2018 Budget: National Treasury response to public comments

Meeting report

Mr De Beer welcomed everyone and indicated that stakeholders present would also be given an opportunity to comment on Treasury’s responses to their inputs on the 2018 Budget.

National Treasury presentation 

• Mr Ismail Momoniat, DDG: Tax and Financial Sector Policy, National Treasury, took the Joint Committee through responses to public hearings on the 2018 fiscal framework and revenue proposals. The main comments from public hearings were as follows:
• The increase in VAT was regressive and, along with fuel levy increases, will hurt the poor the most. VAT increase should be rejected
• There were numerous other options to raise revenue, including: an increase in wealth taxes (inheritance tax, estate duties, etc.), higher taxes on the rich through personal income taxes, increases in the corporate income tax rates and higher ad-valorem excise duties; personal income tax, corporate income tax and property taxes were all low
• There was a need for a higher increase in social grants, as the increment does not fully compensate for VAT increase as not all poor households receive a grant (old age, child support and disability grants only)
• The zero-rating of food items does not protect the poor as they consume many products that are not zero-rated (such as school uniforms, soap, white bread, etc.).
• The zero-rating basket should be expanded to include more items consumed by the poor
• There should be a luxury VAT rate on some foods and expensive items
• There had been insufficient time for public consultation on such large changes that will wide reaching impacts, and NT should provide more information on proposals
• Government should be reducing their wage bill – too high when compared with other countries
• Government should not be increasing taxes as South Africa was already one of the highest tax countries in the world
• Instead of tax increases, government should rather be cutting down on wasteful and fruitless expenditure and stopping corruption and sorting out state-owned entities (SOEs)
• The rate of reduction of the deficit was worrying, it should be quicker

Mr Momoniat indicated that the domestic economic outlook took into account the fiscal measures and had improved since the 2017 medium-term budget policy statement (MTBPS). The economy had benefited from strong growth in agriculture, higher commodity prices and, in recent months, improving investor sentiment. The South African Chamber of Commerce and Industry (SACCI) business confidence index had reached its highest level since October 2015, while Absa’s Purchasing Manager’s Index (PMI) was at its highest level since January 2010. Treasury’s growth projections were closely aligned with other institutions and consensus estimates, and had modelled three alternative scenarios quantifying some of the risks to the baseline economic forecast.

The main budget primary deficit was expected to close over the medium term. Main budget revenue was projected to grow from 25.4 percent of GDP in the current year to 26.6 percent of GDP in 2020/21. Main budget non-interest expenditure remained stable at 26.6 percent of GDP. However, risks to the economy and fiscus remained. These include: growth outlook and associated tax buoyancies; financial position of Eskom and several other large entities; public-service wage bill outlook; uncertain implementation costs of fee-free higher education and training; sub-investment downgrade for local- and foreign-currency debt by Moody’s; and deteriorating financial position of the Road Accident Fund.

On spending reallocations over the next three years, major spending adjustments included: MTBPS baselines expenditure reduction by R85 billion; allocation of R57 billion for fee-free higher education and training; setting aside an additional R10 billion for the contingency reserve; allocation of R4.2 billion for national health insurance; and R2.6 billion allocation for above-inflation increase to social grants. A provisional allocation of R6 billion for drought relief, assistance to the water sector, and public infrastructure projects was also proposed. After taking account of the spending reductions and reallocations, the expenditure ceiling had been revised down marginally over the medium term. Baseline reductions were made, with which national government absorbed the majority of these reductions, in order to protect frontline services at provincial and local levels. Large programmes with budgets of more than R1 billion in 2018/19, and all health and education-related programmes were however excluded. The reductions were as follows:
Administration – an across the board 2 percent reduction on programme administration for all national and provincial departments.

Public entity cuts – a 5 percent reduction on transfer to all entities receiving more than R300 million in 2018/19.  Research councils, health entities and entities that are already in financial distress were excluded from the cuts.

Conditional Grants – a 5 percent reduction of all provincial and local conditional grants, except for health and social development grants. In a number of instances cuts of more than 5 percent were introduced for slow spending grants.

