2018 Budget: Treasury briefing; Minister & Deputy Minister of Finance Input

Meeting report

Mr Carrim welcomed everyone and indicated that the Minister would give a political overview, then the National Treasury would take the Committee through a detailed presentation on the 2018 Budget.

Opening remarks by the Minister of Finance
Mr Malusi Gigaba, Minister of Finance, said the 2018 Budget’s overarching objectives were to implement government policy decisions as outlined by the President during the state of the nation address (SONA), and to spearhead the socioeconomic transformation agenda. The Budget was predicated towards education, health and social development in the face of constraints and challenges such as low economic growth, poverty and high unemployment.  Hard choices involving balancing acts between immediate needs and the needs of future generations were made. The allocation of funds for higher education as a means of empowering future generations was one such decision. In making the choices, means of generating resources to meet both the immediate and future needs in the context of the prevailing economic situation had to be devised. For instance, seeking assistance from multilateral institutions to fund government programs was not a viable alternative. The country would have to generate revenue and carry out its expenditures on its own terms as a sovereign nation. Debt stabilisation was also paramount. Therefore, structural reforms were expected to result in debt stabilisation and economic growth. The various reforms were also meant to boost consumer and investor confidence. The responsibility of leadership was to bear the burden of making tough choices and this was what government was trying to do.
 
Briefing by National Treasury
Mr Dondo Mogajane, Director-General, National Treasury, noted that following a difficult year for the economy and fiscus, a renewed sense of optimism had taken hold. The 2018 Budget outlined a series of measures to rebuild economic confidence and return the public finances to a sustainable path. It responded to revenue shortfalls presented in the 2017 Medium Term Budget Policy Statement (MTBPS), and the announcement of fee-free higher education and training. It also accelerated government’s efforts to narrow the budget deficit and stabilise debt.

New tax measures would raise an additional R36 billion in 2018/19, mainly through a higher VAT rate and below-inflation adjustments to personal income tax brackets. The expenditure ceiling was revised down marginally over the next three years compared to the MTBPS. Underlying this change were major reductions and reallocations including: spending cuts amounting to R85 billion, an allocation of R57 billion for fee-free higher education, and additions to the contingency reserve of R10 billion. Together with an improved growth outlook, the revenue and spending measures would reduce the consolidated deficit from 4.3 percent of GDP in the current year, to 3.5 % by 2020/21. With the main budget primary deficit closing, this would help to stabilise debt at 56.2 % of GDP in 2022/23. However, risks to the public finances which included an uncertain growth outlook, wage pressures, and the weak finances of state-owned companies had to be addressed.

The domestic economic outlook had improved since the 2017 MTBPS. The economy had benefited from strong growth in agriculture, higher commodity prices and, in recent months, improving investor sentiment. The medium-term growth outlook had also improved since the 2017 MTBPS, mainly due to an expected increase in private investment as a result of improved confidence. Rating agencies Fitch, Moody’s and S&P Global had all applauded the 2018 Budget. The preliminary review was that the country was in a much better position than it was in October last year. The agencies understand that out of a tough environment, the country came out better than in October last year.

In an effort to foster economic growth, government had made substantial progress in implementing short-term confidence boosting measures, including the appointment of new boards at Eskom and the South African Airways (SAA). However, translating the cyclical upturn into more rapid economic growth required government to finalise many outstanding policy and administrative reforms. These included: mining sector policies that support investment and transformation; telecommunications reforms, including the release of additional broadband spectrum; lowering barriers to entry by addressing anticompetitive practices; supporting labour- intensive sectors, such as agriculture and tourism, and increasing skills levels across the economy. Treasury estimates that, if the international environment remained supportive, effective implementation of these reforms could add two to three percentage points to real GDP growth over the coming decade.

Revenue collection had improved since the 2017 MTBPS in line with stronger economic performance. However, shortfalls remained significant. Gross tax revenue shortfall was estimated at R48.2 billion compared with 2017 Budget, and personal income taxes, net VAT, and dividend withholding tax were expected to show large shortfalls. Risks included weaker-than expected economic growth, and concerns about tax morality, compliance and administration.

Summary of 2018/19 budget proposals
Treasury proposed revenue adjustments which would raise an additional R36 billion in tax revenue through an increase in the VAT rate, limited personal income tax bracket adjustments and other measures. Expenditure adjustments proposals include: reduction of MTBPS baseline expenditure by R26 billion; allocation of R12.4 billion for fee-free higher education and training; setting aside an additional R5 billion for the contingency reserve; and provisional allocation of R6 billion for drought management and public infrastructure. The baseline spending reductions and tax measures would feed through to the outer years of the framework, while allocations to higher education increase sharply.

