Medium Term Budget Policy Statement: Comments by Economists

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Finance Standing Committee

28 October 2004
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FINANCE PORTFOLIO AND SELECT COMMITTEES AND JOINT BUDGET COMMITTEE


29 October 2004
MEDIUM TERM BUDGET POLICY STATEMENT: COMMENTS BY ECONOMISTS

Chairperson: Dr R Davies (ANC, Portfolio Committee)

Documents handed out:

Submissions by Professor B Kantor
Submission by Mr M Maleka
Submission by Ms P Parenzee

SUMMARY
Three economists gave their input on the Medium Term Budget Policy Statement. A suggestion was made for increased consumption taxes as a way to achieve increased investment as envisaged in the Statement, with investment incentives for companies. It was also suggested that some compulsory savings be introduced for households. A clear issue was the difficulty in bridging the gap between the first and second economies. The gender impact of the Medium Term Budget Policy Statement was highlighted, and the lack of relief for women was indicated. The growth projections were confirmed and the projected inflation rate seemed feasible. The return on spending was questioned, particularly the return on education.

MINUTES
The meeting opened with a minute of silence in memory of Mr N Raju, a member of the Select Committee on Finance, who had recently passed away.

Submission by Professor B Kantor
Professor Kantor (Professor at UCT on leave of absence at Investec) said that he was addressing the Committee in his private capacity as an economist. The government's plan was starting to work in a very helpful way and this was reinforced by the latest MTBPS, which had the right approach for the economy going forward. It had taken a while for benefits to be realised but he encouraged government to stick to its plan. Policy may in fact have been too austere, as government expenditure on infrastructure in particular had been sacrificed to fiscal austerity, and this was now being loosened. It had taken a long time to get people to believe that inflation had dropped and was staying down. Nothing was more important to the strength of the economy going forward than that it should enjoy low inflation and nominally low interest rates and avoid volatility of interest rates.

South Africa's conservative fiscal policies were consistent with permanently low inflation, provided the exchange rate co-operated. Exchange rate shocks had not always been well managed. These shocks had been caused by uncertainty. Before 1994, South Africa had been very bottled up by exchange control, and its loosening had encouraged people to take up relief. Gradual reform at times set up a dynamic that was not very helpful. The anxieties were now in the past and there was a hope that South Africa would not again be subjected to the kind of exchange rate shocks that had occurred in 1998 and 2000. Current fiscal policy would then mean permanently low inflation.

Minister Manuel had reaffirmed that it was an important goal to raise the rate of investment in South Africa to 25% of Gross Domestic Product (GDP). More investment meant a faster growing economy and more employment. To invest at 25% of the economy would mean that the economy was growing at least at 5 - 6% per year, which was a huge achievement, but the investment would have to be backed by saving. Household savings could be expected to remain a small contributor to the savings net. Business was currently investing savings at about 15% of GDP, so business would have to do the bulk of the investment. Savings would have to come from lower corporate taxes paid and this was the only way to bring investment to the 25% target. Companies would save and invest after tax profit. The benefits of corporate savings and investment really went to the contributors to pension funds, so relieving corporate tax would encourage the growth of pension funds and self-reliance on pension funds. Corporate taxes amounted to approximately 27% of national government revenue, and corporates in South Africa played a relatively disproportionate role in the collection of taxes. The tax rates in other countries might be the same, but there were discounts and incentives.

If more savings and investment were required, consumption would have to be taxed at a higher rate. Consumption taxes amount to about 14% of household disposable income, and this could easily rise to 20% and be accompanied by well-targeted poverty relief. The Minister had expressed concern about the delivery of poverty relief and this would then raise the tax pool on which revenue could draw. The future was seen as one of taxing consumption rather than income. The political consequences of this approach would be worth bearing.