The 2018 Budget was strongly aligned with constitutional imperatives. Notably, about two-thirds of the Budget was allocated to functions dedicated to realising constitutionally mandated social rights – including education, healthcare, social security and housing. It redistributes income to poor and working families, and plays a central role in transformation by promoting redistribution and directing scarce resources towards catalytic investments in human and physical capital. However, the Budget depended on the economy to generate the resources to finance these investments, and South Africa has had several years of very low growth. The fastest-growing areas of expenditure included post-school education and training, social protection, health, economic development and community development and basic education.

On the division of revenue, reductions to provincial and local government transfers focus primarily on infrastructure grants, which will result in some delays in infrastructure rollout. Services have been protected, including grants funding school meals, bus subsidies and medicines. Local and provincial government equitable share grows at over 10 per cent and 7 per cent a year, respectively. Also, over the medium-term expenditure framework (MTEF), total provincial allocations were reduced by 1 percent and local government by 3.5 percent. The division of revenue redistributed substantial resources from the urban economy to fund services in rural areas. It also subsidised services to millions of poor households in towns and cities through considerable allocations to urban municipalities and provinces. Metropolitan municipalities account for 70 percent of personal income tax revenue, but received only 31 percent of local government transfers. The 61 mostly rural local municipalities also received 31 percent of transfers to local government, but account for only 5 percent of personal income tax revenues.

Mr Momoniat commented on the Road Accident Fund. Of the 52c/litre increase in fuel levies, 30c would go towards the Road Accident Fund to stabilise short-term liabilities (i.e. claims finalised but not yet paid) at about R8.5 billion per year. Nevertheless, actuarial estimates of the total liability grow to R355 billion by 2020/21. He noted the key features of a good tax system. The tax system should be considered in its entirety, and: taxes should be structured to meet overall spending needs and the earmarking of revenues for particular purposes should be avoided; not all taxes need to address all objectives; and not all taxes need to be progressive as long as the overall system is. Generally, the right tools for achieving distributional objectives were direct personal taxes and benefits/spending. However, personal income taxes (PIT) have been increased substantially over the past four years, such that the scope for substantial revenues from the top were limited. The current estimate was that PIT revenues would fall short by R21.1 billion, contributing over 40 percent of the total expected shortfall of R48.2 billion. Given the relatively small income tax base at the top end of the distribution, increases in the top marginal tax rate were not expected to yield significant revenues. The increase from 41 percent to 45 percent this year was expected to generate an additional R4.4 billion, however this was looking unlikely to be realised as PIT revenues are the biggest underperforming tax category this year. Increasing the top rate to 50 percent may bring in around R5 billion, but behavioural effect was difficult to judge and could lead to a lot less (which is what appears to have happened this year). With much higher rates individuals may increase avoidance, through the use of greater deductions or structuring or through evasion. Also, the real impact on work effort and economic activity as additional returns are diminished.

A VAT increase was expected to have the least harmful impact on growth. VAT is an efficient, certain source of revenue provided that its design was kept simple. Increasing the VAT rate by one percentage point was estimated to have the least detrimental effect on economic growth and employment over the medium term. VAT was last adjusted in 1993, and was lower than the global and African average. Notably, it is a blunt instrument in dealing with distributional issues as higher income households generally tend to benefit more from zero-rating, in absolute terms, than poorer households for which the policy would have been intended. Targeted poverty relief measures (i.e. direct transfers) were better suited to address the possible regressive effects of VAT than exemptions or zero-rating. Increasing the list of zero-rated food items will further erode the VAT base and reduce the revenue potential of a future VAT increase. However, due to concerns around the impact of the VAT increase, Treasury proposed that it will convene a panel of independent experts to investigate the potential for expansion / review of the zero-rated basket of goods. The aim would be to have public hearings on this research by the middle of the year, to then feed potential proposals into any ministerial committees. Treasury would invite stakeholders to demonstrate their proposals even after the Budget was passed.