Tax proposals were expected to generate an additional R36 billion in tax revenue for 2018/19. The proposed VAT increase would have the least harmful impact on growth. VAT is an efficient tax provided that its design was kept simple, and will have the least detrimental effects on growth and employment. At 14 percent, the current VAT rate was lower than the global and African average. Personal income tax (PIT) had been increased repeatedly in recent years, and was now the main contributor to the revenue shortfall. The VAT proposal would increase the cost of living for all households. Notably, the wealthiest 30 percent of households contribute 85 percent of VAT revenue. However, the impact on the poor will be partially mitigated through: zero rating of basic food items and paraffin; above-inflation increases in social grants. To strengthen the progressivity of the tax proposals, government was proposing: no adjustment to the top four personal income tax brackets; increases in ad valorem excise duties, ensuring that households spending more on luxury goods contribute proportionately more; and a higher estate duty rate for wealthy individuals.

Spending cuts, and other small adjustments, would reduce budget baselines by R85.7 billion over the medium term. The reductions fell on large programmes, transfers to government entities, and conditional grants to subnational government. After taking account of the spending reductions and reallocations, the expenditure ceiling had been revised down marginally over the medium term. In 2017/18, however, the expenditure ceiling was likely to be breached by R2.9 billion as a result of the recapitalisation of SAA and the South African Post Office. These appropriations totaling R13.7 billion, would be partially offset by the use of the contingency reserve and projected underspending.

The main budget primary deficit was expected to close over the medium term. The main budget revenue was expected to grow from 25.4 % of GDP in the current year to 26.6 % of GDP in 2020/21. Main budget non-interest expenditure would remain stable at 26.6 percent of GDP, and debt-to-GDP ratio was expected to stabilise over the coming decade.

On expenditure efficiency over the past decade, the public sector had invested R2.2 trillion in economic and social infrastructure. Yet weaknesses in project preparation, execution and delivery had resulted in lengthy delays and cost overruns. Therefore, the Budget Facility for Infrastructure aimed to build a pipeline of projects that had undergone rigorous technical analysis, and ensure that fiscal resources are committed in a transparent manner. The facility had completed its review of 38 large infrastructure proposals. Additional work was being done to ensure that proposals could be considered for funding in the October Adjustments Budget. Options to engage development finance institutions and the private sector through the facility will also be explored. To support higher levels of capital investment, the state needed to contain the public-service wage bill, which had crowded out spending in other areas. More so, government was working to ensure that the current wage negotiations process results in a fair and sustainable agreement.

Mr Mogajane commented on the financial position of state-owned companies (SOCs). The already weak financial position of SOCs deteriorated in 2016/17. Declining profitability was partly a reflection of mismanagement, operational inefficiencies and rising financing costs. SOCs rely mainly on debt to fund infrastructure and operational requirements, and lenders had taken a more active stance in reaction to the governance failures. Therefore, government had undertaken steps to improve governance and reduce liquidity constraints. Over the medium term, the SOC sector would require far-reaching operational interventions including, where appropriate, private-sector participation.

There were notable risks to the economy and fiscus. The recovery in economic growth was not yet broad-based. Much depended on continued improvements in political and policy certainty, and a supportive global environment. Also, tax buoyancy, which declined over the past two years, may not increase as quickly as projected. However, talks on a new public-service wage agreement were in progress, and an agreement locking in salary increases that exceed consumer price index inflation would make expenditure limits difficult to achieve. While decisive action by government to strengthen governance at Eskom had staved off the likelihood of near-term default, the financial positions of the power utility and several other large entities pose risks to the economy and the fiscus. The costs associated with fee-free higher education and training were uncertain. Hence, the Department of Higher Education and Training will need to ensure that its plans are aligned with allocations. Also, the deteriorating financial position of the social security funds was a serious risk, owing to growing liabilities at the Road Accident Fund.

