2016 Revised Fiscal Framework (MTBPS): Treasury response to public hearings

Meeting report

National Treasury responded to questions raised during the public hearings on the MTBPS:

Growth Forecasting
Mr Michael Sachs, Deputy Director General: Budget Office, Treasury, said that the International Monetary Fund (IMF) forecasts for global growth had been revised down in its flagship economic forecast since 2012. It was not only South Africa that was revising down. People had a strong desire for certainty about the future and economists pandered to that desire by providing forecasts. However, the future was highly uncertain.

When one was faced with the kind of global shock of 2008-2009, the assumption was as reflected in the IMF graph of projections was that, although the shock would have knocked one off the path, one would return to the same path. However economists were not very good at accounting for the fact that the path could have changed very drastically. Nevertheless, when National Treasury did its economic forecasts, it was based those on assumptions.

Risk scenarios and fiscal outcomes
For the first time Treasury had published a fiscal risk statement to say what if things did not turn out the way Treasury had forecast in its baseline forecast. As Mr Maynier had asked about the probability associated with the forecasts; Treasury maintained that its baseline forecast was the one it thought most probable. However, it had presented other scenarios that could occur.

Scenario A: Treasury had modelled the impact on SA’s revenue if no tax policy changes were made and the spending ceiling remained the same. That enabled Treasury to see what would happen to SA’s deficit, which in turn enabled determination of what would happen to SA’s debt. The country’s debt would continue rising significantly without levelling off in the medium term.

Building confidence to leverage private balance sheets
Mr Sachs said that in 2016 the most important statistic in the Medium Term Budget Policy Statement (MTBPS) was that capital formation, which was investment, would contract by 3%. That contraction was despite the fact that investment by Government and its parastatals was expanding. Therefore the fiscus had gone as far as it could in supporting growth. What was needed were measures to restore or build confidence in the next two years or so.

A package of actions to restore confidence
In the MTBPS, Treasury had noted that Government was creating the necessary conditions for higher confidence and investments by finalising the regulatory framework for private sector participation in infrastructure projects which had been discussed in Cabinet recently; including partnerships between the private sector and state owned companies (SOCs).

Maturity profile of long term Government debt
Mr Sachs said that the graph on the structure of SA's debt was important for Members’ attention because when Treasury said that SA owed R2 trillion, it showed that the country would still be paying back its current debt in 2050. Moreover, since 2008 on average SA’s redemptions (when the country paid back its debt) had been around R20 to R30 billion per annum. Paying back was in reality borrowing more to pay back, so the debt was being rolled-over. Therefore in a year the Government had to borrow two amounts; the first amount was to finance the deficit of 2016 which was roughly about R150 billion. The second amount was to pay back previous deficits. And that amount was about R20-30 billion a year and if one added those two numbers the ‘gross borrowing requirement’ was the result. From 2018-2020 there would be a huge increase in the redemption levels since all of the debt that Government would have been accumulating over the last few years would be due for payment. There would then be an increase in the gross borrowing requirement which was an additional risk Government faced.

Containing spending on non-essentials
On spending on consultants, there were issues in how things were classified in the ‘standard chart of accounts’ which set out what different spending items are called. The classifications in that standard chart of accounts followed international best practice and sometimes could be very confusing. For example, reporting on consultants included laboratory services, because when a hospital sent a blood test to the National Health Laboratory Service (NHLS) that was the purchase of an outsourced service for the hospital. In accounting terms it was classified as consultants. But of course when there was a complaint about Government spending too much on consultants people were generally not referring to laboratory services. They were referring to consultants as in the presentation which included business advisory services.

On expenditure on leases, Mr Sachs said that Government had a huge property portfolio which was managed by the Property Management Trading Entity (PMTE) at the Department of Public Works (DPW). If there were efficiencies that could be found in that portfolio, that is, if there were unused buildings that Government was paying leases for, that was a waste and the portfolio needed to be rationalised.

