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FINANCE PORTFOLIO AND SELECT COMMITTEE: JOINT MEETING
26 January 2001
DRAFT TAXATION LAWS AMENDMENT BILL: HEARINGS
Chairpersons: Ms B Hogan (Portfolio Committee); Ms D Mahlangu (Select Committee)
Taxing Capital Gains is Good for the Tax System, the Economy and Tax Administration" by Professor Brooks, York University, Canada
South African Institute of Chartered Accountants (SAICA) submission
Economic Policy Research Institute submission
Professor Brooks argued that it makes no sense to continue to exempt capital gain from taxation. He said there is no difference between income derived from employment and income derived from capital. He pointed out that the exemption is rooted, not in economic policy, but in legal definitions from the law of trusts. He said to tax capital gain is fair, both for horizontal and vertical equity considerations. He debunked eight "myths" surrounding capital gains tax.
The South African Institute of Chartered Accountants gave a very detailed submission. The SAICA submission is neither in support of nor against the Bill but, rather, is to draw attention to issues raised by the Bill, both general and specific.
The Economic Policy Research Institute noted that there did not seem to be any reason for a delay in implementing capital gains tax. The data which CGT requires is not the kind of data which financial institutions do not already have. There may be some non-technical issues which must be dealt with but this can be done after CGT has been implemented. The organisation had conducted research which showed that over the past ten years there has been an increase in the capital-labour ratio. The clearest implication of the analysis is that if the capital-labour ratio continues to increase at this rate, South Africa will need astronomical growth to combat unemployment. CGT will promote job creation by reducing the bias against labour.
Professor Neil Brooks, York University, Canada
Professor Brooks, describing himself as a "tax policy junkie", contended that capital gains are not different from income but can be included in the definition of income. He noted that the initial and traditional distinction of capital gain from income stems from legal definitions used in trust law and not from any economic policy. So the exemption of capital gain from taxation has no intended relationship to tax policy.
The professor argues that the taxation of capital gain is fair, both horizontally and vertically. It is fair horizontally, meaning between people who are similarly situated economically, since the removal of the tax exemption on capital gain means if you receive R30 000, that income will be taxed, regardless of its source.
The taxation of capital gain is fair vertically, meaning between people who are not similarly situated economically, since the tax exemption of capital gain benefits primarily, or even exclusively, high-income individuals and households. The removal of the tax exemption will affect these people, and not the middle classes, as is sometimes argued.
Professor Brooks also argued that the taxation of capital gain is efficient, both economically and administratively. It is efficient economically since not to tax capital gain means capital will flow to those assets and sectors in the economy where tax-free capital gains can be realised, and away from investments with a higher before-tax rate of return. It is efficient administratively since to tax capital gain in the same way as any other income removes the impetus to manipulate the exemption to avoid paying tax. In short, taxing capital gain keeps the tax system simple.
Finally, Professor Brooks labelled the following statements as myths:
· Some percentage of capital gains are due solely to inflation and therefore, it is inequitable to tax them.
· Taxing capital gains locks investors into relatively unproductive investments and, therefore, prevents financial capital from flowing to its most highly valued use.
· Taxing capital gains will lead to a reduced rate of personal savings and, therefore, a less productive economy.
· Taxing capital gain will lead to less investment and, therefore, will lower productivity and lower wages.
· Taxing capital gain will discourage entrepreneurship and risk-taking.
· Taxing capital gains will adversely affect small family business and family farms.
· Taxing capital gains will discourage foreign direct investment.
· Taxing capital gains will raise an insignificant amount of revenue.
Ken Andrew (DP) noted that the presentation contained a number of oversimplifications and the presenter displayed a misunderstanding of the South African context. He explained that both savings and skilled people to administer the system were in short supply in South Africa. For these reasons, he said, the Canadian perspective presented by Professor Brooks is not applicable to South Africa. He enquired whether Brooks’ argument ran contrary to the ‘locking-in’ argument.
Brooks argued that many people make investments and choose to hold onto them for a long period. In these cases capital is not "locked in".
Ken Andrew pointed out that the middle classes generated their savings out of earnings initially, but become wealthy via unit trusts and investments which will be subject to the CGT.
Brooks agreed that savings are vital, but argued that exempting capital gains from tax is not the way to do it. He argued that the tax system should be neutral and investors should not have regard to tax systems in deciding where to invest. He referred Mr. Andrew to his document which explained the theory on this issue.
Mr. Andrew referred to the argument that exempting capital gains would encourage corporations to retain their earnings and therefore mean less money will be available for small business. He stated that South Africa had a Secondary Tax on Companies (STC), which encourages companies to retain their earnings. He asked whether Brooks considered this tax to be counterproductive.
Mr. Brookes argued, on the one hand that he felt that the tax system should be neutral, but stated that he would not necessarily argue that STC be removed.
Dr P J Rabie (NNP) referred to Brooks’ assertion that the system should be inexpensive to administer and easy to understand. Dr Rabie (NNP) agreed the tax system should be simple but argued that to tax capital gain is complex. He wondered how the new capital gain tax legislation could be simplified for the layman and also asked about "start up" costs.
Professor Brooks responded that the average "layman" has no taxable capital gain, since any gain from a primary residence or pension fund is not taxed. Accordingly, only a very small percentage of the population has any capital gain and these people are well able to afford access to the information they need to manage their finances. In short, only those with substantial gains will be bothered by the new legislation. Further it is only complex for those who want to get around it and argued that it has to be made difficult for them because of the nature of the transactions they choose to get involved in. He said that one has to reduce the pay-off for engaging in tax avoidance schemes. The Professor added that another indirect benefit of taxing capital gain is that it results in the collection of information on what is happening financially in terms of capital.