Mr Ian Stuart, Acting DDG: Budget Office, National Treasury, said Treasury received valuable input from stakeholders. He concluded by indicating that the Budget accelerated 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 included a one percentage point increase in the VAT rate in 2018/19 and large-scale spending reallocations over the medium term. In combination with the improved growth outlook, the 2018 Budget proposals would result in a considerably narrower budget deficit than was presented in October, and a clear path to debt stabilisation. It was absolutely crucial to stabilise the debt at this stage as it would raise confidence levels, the basis for growth. Despite positive signs, significant risks remained to economic and fiscal projections. However, government was working to boost economic growth, promote more rapid investment to create employment, and stabilise the precarious finances of state-owned companies. The budget was the first step towards stabilization and economic growth.

Mr De Beer appreciated the responses by Treasury, and welcomed comments from stakeholders.

COSATU Input
Mr Matthew Parks, Parliamentary Liaison, COSATU, said that Parliament should cancel the VAT rate or expand the list of zero-rated items to include essentials such as sanitary pads, toiletries, school uniforms and textbooks. He said that consulting with experts and reaching a solution for 2019 would be too late. COSATU did not get a sense how Treasury would deal with the recurrent losses in government. Government was actually asking for more money to plug the hole. There was no clarity as to how stolen money was going to be recovered. The little that was being done seemed to be public theatrics rather than real action. There was a deep sense of anger among workers that government money was stolen then workers were now being made to pay back the money. COSATU was willing to engage with government through the bargaining council and other forums, and had moderated the amount of strikes, but the political honeymoon was over.

Civil Society Coalition Input 
Dr Gilad Isaacs, Institute for Economic Justice, appreciated the responses but urged Treasury to capture some of the nuances of the models and scenarios presented by stakeholders. Some of the arguments that all tax increases would have a detrimental effect on economic growth were counter-intuitive and unsound. Evidence in the past decades did not support such claims. Also, stakeholders were not necessarily saying taxes were low but that there was still room to manoeuvre. Zero-rating additional items needed to be seriously interrogated. He noted with concern the spending cuts on provincial grants. The country’s debt matric was not the only concern for rating agencies. The debt matric was a ratio, therefore debt borrowing was to be viewed in terms of what the borrowed funds would be used for. If such funds would be used to stimulate the economy then the ratio would fall. He emphasised the need for more thorough conversations about the various issues.

Dr Sean Muller input
Dr Sean Muller, Senior Lecturer: School of Economics, University of Johannesburg, believed it was disingenuous for Treasury to come to the Joint Committee and make arguments about it being more appropriate to make changes over the medium term when there were significant departures from the MTBPS in the 2018 Budget Review. How was civil society and Parliament supposed to make inputs when all that was present in the MTBPS was vague claims about possible expenditure cuts and revenue increases? On higher education allocations, it was hard to see that the decisions made were consistent with constitutional obligations given that the massive increase in expenditure allocation for free higher education coincided with cuts on more basic social expenditures which, arguably, receive greater priority in the Constitution. In relation to tax, it was important to separate the technical usage of the terms ‘progressive’ and ‘regressive’ from the more common political or normative usage. Some authors estimate that VAT with zero-rating in South Africa was slightly progressive. However, a technically progressive tax can still have a very negative impact on the poor. Furthermore, increasing reliance on less progressive taxes, such as VAT, and decreasing reliance on more progressive taxes, such as personal income tax, reduces the overall progressiveness of the tax system. He noted that Treasury was saying the trend was down on corporate income taxes and the threshold had been reached for personal income taxes. Did this mean that there had been a change in tax policy such that there would be a switch to indirect taxes in future? If that was the case, Treasury had to also substantiate why indirect taxes were underperforming. There were various issues which still needed to be discussed and it was problematic that the Joint Committee was being made to deal with them within a very short period of time.
Parliament Watch Input
Ms Vivienne Mentor-Lalu, Researcher and Facilitator, Dullah Omar Institute, said the organisation felt there was more Treasury could do to facilitate public participation. There was need for more meaningful participation in the budget-making process annually.

Discussion
Mr De Beer indicated that the two committees would be engaged with revenue bills discussions for the next nine months. He urged stakeholders to participate during the processes. He commented on the proposed VAT increase. If the VAT proposal was rejected, R22.9 billion had to be sourced somewhere else within the next twenty days. That was the real situation.  