Submission by Mr M Maleka
Mr M Maleka (Chief Economist: Eskom Treasury) said that the prudent management of the economy had benefited the first economy. Every possible avenue had been tried, but the problem of the widening gap between the first and second economy remained. The first economy had the financial wherewithal, they were articulate, vocal and educated, while the second economy was weak and lacked negotiating muscle. It was therefore excluded from being an active economic agent. Skills acquisitions meant better work opportunities and improved livelihood, thus creating links between the first and second economies. Structural deficiencies included a low return on high education investment, low savings rate, increasing fiscal deficit and a strain on social security was a reflection of reality on the economy. If a person was trapped in the second economy, s/he might be attracted to corruption.

The increase in investment from state owned enterprises such as Eskom, Transnet and others, had to translate into meaningful bridges to close the gap between the economies. The example of the European Union should be followed and a huge middle crass created. The challenges facing the economy included a tepid global recovery (with South Africa still a commodity-driven country); the risks imposed by high crude oil prices; a widening current account deficit as a result of the strength of the Rand; the problem of attracting sustainable Foreign Direct Investment (FDI); maintaining the competitiveness of the resources sector; and sustainable interventions to reduce poverty and unemployment. The low debt service cost made resources available for other social imperatives, but tax cuts should have been directed at savings. He advocated a compulsory household savings scheme.

The incidence of poverty, unemployment and the rampant spectre of HIV/AIDS was a threat to fiscal prudence. The sale of state assets should be used to retire debt, not to re-capitalise, and the public sector remuneration required review. If professionals were to be produced, these needed to be fairly remunerated. It was suggested that the Statistics SA revision of GDP figures in November could impose revision on revenue estimates, and retirement tax should be reduced. Individuals who had saved for their retirement had contributed positively to the country. It was therefore unfair to tax them at 18%. This also served as a disincentive to savings.

Submission by Ms P Parenzee
Ms P Parenzee (Researcher: Women's Budget Project: Idasa) suggested that poverty and unemployment remained critical challenges to South Africa as it entered its second decade of democracy. The challenges were acknowledged in the MTBPS and there was expressed commitment to address poverty and create jobs. The reality was, however, that there were gender implications to the government's approach. In not acknowledging that household investment was as important as economic investment, the MTBPS disregarded women's contribution to the economy through (re-) production that happened in households. It could also hamper their contribution to, and benefiting from, the paid economy. Several programmes were identified in relation to the objective of facilitating economic growth within the second economy, particularly the expanded public works programme (EPW). Work on the EPW programme was low paid and required low skills levels. This translated to very little income for the household and poverty levels in the household not really being addressed. The way in which the work opportunities were reported provided a distorted picture. The reference to the number of jobs created did not reflect the duration of the job, nor the job creation in terms of person days of work. Training was very job specific, and upon exiting, it was women who would still remain unemployed. There were also concerns that the impact of the National Skills Development Strategy (NSDS) approach on unemployment was often exaggerated and the statistics presented in the second report released by the Department of Labour in 2003 indicated that the NSDS performance to date had not been up to scratch.

In respect of social services, income support and human development, the creation of a single national social security agency to manage the financing and provision of grants presented concerns that the new structure would merely inherit the existing shortcomings and not solve them. There was no indication as to how things would become smoother. According to the MTBPS, the growth rate of the HIV and Aids conditional grant dropped markedly in the last year of the medium term cycle. This was concerning given that HIV and Aids conditional grants in the health sector were the primary funding vehicle for the ARV treatment programme and funded other HIV/AIDS interventions. From 2006/07 to 2007/08, there was also a decrease of 0.2% for the community and home-based care conditional grant. This decrease did not bode well for women, as it was women who mainly assumed the home-based caring functions for those who were sick. There had also been rollovers of allocations for HIV and Aids. In light of the above, it was imperative that the response to HIV was prioritised.

In concentrating on improving the performance of the state over the 2005/6 Medium Term Expenditure Framework (MTEF), the approaches included expansion of public services and compensation of public service employees. Commitments were made in the MTBPS to increasing the salaries of police and educators. While these were welcomed, it was of concern that no mention was made of increases to the salaries of nurses.