In conclusion, the 2018 Budget would accelerate government’s efforts to narrow the budget deficit and stabilise debt, laying the foundation for faster growth in the years ahead. It set out a series of proposals to bolster the public finances by raising taxes and adjusting expenditure – decisions that involve difficult trade-offs. Major steps include a one percentage point increase in the value-added tax (VAT) rate in 2018/19 and large-scale spending reallocations over the medium term. In combination with the improved growth outlook, the Budget proposals would result in a considerably narrower budget deficit than was presented in October, and a clear path to debt stabilisation. Despite these positive signs, significant risks remain to economic and fiscal projections. Government was working to boost economic growth, promote more rapid investment to create employment, and stabilise the precarious finances of state-owned companies.

Discussions
Mr De Beer appreciated the expertise within Treasury. The gravitas of Treasury was being felt and experienced. He asked about the outcomes of special voluntary disclosure programmes.

Ms T Tobias (ANC) commented that the Budget was formulated under difficult circumstances. Trade-offs were made amid a lot of constraints. She asked Treasury to explore the possibility of enabling access to zero-rated goods by those on social grants using their cards. She wanted to know how VAT regulations would apply to foreign companies especially those in digital technologies.

Mr O Terblanche (DA) agreed that the Budget was formulated under numerous constraints. However, the Budget could not be considered to be poor-friendly. The implications of the VAT and excise tax increases would be felt significantly by the poor. He asked about the implications of the cuts on grants within provinces. The cuts would have a severe impact on capital works and infrastructural development. He was not very optimistic about the budget allocations.

Mr A McLaughlin (DA) asked why the revenue collection targets were set so disproportionately high such that they could not be met. Also, he commented that something had to be done to stabilise the debt to GDP ratio.

Mr D Ross (DA) welcomed the improved macroeconomic outlook. He noted that there were no set timelines for debt stabilisation. He asked how debt reduction was going to be financed in the future. Was it going to be financed through taxation? He asked for an indication how private sector participation in SOCs would be brought about. What were the terms and conditions of the Public Investment Corporation (PIC) loan to Eskom? Was it not going to be detrimental to pensioners’ funds?

Mr N Gcwabaza (ANC) identified the need for reviewing the presidential review committee on state-owned entities. This should be part of the turnaround strategy for SOCs. Funding of education was greatly appreciated. However, were there discussions on the Technical and Vocational Education and Training curriculums to ensure that they spoke to the needs of the economy? Also, what were plans being put in place to deal with financial leakages and illicit finance?

Mr A Lees (DA) commented that debt to GDP ratio stabilisation was dependent on the GDP growth rate. What was the basis for pushing the growth forecast upwards? On the proposed VAT increase, how exactly would it be implemented in terms of the law? Was it part of the Rates and Monetary Amounts and Amendment of Revenue Laws Bill or some other instrument? What was the situation on talks on the public service wage? Also, there seemed to be no mention about risks posed by SOCs such as Eskom and Denel on the economic outlook.

Mr M Hlengwa (IFP) asked if there was any possibility of expanding the zero-rated basket to cover more items as a means of cushioning the vulnerable. He asked for Treasury’s position on the President’s pronouncement in relation to land expropriation without compensation. The South African Social Security Agency (SASSA) was a big problem which had to be dealt with. Was Treasury satisfied with the transition from SASSA to the Post Office? Would Treasury institute certain guidelines in dealing with expenditure deviations to ensure accountability? Has Treasury engaged the Department of International Relations and Cooperation, towards the rationalisation of foreign missions which were a huge cost to the fiscus?

Ms P Mabe (ANC) commented that VAT and excise tax hikes, together with the sugary beverages tax would impact negatively on the poor. Also, Treasury had committed to reviewing the taxation of sanitary pads back in 2016. What was its current position as there had been no mention on same? She felt women’s needs had been neglected. There had to be a relook that would see sanitary pads becoming tax exempt to address the plight of the girl child.

Mr S Swart (ACDP) asked if it was possible to add other items on the zero-rated list as a means of cushioning the poor after the VAT increase. He asked how significant the identified risks were on economic growth. He asked for an indication on the progress of the Bill that would realign SOC ownership and operations in line with the identified rationalisation programmes. He welcomed the steps being taken in dealing with the rot in SOCs. He felt a reduction in allocations to public works would be detrimental given the poor state of water infrastructure in most provinces. He asked for an indication on the savings to be achieved due to the strengthening currency.

Ms T Motara (ANC) commended Treasury’s efforts under the prevailing circumstances. She emphasised the need to strengthen tax collection by ensuring proper compliance and administration. She noted that many of the challenges in SOCs were not limited to governance issues but were also structural. Therefore, each SOC should be analysed individually based on its merits. Also, policy certainty was crucial.

