However, he warns that when global conditions change, SA’s tax revenues will fall and interest rates will rise. (Indeed, the Reserve Bank’s hiking cycle is already under way.) Introducing a permanent BIG against this backdrop would worsen SA’s fiscal position and damage the credibility of fiscal policy, probably putting upward pressure on bond yields, which could, in turn, slow the pace of growth and employment creation.
International commentators and investors are alert to the dangers.
London-based Capital Economics economist Virág Fórizs fears that SA’s apparent shift towards providing more social support could leave public finances on an unsustainable trajectory. She worries that "with a one-year extension potentially turning into a permanent expansion of the social safety net, the government has opened a door that it might struggle to close".
To minimise the potential financial market fallout, Sachs calls for upfront clarity on plans for increased taxation.
Godongwana is likely to reiterate in next week’s budget the Treasury’s stated position that any permanent BIG would represent a structural increase in expenditure and that this can only be financed out of a permanent increase in taxation.
This is not to say that he will earmark specific tax hikes yet — a great deal more technical work still needs to be done on the appropriate funding mechanism — but taxpayers should be in no doubt that they are coming, possibly as early as 2023.
Sachs suggests that some combination of the following three options be considered. First, removing the tax breaks on retirement savings. This would raise the effective rate of PIT for the most affluent. The government could also provide less generous relief for fiscal drag, which would shift the burden onto the middle strata of taxpayers, and/or it could raise the rate of VAT. A 2 percentage point increase in VAT would yield about R50bn more a year.
PwC tax policy leader Kyle Mandy is not expecting any significant tax changes this year. Like most economists, he expects the 12-month extension of the SRD grant to be financed out of windfall revenues, not through hiking taxes.
As far as the funding of a permanent BIG is concerned, Mandy also expects government "to kick the can down the road". But he’s emphatic that if it does go this route, it should not increase corporate income tax (CIT) or PIT to pay for it.
"The Treasury’s stated intention is to reduce CIT over time while broadening the base," he says. "It’s a pro-growth position and we don’t expect that to change."
(The planned reduction in the corporate tax rate from 28% to 27% that was supposed to take effect in 2022/2023 has been postponed for at least a year because it is tied to a package of new tax-broadening measures that have been deferred to allow companies more time to recover from the pandemic.)
Mandy maintains that the government has maxed out the revenue it can wring from the PIT base. (By 2019, the PIT/GDP ratio was at a record 9.3%, compared with 6.5% in 2004.) The Treasury has acknowledged that the PIT burden is approaching its limits and said in the 2021 budget that its intention was to reduce it over time.
"Most economists and tax experts would tell you there’s no scope to extract anything like the taxes you’d need to fund a BIG from the PIT base," says Mandy. "The most credible, affordable way to do it would be by raising VAT."
However, most political analysts would say that increasing VAT is politically impossible, certainly in the run-up to the ANC’s 2022 elective conference and, equally, in the run-up to the 2024 general election.
This suggests that by failing to be upfront about the painful policy trade-offs involved, the government risks backing itself into a dangerous fiscal corner over a BIG.
In shifting towards providing more social support, the government has opened a door it cannot close and may place public finances on an unsustainable trajectory
— What it means:
Moreover, it’s not as if financing a BIG is the only big upside spending risk SA faces.
Next week’s budget will also be scrutinised to see if the Treasury’s expenditure framework is still predicated on an unlikely pay freeze for public sector workers. A more reasonable assumption is that public sector workers will achieve a 4.5% wage increase in line with expected average consumer inflation this year. This would add another R27bn to overall expenditure.
The Treasury has also failed to pencil in any further bailouts for delinquent SOEs or municipalities. Though Godongwana has said there will be no more bailouts, previous finance ministers have made similar assertions, only to have to walk them back.
Responding to the IMF report, the Treasury acknowledged in a statement that SA is at a "difficult juncture" and the economy is subject to "significant downside risks". Even so, it is more optimistic than the IMF on the growth and fiscal outlook.
It argues that progress is being made in advancing pro-growth structural reforms, including corporatising the ports, restructuring Eskom, facilitating skilled migration, unblocking the release of high-demand spectrum and securing significant climate-change grant funding.
The Treasury also reiterated that it remains committed to ensuring fiscal sustainability through growth-friendly fiscal consolidation and, through Operation Vulindlela, to addressing long-term structural constraints to foster growth.
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