Discussion
Mr B Mnguni (ANC) said that, if households did not save, and savings had to come from corporations, private income tax was a major source of revenue but corporate taxes played a role. There was a R5 billion deficit because of the exchange rate. If the intention was to tax corporates less, would that not increase the budget deficit and what would the long-term effect of this be. Was Professor Kantor suggesting fewer tax incentives for individuals?

Mr K Moloto (ANC) referred to Professor Kantor's suggested consumption tax and referred to estimated revenue for 2004/05, where private income tax was R110.5 billion, corporate tax was R63.4 billion and VAT was R93.5 billion. How far should such a tax go if VAT outstripped corporate tax collection? Was this not too fixated on export-led growth?

Mr Z Kolweni (ANC, North West) said that he was sceptical about Professor Kantor's proposed consumption tax. People in low-income brackets were high consumers and he asked the panel's comments. He asked whether Professor Kantor was in favour of Mr Maleka's call for institutionalised savings.

Professor Kantor said that his submission was a response to the government and Minister's intention to promote investment-led growth, from around 16% to 25% of GDP. If this happened, the economy would grow at 6% per year. This clearly had to be funded from savings. If the economy grew faster, it would attract more foreign savings and South Africa was attracting offshore capital at a meaningful rate for the first time in years. It seemed clear that there would be no more savings unless there was less consumption. A large proportion of the growing economy would have to be savings. He did not believe households could raise savings significantly although every incentive to save should be encourage. South Africa had excellent private pension funds and these represented savings. They were a highly competitive business and he felt the system works very well. He agreed it did not make sense to tax retirement income as most was earned from government bonds and government would be the net loser. There was a need for people to work, to contribute to pension funds and reduce their dependence on grants. Households should be encouraged to borrow to own houses and so on, so there would be no net savings from the household sector. He disagreed with Mr Maleka that companies had uninvested cash on their balance sheets and said that private sector investment was growing very strongly.

Mr Mnguni asked the panel's opinion on exchange rates.

Mr Mnguni asked Mr Maleka what impact the broad based employee share scheme proposed would have on the gap between the first and second economies.

Mr Maleka replied that the first economy was very vocal, educated and had finance. If a person participated in the broad-based employee share scheme, they would almost certainly be in the first economy, although the benefits might trickle down. He had been speaking more about the unemployed and those affected by HIV/Aids, who were trapped in the second economy. The share schemes solidified the first economy and widened the gap.

Mr Moloto said that Professor Kantor had suggested a Chinese style route to labour market flexibility. Reports from the World Bank, however, indicated that South Africa's labour laws were very flexible and he asked how low South Africa should go.

Professor Kantor replied that the regulation of the labour force was a severe inhibitor of offers of employment. He did not believe South Africa was about to follow the Chinese example. The way out of the poverty trap was to raise incomes by running a productive and efficient economy.

Mr Moloto agreed slightly with the suggestion to lower corporate taxes, but said that South Africa was not too far out of line with corporate taxes in comparable countries. He asked the extent to which South Africa's depreciation allowance and incentives had been helpful.

Professor Kantor replied that he was not talking about cutting corporate tax rates but about offering a more generous investment allowance, in other words, a company would only benefit if it invested. Approximately 14% of disposable income was collected in consumption taxes (VAT, fuel levies etc) and this amounted to R110 billion at present. If this was raised to 20%, in a gradual process, it would provide room for companies to save and invest. He did not see anything like this in the forward-looking plans.

Ms R Taljaard (DA) focused on the quality of composure of the deficit, especially where there was expansion of capital expenditure. She asked the panel's view on the ratio of consumption to capital and suggested that South Africa might be on the wrong side of the ratio over the MTEF period. She referred to Mr Maleka's observation that proceeds from the sale of SOEs were emphasising infrastructure expansion and said she felt there was a debate as to whether this represented a policy change.

Mr Maleka replied that, in the apartheid era, investors had been compelled to hold government stock. Most of the debt was operational not capital in nature. He felt any borrowing should have the capacity to retire itself. The nature of the country meant it would take a while to escape this.

Professor Kantor's view was that less consumption spending was better for growth. It was not the deficit itself, but the mix that was important. The more positives there were, the better. If current expenditure was compared to the capital expenditure of thirty years ago, today's was a fraction of that amount.

