Budget 2005: briefing by Minister

Meeting report

FINANCE PORTFOLIO AND SELECT COMMITTEES AND JOINT BUDGET COMMITTEE
24 February 2005
BUDGET 2005: BRIEFING BY MINISTER

Chairpersons:

2005 Budget – Growth, development and equity
2005 Budget Errata (see Appendix)
Budget Review 2005 (link to Treasury website)
Budgets for all Departments – 2005/6 (link to Treasury website)
Budget Speech 2005 as presented by Minister of Finance – 23 February 2005

SUMMARY
The Minister of Finance briefed the Committees on the policies underlying the 2005 Budget. These could be summarised as sustaining higher growth, advancing social development, and equity and redistribution. The economy was growing well, but it was essential to increase infrastructure investment, lower the cost of doing business, produce more skilled people and improve the quality of services. A commitment was made to tightened social grants, quality services and a reduction in crime and insecurity, and renewed investment in small and emerging farmers.

The Committee questioned a delegation from the National Treasury and South African Revenue Service (SARS). Particular emphasis was placed on the fact that many entrepreneurs in the second economy would not benefit from the tax cuts and incentives, as they fell outside the tax net. The need for sustainable development and increased investment in skills was emphasised. It was hoped that the decision to increase infrastructure development would be of particular benefit to those in the second economy. Social grants were on the edge of being disincentives, and it was important that they be carefully monitored.

MINUTES

Minister’s briefing
Mr Trevor Manuel (Minister of Finance) summarised the policies behind the 2005 Budget in three main categories: sustaining higher growth, advancing social development and equity and redistribution. When the 2004 Budget had been tabled, models had forecast 2.9% growth in the fiscal year. This had been treated with extreme scepticism. Growth had, in fact, come in at 2.2%, and the Government was looking to an average growth of 4.2% over the Medium Term Expenditure Framework (MTEF) period. A low year was forecast for 2006 because of price effects in the global economy.

There was a sense that infrastructure investment projects were on budget. Of the many projects listed in the Budget Speech, some were private and public partnerships, but the bulk were funded off the balance sheets of State-owned enterprises. The Treasury was dealing with the "route to market" concept. There was a need to increase the level of business by removing obstacles, helping small businesses do things better, and by creating jobs. A study from the World Bank, "Doing Business in 2004", had measured a series of industries. South Africa fell in the middle sector, and this was a problem. People from the South African Revenue Service (SARS) had been deployed to tour the country, trying to understand business and the problems experience with collections of taxes, and who was actually running businesses. This was a huge study, and was combined with a more formal study. It had led to the decision to allow small businesses to render VAT returns every four months, an increase in tax relief for small businesses, and an increase in the Skills Development Fund threshold from R250 00 to R500 000. Non-compliance with regulations was at time an issue of ignorance, and this was being addressed.

Spending on educators’ salaries had been increased, as part of the initiative to produce more skilled people. This would be headed by the Department of Education. R1.05 billion had been set aside for further education and training (FET) with a big investment being made in project design. The money would be allocated in two tranches of R500 million and represented a big investment in upgrading facilities. It was felt that politicians needed to take increasing responsibility for the quality of services. The need for a management information system in education was very important, as the information was required to enable Government to respond to crises.

By the end of 2005/06, it was estimated that there would be eleven million beneficiaries of social grants. Because of the Treasury’s concern at the rate of growth, there would be a focus on better administration, for example with means testing. The need to supply clean water and electricity was closely linked the improvements in municipal infrastructure. Quality education, health and municipal services were priorities. Community housing had to include social infrastructure and it was hoped to convert concrete landscapes into living communities, with green areas and social amenities. To reduce crime and insecurity, provision had been made for additional policing, with increased money for training of police officers.

The Fiscal Incidence Study, accessible through the National Treasury website, showed an increasing shift of spending to the poorest two quintiles of South Africans. Welfare and social assistance, education, land restitution and housing had evolved into expenditure programmes that brought the average value of services of the social wage to an estimated R956 per month. This increase was measurable and the Government needed to try to maintain its pace. The estimate was based on Human Sciences Research Council (HSRC) research using 2002 household survey data.

Progress in broad-based black economic empowerment should be read with the scorecard that was to be issued by the Department of Trade and Industry. The National Empowerment Fund was linked to this over the MTEF period. Transport linkages were coupled with increases in municipal infrastructure grants and increased provincial spend, particularly on roads. Section 32 reports had raised concerns that problems were systems related, and momentum had to be developed.

There were two programmes to assist small emerging farmers, the Micro Agricultural Finance Scheme (Mafisa) and a conditional grant funding an agricultural support programme for new and emerging farmers. This was very closely linked to the land restitution programme.