Ms Mahlangu (ANC) asked what were the circumstances around the introduction of the capital gain tax in Canada.
Professor Brooks said the tax was studied for a long time before the Bill was passed in mid-1971. It did not come into effect until January 1972, so Canadians had at least six months to prepare for the new tax.
South African Institute Of Chartered Accountants
Mr Croome of SAICA said the implementation date of 1 April 2001 is unrealistic, since it does not allow for sufficient consultation. He suggested 1 March 2002, saying this would also allow business to adapt its accounting systems.
SAICA suggested there had been insufficient time for comments and submissions given the Bill was released on 13 December 2000 and submissions were expected between 8 and 10 January 2001.
More education needed to be carried out to educate both SARS staff and the general taxpayer. This could not be accomplished if the Bill is rushed. The responsibility of educating people should be taken by SARS.
SAICA commended SARS for a Bill whose language and style are easy to understand.
Refer to SAICA’s submission for in-depth commentary.
Ms Taljaard (DP) commented that she shares some of the concerns of SAICA, particularly about the definition of base costs beyond marketable securities at paragraph 22(1)(a) of the Bill and the determination of the primary residence in polygamous marriages.
An ANC Committee member asked what yardstick would be used to measure the success of the Bill’s implementation.
The Chairperson, Ms Hogan, pointed out that the Minister had asked people to submit proposals for or against the Bill already last year.
Mr Croome reiterated that SAICA considers the proposed implementation date of 1 April 2001 as too soon for proper consultation and submissions.
Economic Policy Research Institute (EPRI)
Dr Michael Samson, Director of Research at the Economic Policy Research Institute, noted that the benefits of CGT are equity, efficiency and job creation. He then proceeded to look at the ‘’disadvantages’’ which critics have levelled against capital gains tax (CGT) pointing out that they were not really disadvantages at all:
Equity – various studies show that it is primarily the wealthy that incur capital gains. Currently the South African tax structure is regressive at the top because there is no tax on capital gains. The wealthy are not being taxed on a particular source of their income. CGT will correct this inequity.
Economic efficiency – CGT brings about economic efficiency by broadening the tax base. It will also reduce income conversion (where people characterise income as capital to avoid paying tax). South Africa’s system suffers from high levels of tax avoidance and evasion. To measure compliance with CGT, audits could be conducted. These audits must focus on those with high capital gains.
Job creation - CGT promotes job creation by reducing the bias against labour. For the economy to grow it needs capital and labour. There has been a steady increase in the capital-labour ratio. This indicates unemployment. Reversing the rapid upward growth means creating jobs. It eliminates the capital bias against labour and will generate jobs. Job creation will come from reducing the bias in the production process against labour.
Competitiveness – arguments that CGT will reduce competitiveness do not hold any water. CGT will not discourage investment or savings. A study conducted in 1992 has shown that the lock-in effect can actually increase savings.
Low revenue – this argument also is not valid. CGT will raise more revenue than expected because of the increased growth in capital gains over time. There will also be an increased revenue which comes from reducing conversions.
Administration – South Africa’s financial system is one of the most sophisticated in the world. Indexation will bring in too much complexity. SARS has built up its administrative capacity and has exceeded budgeted revenue targets. South African companies have a strong technical capacity. There is no administrative reason to delay CGT. The basic parameters are well known. He doubted financial institutions did not have the necessary data in their transaction database to deal with CGT.
Economically it would be desirable to have a 100% inclusion rate for CGT. Politically however this is not feasible. The disadvantages mentioned by critics are not really disadvantages. The main concerns which relate to CGT are possibly the low yield and administrative issues. However the administrative issues are not sufficient to warrant a delay in the implementation of CGT.
Dr Rabie (NNP) commented that the increase in the labour-capital ratio over the past few years was not unique to South Africa but was a universal phenomenon.
Dr Samson replied that this was the case in many countries especially in industrialised countries. South Africa however has a higher unemployment rate than most other countries. Distortions in the tax structure contribute to the unemployment rate. Correcting this distortion is imperative. In SA there should be more concern about the labour-capital ratio.
Chairperson Hogan asked Dr Samson for his view on delaying the implementation of Capital Gains Tax (CGT).
He replied that he would have to research this more before he could tender a complete answer but noted that on face value he did not see a reason for the delay.
Ms Hogan noted that some organisations were in favour of a delay. She asked if this was not perhaps necessary in order to identify necessary system changes.
Dr Samson replied that without knowing the parameters one cannot change the system. It is possible that the systems can be revised after the law has been implemented. However the data which CGT requires is not the kind of data that financial institutions would not already have. There may be some non-technical issues but on the face of it there is no technical reason for a delay.
Chairperson Mahlangu asked how CGT would contribute to job creation.
Dr Samson replied that in his organisation’s research they constructed a sectoral model of the South African economy. One of the things that they measured was the capital-labour ratio. The clearest implication of the analysis is that if the capital-labour ratio increases at the rate it has increased in the past ten years then South Africa will need astronomical growth to combat unemployment. To combat unemployment one needs an appropriate industrial and fiscal policy to support job creation. The simplest area in which to address this is in tax. If it is cheap to buy sophisticated equipment by not taxing capital gains then firms will produce in a capital intensive manner and not in a labour intensive manner.
On a point of clarification Ms Rajbally (MF) asked if middle income earners would bear the brunt of the tax.
Dr Samson emphasised that this was not the case. The tax would primarily affect high income earners.
The meeting was adjourned.