Ms Taljaard referred to the SOE capital expenditure expansion and asked whether there was a concern that the need for loans might crowd out the private sector and have a negative impact.

Mr Maleka replied that this was possible, but SOEs operated as private concerns. He would have a problem if central government was borrowing, but SOEs borrowing would be beneficial to the economy.

Professor Kantor replied that the SOE plans were very welcome and said that the private sector would not be crowded out if the economy grew fast enough to grow foreign capital. This had been recognised by the Minister.

Ms Taljaard referred to the consumption component in public spending and asked whether it was time to disaggregate the wage bill.

Mr Maleka replied that, as a democratic country, South Africa had to cater for all. If individuals wanted to organise themselves to increase their voices, this should be allowed.

Professor Kantor replied that the public sector had had a better deal than it should have. Inflation should be CPI not CPIX inflation. The labour survey was very good news about employment.

Ms R Joemat (ANC) said that she knew household savings were largely through pension funds and her other concern was the high cost of retirement savings, which often exceeded interest. How could this cost be controlled? Savings were not automatically passed on to pensioners.

Dr P Rabie (DA) referred to Mr Maleka's suggestion that retirement tax be reduced and asked what rate should be imposed, or whether the rate should be abolished.

Mr Maleka said that retirement tax increased the number of dependents on social services and might be a perverse incentive not to save. As long as the economy grew, the revenue base would grow. The point was the need to liberate the second economy and give them the means to be employable. Older citizens had contributed taxes in their working lives, it was unfair to tax them in their retirement.

Professor Kantor felt that benefits should be taxed. In other words, tax as the money was spent.

Dr Rabie referred to the very high unemployment rate and expressed concern that increasing consumption taxes would contribute to further unemployment and a decline in domestic consumption.

Professor Kantor suggested offering companies an employment allowance, for example 150% for learners, and said it was the only practical and realistic way to go.

The Chairperson asked the panel to comment on the projection of growth of 4% and asked whether it was realistic or likely. He asked them to tell the Committee what growth they had predicted for this year.

Mr Maleka replied that he had put it at 2.6% for this year and felt the 4% was commendable but had to materially translate into release from the second economy.

Professor Kantor replied that 4% was realistic under the current inhibitions. If the investment rate was raised, it could be pushed to 5 or 6% and would then attract masses of foreign investment. He had forecast 3% and felt it was still obtainable. There was a serious chance of getting inflation down to 3% and he was disappointed at the anticipated 5%. If there was exchange rate stability, inflation could easily drop to 3%.

The Chairperson asked to what extent the panel felt that unemployment was structural, so growth of four or even five per cent would still be trapped structurally. He felt that so-called cheap labour marginalized the unemployed and asked whether there was a future in a race to the bottom. Was a more complex set of interventions required? If there was a decline in demand for low skilled labour, and it became easier to fire labourers and pay less, would this not just result in more dismissals?

Ms Parenzee replied that there was an acknowledgement that the unemployment was structural and that is where concerns had been raised on the limitations of the EPW programmes. She had flagged issues, but had not made recommendations.

Mr Maleka replied that unemployment was definitely structural and said that South Africa was bearing the brunt of misdirected policies. Returns on education were very low.

Professor Kantor replied that this was a very serious issue. There was no doubt that employment opportunities for people with limited skills could be increased if companies were able to offer very low wages. It would not solve the poverty problem, but might solve some of the dependence problem. People's willingness to accept very low paid work was affected, particularly in the rural areas where there was low labour force participation. The high rate of migration reflected young people. Older people's choice to seek work was not terribly meaningful so there was very little subsistence cultivation in rural areas. People without skills were dependent on welfare for survival. One of the ways out of the dilemma was to provide them with skills and this was a huge task for education. The challenge was clearly to get better delivery out of resources and to look at incentive systems. The system was not a trap, but a stable system. The poverty problem had been addressed with the welfare system. The concern was that now that this was too expensive to sustain, but it did provide significant poverty relief. It should not have employment-destroying effects. If there was greater freedom, there would be more hiring, firing and employment. He did not believe that South Africa would go that way.