He said it was true that economic services had not been growing very rapidly. There was a statistical problem there as the way the SA Government defined economic services was too broad and happened to have included the Road Accident Fund (RAF). The way the RAF was allocated its budget; the financials given to Treasury by the RAF because of the RAF’s peculiar financial problems, assumed that revenue and expenditure did not increase over the next three years. Revenue and expenditure remained constant at about R30 billion for each of the three years, since RAF assumed there would be no increase on the levy which was transferred to them, which could or could not be a correct assumption. That then meant that R30 billion grew at zero which was a lot in economic services. That then meant that the low growth rate of economic services was influenced by that factor. So when reviewing the Department of Trade and Industry (DTI) or the other departments delivering economic services (although Mr Sachs was not saying their growth rate was rapid but in the numbers in the document), economic services were growing only at 4%, whereas the DTI budget grew at around 6.5%.

Economic affairs grew at 5% but if the Committee read the table on page 38 of the review it would see that industrial development and trade, effectively the DTI grew at 7.3%. Economic infrastructure and network regulation, which was Departments like Energy and Telecommunications, grew at 6%. Science and technology, innovation and the environment grew at 6.2% but the one component which was employment, labour affairs and social security funds, including the RAF, only grew at 2.3%.

Basic Education: Real spending per learner
In 2002 the Government was spending R8000 per learner in basic education and in 2016 the Government was spending almost R18 000 per learner having taken out the effect of inflation. The Medium Term Expenditure Framework (MTEF) then essentially sustained without diminishing or increasing that expenditure over the next three years. Though Government would like to increase that expenditure it was quite difficult unless there was a return to economic growth. Additionally, most of that increase in expenditure on basic education was because it was labour intensive, that is, the increase per learner was expenditure due to teacher salaries. That had been a result of two things: the number of teachers employed had massively increased over the last 10 years. Secondly, the conditions of service of those teachers had also improved drastically both through annual cost of living adjustments and the Occupation Specific Dispensation (OSD) that had been introduced. Two questions then arose: were South Africans getting quality and performance out of that investment? Secondly, having sustained that massive increase over a period of 10 years, how now was Government to navigate through a time of more limited resources, including in the education sector? If SA had been used to that escalation annually, it was currently in a position where there was no more escalation year after year.

Employment levels in health services
This slide responded to the Rural Health Advocacy Project (RHAP) submission. Treasury felt that RHAP had raised very important points. In the health sector a similar escalation as that in basic education had occurred. There had been a 38% improvement in the real take home pay of nurses because of OSD.

A Progressive Fiscal System
Mr Sachs said the graph in slide 16 had come from a study commissioned by the World Bank at the University of Cape Town done by Ingrid Woolard. The graph gave a good representation of the point he was making about a progressive fiscal system. Within the three categorisations presented, there were big variations: the top 10% earned somewhere about 60% of the income in the economy; the middle income of 50% earned somewhere about 35% of national income; and the bottom 40% earned less than 2% of national income.

Corporate tax had been excluded from the analysis as it was not paid by corporates first off. It was paid by shareholders and employees, that is, it was paid by capital and labour and the division between capital and labour was not easy to disaggregate. But in general the international consensus had been that about 80% of corporate tax was paid by capital, that is, shareholders so that labour paid the remaining 20% in the form of lower wages and higher unemployment.

The top 10% received about 6% of spending as per the graph where Mr Sachs reckoned that the entire sending was through the university system. Because the university system was the one element of Government spending that had been channelled to benefit the wealthiest 10% of South Africans. As van der Berg at the University of Stellenbosch had estimated that anywhere, between 60-80% of that subsidy benefited the wealthiest 10% of South Africans.

What had to be kept in mind therefore was that as taxes were to be increased, the wealthy had already been paying more than their share of national income; though he was not saying they should not be taxed more. But the middle 50% had been paying less than their share of the national income, though he was also not saying they had to pay more. But how the progressivity of the whole system was thought about was more important than looking at an individual tax instrument.