Discussion
Dr G Woods (IFP) said that the Review recognised the current growth curve was demand-led and potential for growth might be constrained by a downward response on the supply side. Could the Government not have done more to stimulate the supply side, as the Budget encouraged the demand side? Was there any concern that this could be an ongoing constraint to growth and possible further current account concerns?

Dr Davies said that one of the important things motivating the cut in company tax was that old incentive schemes and tax holiday schemes were expiring. The Treasury had hinted that it was important to move to create a climate favourable for investment, and he asked for an explanation.

Mr J Moleketi (Deputy Minister of Finance) replied that inflation became a threat once production reached full capacity. At present, most industries had not reached full capacity. The challenge faced the Treasury was what was making it difficult for enterprises to increase their output, and how they could be assisted. For example, although the property boom had been active for some time, it was only now that cement supplies were identified as problematic. Options included incentives and tax cuts. A range of levies had been introduced, for example the skills levy, and more was being spent on FET. In South Africa, it was important to switch the focus away from tertiary studies to technical skills. Sasol, for example, was experiencing a severe shortage of technical skills. Some of the measures introduced were medium term interventions, but it was important to incentivise the economy. In terms of the global environment, a number of things came into play, as price shocks, for instance, created uncertainty. The strength of the rand had cushioned South Africa, but had also caused some industries to lose their competitive edge.

Dr Woods asked whether the Minister had been restricted by the announcement of the MTEF in November and if his options had been limited.

Dr Woods noted there had been an R11 billion overrun in taxes, and that R6 billion of this was from VAT revenue. The trend in VAT continued into the projections in the next figures and showed an increase in 10%, the highest in the Budget. What was driving the escalation in the VAT take as it was possible to see a narrowing between VAT and personal income tax. With VAT a greater percentage of revenue, there appeared a diminishing progressivity quality to the overall tax base, and it was queried whether this was appropriate.

Mr P Gordhan (Commissioner, SARS) replied that, according to the macroeconomic projections for 2004 – 2007, two indicators related to VAT and VAT collections: household income and imports. In terms of household income, it was expected that increased spending would lead to increased VAT collections. The issue of the relationship between personal income tax and VAT had been discussed for some time. There was ongoing monitoring of the tax mix, and at present, the Treasury recognised that private income tax concessions were an important factor in keeping the economy going. Treasury would continue to monitor and evaluate the position. In respect of the progressivity efforts had been made to increase the tax threshold in an attempt not to burden the people at the lower end, and to ensure that tax was not too difficult a burden.

Mr K Moloto (ANC) said that about two years ago, SARS had given the Committee a presentation on an international comparison of company tax. He would welcome another comparison now, taking into consideration the reduction in company tax rates and the improved depreciation allowance for companies, to determine the effective tax rate. What had motivated the reduction?

Mr L Kganyago (Director General, National Treasury) replied that data from the Organisation for Economic Co-operation and Development (OECD) countries showed a comparison of 30 countries for 2003/04. Of these countries, 16 had corporate taxes over 30%, 10 had corporate taxes below 30% and 4 had corporate taxes at 30%, the average thus being 31.9%. The average in the European Union was 35.4%. South Africa was thus roughly in the ballpark, and it would be interesting to see data from other developing countries. Despite repeated arguments from Treasury, people added secondary tax on companies (STC) to the rate, and this distorted it. South Africa did not have a dividend withholding tax. Although STC had been introduced as a temporary measure, it had proved very efficient and was actually a tax that would otherwise have been paid by recipients. Withholding tax would have been levied at a higher rate. When the Treasury had looked at tax collections, it had seen that there had been increasing reliance on corporate income tax. The problem with this was that corporate income tax was very volatile. The OECD averaged about 14% of its collections on corporate taxes. Ours were higher, so we were more exposed to this volatility. The reduction was also a meaningful way to reply to the need for a supply response. The general approach had been to try for lower tax rates and very limited incentives, but this was not wholly possible.

Dr Davies said that Mr Manuel had said there was a need to raise growth to around 4% and a need to confront making it pro-poor. Figures showed higher employment, but if growth was on a higher plane, with no structural changes, what would this mean to the employment target and what needed to be done to make the unemployment target a reality.

Mr Moleketi replied that there was a need to ensure increasing intervention to create sustainable incomes within households. Mafisa, for example, ensured that rural communities could raise income through agricultural activities, and through activities such as the building of dams.