Ms T Tobias (ANC) urged extensive engagements on the contribution of indirect taxes to redistribution and economic growth. There was also need to explore the possibility of exempting the poor from paying tax on basic services such as electricity and water so as to cushion them. The public was not being helpful by criticising Treasury proposals without making any concrete recommendations and providing alternatives.

Mr A Lees (ANC) commented on the proposed VAT increase. He asked for an indication as to which items would be added into the zero-rated basket as part of the identified potential review processes. He noted the provisional R6 billion allocation for drought relief. The drought was not only a Cape Town issue but other parts of the country were also suffering from severe consequences of low rainfall. Therefore, the allocation had to take that into consideration. Also, there seemed to be little provision for real risk items such as Eskom. Was there any plan to deal with Eskom as it might require a bailout of some sort?

Ms S Shope-Sithole (ANC) appreciated that Treasury had done its best under difficult circumstances. She commented that there were rural families without any income at all. The proposed tax increases would leave such indigent families literally grounded. There was need for further engagements on the tax increases.

Mr Momoniat replied that Treasury was willing to engage with the stakeholders. He emphasised the need for balance as a VAT multi-rated regime would be tremendously complex to administer, and would increase scope for evasion. At some point, hard decisions would have to be made. Treasury was equally frustrated by corruption at entities, such as Eskom, which exerted pressure on the fiscus. Spending inefficiencies were high and there was need for bolder steps. The issues should not be addressed from the side-lines. Treasury planned to take a collaborative approach in the consideration of goods to be added to the list of items zero-rated on VAT. He reiterated that increasing the list of zero-rated food items will further erode the VAT base and reduce the revenue potential of the VAT increase. However, Treasury was open to reviewing the current list of zero-rated products due to concerns which had been raised over the VAT increase. Treasury was not working with one exact mechanism and was considering asking the Davis Tax Committee to get a panel of experts to provide a report.

Mr Chris Axelson, Acting Chief Director: Economic Tax Analysis, National Treasury, underscored the complexity of VAT multi-rating. He made reference to the Margo Commission (1987) which stated that it was satisfied that to charge different rates of indirect tax on different goods and services was the most wasteful and ineffective way of trying to redistribute income. That task was best achieved by well-designed public expenditure programmes, supplemented at the top of the range of income and wealth by a progressive expenditure (income) tax. Measures on the indirect tax side complicate the system, give increased scope for evasion and accomplish little in the way of redistribution. The Katz Commission (1994) also indicated that the disadvantages of multiple VAT rates outweigh the possible redistributive gains available from this option.

Mr Stuart said the risks to the Budget were huge and Eskom was just one of the major risks. Treasury was well aware that the current contingency fund was not enough. There was need to stabilise SOEs so that the need for bailouts, which put pressure on the fiscal framework, would not arise. 

Mr Carrim said the public hearings and Treasury responses were helpful and intellectually stimulating. Horizons had been broadened but there was need for concrete proposals to be included in the Joint Committee report on the 2018 Budget and Fiscal Framework. He noted that the debates were polarised because of the various schools of thought and vantage points. Final decisions could not be made in the current conjuncture, but if the VAT increase was to be rejected, R22 billion would have to be raised through other alternatives. He urged Treasury to give further attention to suggestions by stakeholders. He asked Members to submit their inputs for consideration for the Committee report to be voted on the coming week.

Mr Lees asked about the Joint Committee processes in relation to the report. When would Members be given time to consider the submissions and Treasury’s responses? He felt there would not be enough time for Members to formulate their positions to be incorporated into the report.

Mr Carrim indicated that the Joint Committee would follow normal procedure as per previous years and Members were expected to submit their proposals and comments to Committee Researchers over the weekend. 

Ms Tobias said there was an intention by the DA to stall and delay Committee processes. This happened even during Parliament’s Joint Programme Committee meeting the previous day. She warned the Co-Chairpersons to be alive to this.

Mr Lees interjected, and said he had no intention to delay processes. His was a clarity seeking question, and would formulate the DA’s positions and submit them to Committee Researchers for consideration on the report.

Mr Carrim said while it might not have been Mr Lees’ intention to delay processes, Ms Tobias was correct to raise the issue.

The meeting was adjourned.