Discussion
Mr De Beer said that in future the scheduling of the joint meetings had to consider the Committees on Appropriations and the Financial and Fiscal Commission (FFC) and the response by Treasury was in line with the seriousness that Parliament had in reviewing the Money Bills Procedure Act.

Ms T Tobias (ANC) said she wished that RHAP had been present because they would be witness to the fact that Treasury had addressed its concerns. The notion that Treasury had not paid attention to economic affairs in terms of allocating resources had been dealt with and based on Mr Sachs presentation the economic affairs sector got more funding. Possibly there needed to be a separate paragraph to demonstrate how economic affairs had received its adequate slice, when going to the MTBPS debate; though individual Ministers could have differences in opinion about how allocations had been made in the economic cluster, the matter would have been clarified.

Mr D Maynier (ANC) agreed with that the FFC had to have its separate slot on the Committee’s programme. He accepted Treasury’s view on growth projections for SA but the issue arising was about Treasury’s growth projection in the outer year as there was a narrative developing that Treasury’s projection in the outer year was not credible. What was Treasury’s response to that?

Although Treasury provided Parliament with a full report on contingent liabilities every year during the main budget it would be useful if Treasury could during the current budget period, provide the Committee with an update on the current state of contingent liabilities before the debate on the MTBPS on 1 December 2016.

Mr M Hlengwa (IFP) said that the biggest problem was that on both sides of the scale in terms of building confidence to leverage private balance sheets, especially since that had been preceded by the presentation slide on fiscal challenge: avoiding a low growth rate: the suggestion that to avoid the trap Government was proposing a balanced consolidation that had to be focused on, was problematic, especially the dynamics of thereof. Having talked to laboratory services being classified as consultants, the same graph also listed laboratories under contractors. Could Treasury clarify to what extent those services were consultants and then a standalone item in the same graphic?

Mr Carrim had difficulty understanding the overlap alluded to in terms of economic services being a broad category. He would want further clarity on that from Mr Sachs outside the meeting. He said the two documents were insightful and he would urge Members to read both. He agreed with most of the points in the document but he was not convinced that Government could not save more on items like travel and accommodation.

Mr de Beer added that on travel and accommodation when he looked at directors or managers of the Northern Cape provincial departments, they would be found in Kimberley. Travelling to Springbok and back took two days as the distance was 800 plus kilometres. His proposal was that video conferencing had to be an alternative that was considered for savings on travel costs.

The Committee content advisor noted that since Treasury had explained the assumptions on which the growth projections were based; the South African Revenue Service (SARS) had more or less collected revenue as expected for the revenue projection in 2015/16. In the same financial year growth projections had been revised down and no more jobs had been created. She asked if it was correct to imagine that if the forecasts had not been revised down SARS would have significantly collected more revenue. She also asked about the relationship between growth forecasts and revenue forecasts or possibly something could have happened where SARS had become more efficient or there was more tax compliance from citizens.

Mr Maynier said the FFC had reported that 68% of the composition of SOC debt had been in foreign currency. He wondered if Treasury could provide a breakdown of that SOC debt.

Mr Sachs clarified that the numbers on slide 12 regarding containment on spending on non-essentials, were each an average annual real growth rate. Therefore each year on average since 2012 travel and subsistence had fallen by 5% in real terms.

The terms used in the presentation were not necessarily those used in the accounting systems, that was why when one met someone claiming that Government had spent R50 billion on consultants, that meant that they had taken the accounting term where the accounting system specified consultants as business consultants and everything else in that category. In the presentation ‘consultants’ had been used generically and not specifically in terms of the standard chart of accounts. Consultants therefore included laboratory services, contractors - maintenance and repair of infrastructure contractors. People employed as part of the Expanded Public Works Programme (EPWP) salaries were classified under the contractor category as they were not employees; where accounting conventions required that in the accounting system. But that created some confusion when one had to translate that to what people wanted to hold Government accountable for.