Mr Kolweni asked whether Mr Maleka agreed with the suggestion to review corporate tax and consumption taxes.

Mr Maleka replied that all tax systems should be reviewed from time to time. Increases in taxes served as disincentives.

Mr Kolweni agreed with Ms Parenzee that there had been an oversight on the gender budget concept. Labour by women was not taken into account. He recommended that her input be referred to the period of the FFC for recommendations.

Mr T Ralane (ANC, Free State) asked the ideal inflation rate for a country like South Africa.

Mr Maleka replied that ideal inflation was a stable price environment, not necessarily a figure. The risk is that South Africa did not want to be in a deflationary environment.

Mr Ralane asked what could be done to attract sustainable FDI.

Mr Maleka replied that everything humanly possible had been done. He suggested that it should continue, as South Africa was only ten years into democracy.

Mr Ralane asked the panel's view on the write off of odious debt and what spin-offs this would have.

Mr Maleka replied that when a government assumed power, it took over all the problems as well. Write-offs could potentially cause the collapse of the financial system. The government needed to manage debt, as it had done, and reduce debt service cost.

Mr Ralane referred to the thousands of absentee landlords and asked whether a land tax would be appropriate.

Mr Kolweni said that Professor Kantor had raised an interesting debate on incentives for employment but he was worried that the question of rural development was not advocated. No mechanisms were in place to halt the urban flow. Professor Kantor had recommended lower wages, but he felt that it would be better to talk about rural development.

Professor Kantor replied that the growth machine was an urban one. Agriculture represented 3 - 4% of GDP. Skills were a source of growth and a large proportion of funds had to be directed to urban areas and it was important to be realistic about migration. In respect of absentee landlords, it was necessary to ask why the land was vacant and what would happen if it was occupied.

Mr Maleka replied that a land tax was a very difficult issue. It would be an unfair system unless anyone from outside was prevented from investing in land.

Mr Ralane asked whether farm workers and domestic workers would be defined as fully employed.

Mr Maleka replied that if a domestic worker was registered, they would be considered to be employed. The government regulated inflation related increases.

Mr Ralane suggested that it might be appropriate to exempt the poor from VAT.

Mr Maleka replied that the government had done well in exempting basic foodstuffs. It would be an onerous task to prevent all from benefiting from any VAT relief.

Mr K Durr (ACDP) referred to increased consumption taxes, which would mean increased VAT and fuel levies. One of South Africa's success stories had been the reformed tax and collection systems. As soon as rates were increased, tax avoidance increased. This would cause a higher administrative burden. If differentiated rates were introduced, for example on luxury goods, there would again be the problem of avoidance. He asked the panel's opinion, as one of the benefits had been that everything was in the net and rates were low.

Professor Kantor replied that VAT and fuel levy rates were not especially high by international standards and there would be concerns about evasion if the taxes were raised. He suggested food stamps on a means test as a targeted relief measure.

Mr Durr said South African companies had cash piles and there should be more investment. He was concerned that corporate tax relief might translate to dividends and buybacks. He asked what could be done to prevent this.

Professor Kantor replied that cash piles did not make sense. The free cash flow of South African businesses seemed to have declined and in fact be negative. There was no doubt that investment rates were very satisfactory. It had been necessary to convince South African companies that the best growth rates were in South Africa. The companies that were thriving were those that depended on the South African economy not the export markets. The forex panic was behind us and South Africa was now seems as a very good economy and South African assets were helpful to valuations. To sustain this, there was a need for low and stable inflation that people could believe in. Given South Africa's fiscal policies, it was perfectly feasible to get inflation of 3%.

Mr T Vezi (IFP) said that, although everyone applauded the relaxation in exchange control, it went hand in hand with the inflow / outflow or capital. He had seen the demise of small black businessmen in the Eastern Cape, where big businesses bussed in their own operators and then bussed them back to KwaZulu-Natal. Eastern Cape towns were getting poorer and the money was being used to develop KwaZulu-Natal. He asked how this could be avoided.