Ms Phosa asked about Treasury’s plans in dealing with evergreen contracts as part of SOC restructuring framework. When and how would the funds raised by the CEO initiatives be used in developing Small, Medium and Micro-sized Enterprises (SMMEs)? Were there any specific steps or measures to improve the schools infrastructure grant backlogs? What plans were being put in place to develop startup businesses in townships?

Mr Carrim acknowledged that these were tough times which required a tough budget. The VAT increase proposal was the main issue which needed discussion and decisions from Members. The impact of the VAT increase, added with excise tax hikes, on the poor had to be explored. Was it possible for Treasury to begin being more selective on the items which are zero-rated? Were there any studies on the impact of such an increase in VAT especially in developing countries? 

Mr Mogajane acknowledged that the main takeaway from Members’ questions was the implementation aspect of the Budget. All the comments would be taken into account. Treasury was well aware that this was a tough budget. The expenditure cuts and reprioritizations would have much effect on service delivery and might, in some cases, result in delays in the completion of infrastructural projects. Treasury was not in any way shying away from these facts. These decisions were made because Treasury believed the alternatives were worse. Consequences for alternative decisions would include debt increases and further downgrades, which would be the worst for jobs and economic growth. The fiscus had come under increasing pressure overtime but the economic outlook was anticipated to improve. However, risks remain significant especially in SOCs. Hence, interventions on their structures, funding models and operational plans would ensure their long-term sustainability.

Mr Ismail Momoniat, DDG: Tax and Financial Sector Policy, National Treasury, indicated that the draft Rates and Monetary Amounts and Amendment of Revenue Laws Bill had been published for public comments. The Bill would guide implementation of the proposed tax changes. Some of the changes took effect immediately when the Minister was delivering the Budget, others changes would take effect from the start of the tax year in March whereas other provisions were linked to the fiscal year. The tax changes were necessitated by the need to finance government spending. Treasury explored various alternatives from both technical and feasibility perspectives. It would be necessary for Treasury to appear before the Joint Committee at a later stage to present the tax proposals in much detail. The need to limit impact of tax increases on the poor was central to the decisions taken. However, delivering any tax changes required trade-offs. On zero-rated items, there were currently 19 on the list. There were also exemptions around education, transport, among others to augment the list. However, there was no universal knowledge about what is to constitute the zero-rated list, thus the list could be amended. On the need to exempt sanitary pads from taxation, there was a whole process being spearheaded the Department of Women on access to sanitary pads by poor communities, however, Treasury had not made any commitments on their tax exemption.

Mr Carrim suggested that outstanding questions be responded and forwarded to the Joint Committee in writing.

Dr Randall Carolissen, Group Executive, SARS, commented on illicit financial flows. As the South African Revenue Service (SARS) and the Reserve Bank were sprucing up efforts in cracking down illicit financial and custom flows, the worrying trend currently was the movement of crypto currency through block chain technology. Therefore, SARS was engaging other foreign authorities in an effort to deal with these challenges, and a report would be released soon.

Mr Sfiso Buthelezi, Deputy Minister of Finance, said the R5 billion PIC loan to Eskom was above board. PIC got a mandate from the Government Employees Pension Fund as to how it can invest and lend money. The said transaction was purely on commercial terms and was not a grant. No pension money had been jeopardised by the transaction.

Minister Gigaba, in closing, welcomed the opportunity to provide written responses. On SOC reforms, the position of government on their restructuring was well articulated by the president’s responses to the SONA. The president indicated that the SOC coordinating council would be reestablished and he would chair it himself. The council was going to focus on streamlining their architecture, addressing the structural challenges and remodeling shareholders pacts. The Government Shareholder Management Bill was also expected to be brought to Parliament this year. The processes were going to go a long way in ensuring that SOCs are financially viable. There was a view that the budget was not poor-friendly due to the VAT hike. To the contrary, the budget was indeed pro-poor. It addresses itself very firmly to the needs of the poor. The argument that to spend now and pay later was pro-poor was incorrect as the accumulating debt would be inherited by future generations. Decision-makers ought not to be populist in the choices they make as such choices would be felt most by the poor. Under the prevailing circumstances, the presented choices were the best among alternatives. The budget must not be viewed in terms of its individual items but in its totality. All decisions taken served to advance the interests of the poor in particular and the people of South Africa in general.

The meeting was adjourned.