On growth and revenue projections including SARS, there had been a lot discussion on that matter on page 28 of the MTBPS, though it was technical. Essentially, previously there had been substantial downward revisions to growth whereas revenue had held up. Therefore there had been some years where Treasury had projected growth of about 3% where eventually growth would be 1.5% in a particular financial year, however; the revenue target would be achieved in the same year. In 2016 the downward revisions to growth had not been that big compared to previous years for the in-year. In the budget, growth in the fiscal year had been projected at 1.2% whereas in the MTBPS that had been revised to 1%; yet Treasury projected significant shortfalls on the revenue side of R23 billion.

The technical term defining the relationship between growth and revenue collection was named ‘buoyancy’. For 1% change in growth what would be the percentage change in revenue collection. Over the last five years buoyancy had been very high and there was a graph of the Fiscal Risk Statement (FRS) and for a 1% increase in growth, tax revenue had grown at 1, 2 or 1, 3 %. There was a concern reflected on page 27 of the MTBPS where growth and revenue performance was discussed. One of the factors was a review as illustrated by the graph on slide 16 that when talking about Gross Domestic Product (GDP) growth, the graph showed that about 65% of that growth was growth in the income of the top10% of the population. Therefore whilst growth could be slowing; if the incomes of the top elite, that is people shopping at Woolworths and if Woolworths was booming and its stock was performing well, that implied that the top 10% were performing well. That top elite of course paid on average 70% of taxes. When one looked at personal income tax which had been a particular driver of buoyancy; the elite paid 90% of personal income tax. If the wealthy were faring well, even at slow growth high buoyancy could result. A fundamental question following that was whether the elite were now starting to feel the effects of the economic slowdown in the period under review. Another issue which had been affecting SA over the last few years despite the depreciation in the exchange rate and the rand getting weaker, imports had remained extremely strong and the country got a lot of taxation on imports as there was Value Added Tax (VAT) and Customs Duties levied. If the rand was weakening and the imports remained constant there was an immediate tax boost since the value of the import in rand terms would have increased as the rand would be lower. Since imports had started to significantly contract in the current year, the buoyancy factor was no longer there. Mr Sachs said there were those complicated factors and he would very cautious about finding implications that concerned SARS. It was not necessarily that SARS was good or bad if tax collection in a particular year had been achieved or the target missed. Additionally SARS was part of the revenue analysis working group at Treasury which met to discuss the in-ear projections and it involved SARS, the South African Reserve Bank (SARB) and Treasury.

Mr Sachs said he had been quoting from a table in page 38 of the MTBPS which broke down the disaggregated numbers. Also included was the security cluster where there were differences in the growth of police and that of defence. When aggregated the growth numbers made-up an average. Certainly Mr Sachs would not say Members had not clamouring about how Government could shift spending from consumption to economic affairs and if economic affairs could grow faster. He was not arguing against that there, rather he was saying the aggregated number tended to exaggerate the issue because of the RAF.

He also was arguing that Government had to be focusing on the impact rather than arguing about the money spent. And in economic affairs one factor that had not been included was that they had massive subsidies through the revenue system. Those huge tax incentives advanced to small business and automotive sectors were not spending which had to be regarded as spending in reality as they were a subtraction from revenue.

On the outer year projections in the graph on slide 2, the Committee would see that the outer year projection though it could be construed to be optimistic was falling. Everyone would agree that even if potential or trend growth had fallen significantly, the growth experienced in 2016 of 0.5% was well below what SA could achieve and would expect a recovery overtime. How strong that recovery would be was difficult to have an opinion about.