Mr Vezi said that the municipality in his area had virtually no tax base, but the municipal manager was drawing R100 000 more per annum than a deputy state attorney. He asked Mr Maleka how he reconciled this with his statement on public sector remuneration.

Mr Maleka replied that local government was responsible for about 90% of its own income so this was different. In this case, salaries were determined by SALGA and the constituency. When he had referred to public service remuneration, he meant that government by national and provincial government.

Mr Vezi asked whether, in view of the high incidence of child abuse and other problems, Ms Parenzee would encourage the cottage industry system that had originated in Japan, where women took work home to do there, rather than in factories.

Ms Parenzee replied that the problem was that, as a result of the unpaid economy, women did not enter the paid economy. She was not familiar with the cottage system, but her initial concern would be how it worked.

Ms Taljaard said that the current account was at 3,8%. Some extraordinary items would obviously run on and there would be the roll out of the SOE spending, which would be export-heavy in content. She asked whether there were any ongoing concerns about the current account.

Mr Maleka replied that one of the challenges was to widen the current account. If there were sufficient inflows from the capital account, it was fairly safe, but needed close management.

Ms Taljaard said that Stats SA was working on a distinction on administered and regulated pricing. Did the panel have a view on this distinction and its impact on inflation projections?

Professor Kantor replied that competitive forces were relied on to keep prices down. Where there was no competition, regulation might be necessary. Regulated or administered prices both needed to be regulated in the interests of consumers. Municipal government was a big issue, as it did not always perform optimally. The tricky part was calculating the return on capital. This should not be built into electricity pricing, which should be financed through debt not equity. Utilities charged too much to bring down their debt ratios.

Ms Taljaard said that she had been alarmed to see the export figures for China and India. There was no doubt that the bulk of South Africa's exports to China were commodities. Was South Africa maximising product markets in respect of China and India or was it too reliant on its traditional trade relationships? Did the panel see scope for South Africa to grow its export strategy more robustly?

Mr Maleka replied that it had been economically beneficial to have dropped trade with Taiwan for trade with China. The problem was that the potential with China had not been optimally used. China itself possibly produced goods more competitively. South Africa was set up for good growth, as he saw the Yuan as the leading world currency in fifty years.

Mr Moloto asked Mr Maleka what impact current government measures, such as support for small agriculture, were likely to have on the second economy.

Mr Maleka replied that there was no doubt that anything that minimised the pain of the second economy was good and would go a long way to close the gap, but the ties between the two economies should be strengthened.

The Chairperson said that no one had spoken against the moderately expansionary stance of the MTBPS, and it was well within the parameters of fiscal discipline. Most of the panel had been relatively comfortable with the growth projections included in the MTBPS and most had felt that the relaxation of exchange controls did not pose a major risk of capital outflow. The big issue to have come out was the impact on the question of poverty, unemployment and inequality. Questions had been raised on the quality of spend on some programmes, such as the EPW programme, and the gender impact was not as clear as it should be.

Ms Taljaard asked the Chairperson to flag the impact of capital expenditure and the possible impact of the rebasing of GDP figures.

Mr Durr said that the MTBPS was predicated on optimistic growth projections, but asked what if this did not happen. There should be a second plan.

Ms Taljaard suggested flagging the inflation rate.

The Chairperson was not sure that everyone would agree with Professor Kantor on a 3% inflation rate. It was clear that there was no serious risk of South Africa falling outside the 3 - 6% band, provided the exchange rate remained stable. He asked the panel's opinion on the outlook for the global economy.

Professor Kantor replied that the world economy was proceeding in a highly satisfactory way for South Africa at present and it would be very helpful if it continued this pace. He agreed that the budget statement was not out of line with the consensus view. The world economy was in a good robust state. Should it slow down dramatically, the rand would come under pressure and there would be inflationary implications. The exchange rate should be allowed to take the shock, and not be protected with high interest rates.

The meeting was adjourned.

 

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