Mr Ian Stuart, Chief Director: Fiscal Policy, Treasury, added that on the outer year forecast Treasury had revisited the three year forecasting accuracy since 1997 when the MTBPS had been first introduced. Treasury’s conclusion was that Government was fairly conservative or slightly pessimistic typically in-year or one year ahead and marginally optimistic in the outer year. However; those were very small margins. The issue therefore had be more around what had been happening in the past four years. Both in SA and globally the economists that did the forecasts were not coming to terms with the fact that global growth had slowed down significantly. There was an optimism bias in the three year forecast done by the World Bank and other institutions. Also the comparatives available were for the one and three year forecasts and not for the outer year of the MTEF.

On the question of SOCs and foreign debt exposure, Treasury had been looking at that in great detail when working on the Fiscal Risk Statement (FRS) 2016. Indeed about 40% SOC debt was in foreign currency but there were two mechanisms through which Treasury tried to mitigate that risk. Firstly, SOCs were required to request from Treasury whether they could increase their foreign borrowings over time. The request went to the Fiscal Liabilities Committee which looked at whether the SOC could afford to go into the foreign market on the strength of its balance sheets. Secondly SOCs engaged in foreign currency risk hedging which meant they paid banks to take the risk for a significant depreciation in the rand for example. Though there was a cost associated with that risk hedging, effectively one was putting the risk onto the balance sheets of the private sector which were the banks.

Mr Sachs said the delegation from Treasury would take the proposal that contingent liability updates be given to the Committee, to the unit that dealt with the liabilities at Treasury.

Ms Tobias asked whether the Committee had agreed in principle on whether it would want to look at contingent liabilities of SOCs in an aggregated manner.

Mr Carrim said the Committee would certainly look into that.

Mr Maynier wondered if it would be possible on the same basis as contingent liabilities, that Treasury could provide the Committee with a breakdown of the foreign exposure per SOC.

Mr Stuart repeated Mr Sachs sentiments that they would have to go back to the assets and liabilities unit.

Ms Tobias said she had asked her question because the Committee was still awaiting a report from the Inter-Ministerial Committee (IMC) on whether there was a need to expunge some SOCs which would also cover financial liabilities. She wanted the issues to be dealt with holistically and if the Committee wanted the information before the IMC report, she was not sure if that would not be putting the cart before the horse.

Mr Carrim said that indeed there was a principled consensus that something had to be done. How and when was something to be discussed in the Portfolio Committee. He would also follow up with the Minister on the work of the Inter-Ministerial Committee and its progress.

He said the deadline for the first draft of the Committee Report on the MTBPS was 17:00 today. However, the Committee could not expect the researchers to make recommendations in that report which the Committee members had not made. Could the Committee make proposals on what the staff could include in the first draft of the Committee Report on the MTBPS?

He had looked at the previous two years’ Committee Reports and to be frank had found the reports not to be up to standard. The Committee had not been addressing the issues at all. What was the Committee’s view about the amended fiscal framework and what did the Committee think of the amended fiscal framework that defined the MTEF?

Ms Tobias proposed that Treasury consider middle income earners to be part of the consideration for tax increases that had to be made. She recommended that the DPW had to address inefficiencies in the management of its property portfolio.

Mr de Beer noted that in the Committee Reports they had to refer to the revised fiscal framework.

Mr Maynier said he would email his recommendations and he intended to traverse all the documentation from the MTBPS speech to the final response given to the Committee today. His request was that if Treasury undertook to disclose the contingent liabilities, it would be useful if he received those before he submitted his recommendations to the Chairperson.

Ms Tobias interjected that she did not feel there had been consensus that the contingent liabilities had to be disclosed before any particular day. Her proposal was that the Inter-Ministerial Committee be allowed to finish its work in that regard which was what she had proposed earlier.

Mr Carrim said it did not seem as if there was disagreement in the Committee as Mr Maynier had qualified his statement that ‘if’ Treasury were going to disclose.

He then thanked the Treasury delegation and the meeting was then adjourned.