Dr Davies referred to the tax concessions for small businesses, and said that he understood that, as National Treasury, there was a responsibility for tax. Many small businesses had an income of less than R30 000, particularly in the second economy, however, and these incentives were not meaningful for them. He asked what was being done for them, as he understood there was R100 million budgeted for the Apex Fund, and R600 million for Mafisa over three years.

Mr Manuel replied that the second economy was clearly beyond tax incentives. The issue of access to financial services was also important. Mzansi had achieved 550 000, which was impressive, but this was just a loan scheme. Many informal traders had said that there their biggest insecurity was travelling between town and home with their cash, so the ability to bank would start to change life for people. Apex and Mafisa would make a big difference, and Government needed to be more active in its support.

Mr M Stephens (UDM) said that, on the question of sustainable higher growth, he agreed that lowering the cost of doing business was an important step in the right direction as high costs caused risk and failure. He queried the use of tax cuts for small businesses under the present circumstance and questioned whether this was really lowering costs. He suggested it was not doing so, but rather increasing the reward for doing business. The real problem was the cost of capital. While the Reserve Bank was independent, this did not absolve the National Treasury from some responsibility in terms of interest rate policy. The Reserve Bank could not have a policy opposite to fiscal policy.

Mr Manuel agreed that the cost of capital was a problem and said that the difficulty was where to find it. It could be seen from the back page tables on a leading weekly publication that all developing countries had the same problem with the high cost of capital. In the OECD countries, capital cost was low, and this followed a global supply and demand pattern. This would be a key challenge for the monetary policy commission in April, in respect of its stand in relation to the global trend of increasing interest rates.

Mr Stephens referred to social grants and pensions and said that the really felt that hoped-for progress was not being made. He accepted that it would be impossible to treble the grant, and that there would still be poor people, but he felt that the R9.2 billion rand in tax cuts would have gone a long way to advancing the poor if it had been spent on social grants. Inflation related increases meant that real income remained the same. People receiving grants were needy, and there was a need to advance their situation. It was not acceptable to say it was not affordable if over R9 billion could be given to those who were better off.

Mr Manuel pointed out that South Africa was a poor country, and there was always a spill over effect. The Minister of Labour had gazetted the minimum wage for agricultural workers at between R600 and R800 per month. Domestic workers earned similar rates. It was important to ask the point at which someone would become dis-incentivised, and he suggested that, at R780, South Africa was close to the edge, and called for rationality about affordability. The Basic Income Grant (BIG) campaign, for example, was calling for R100 to R150 per person. If R20 was added for administration, and this was distributed to the population of 45 million people, it would amount to R90 billion per year, virtually equivalent to the total VAT take. Should the VAT rate be doubled? When grants were budgeted, money had to be provided to finance them. Emphasis was being placed on the quality of services, as it was not possible to just throw money at problems.

Mr K Durr (ACDP) asked whether the Minister considered that investment and savings levels were adequate to sustain growth. There appeared to be a problem with low savings rates in both the corporate and private sectors and there had been a net outflow of R3.8 billion in the first nine months of 2004.

Mr Moleketi replied that both consumption and investment spending were growth drivers. When discussing investment in the domestic economy, it was important to address the level of savings. Government investment spending, salaries and government grants also increased net exports.

Mr Durr referred to the increase in the fuel levy and asked whether that space should not have been left for provinces to raise taxes, as they had limited scope to do so. This increase might be crowding them out.

Mr Moleketi replied that fuel in the coastal areas was cheaper than inland. Although it might be argued that it was important for the provinces to look for sources of revenue, this could not negatively impact the economy. The fuel levy represented 5c of the 10c increase, and the remainder was required to fund the Road Accident Fund (RAF). If it was not possible to decrease the rate of road accidents, it was essential to have the RAF funded.

Mr Durr said that he had got the impression from his constituency work that more was happening than people realised. The economy looked stronger, and he felt that Government was failing to capture or measure this. The constant economic activities were very encouraging, but it was important to know what was happening. Did the Minister share this impression?

Mr Moleketi replied that the Government still faced the challenge of understanding what was happening within the second economy, as there was minimal information on the informal sector. Some people no longer actively seeking work were involved in backyard entrepreneurial activities. This information gathering was a challenge.

Mr Manuel replied that there was a lot in the economy that could not be measured. SARS, Statistics SA and the Department of Trade and Industry were working on a project to redo the business register, but many activities were not businesses. Although there were some informal sellers at traffic lights, some people were making a good living with artisan skills, and this could be picked up on the increased VAT take, as people were buying. It was possible to track buying information. Some trades unions had suggested extending protection to these informal workers, and Cosatu had confirmed the complex labour market. The quoting of the unemployment rate at 40% was simply not true, but it was hard to measure. The question that needed to be faced was which part of the population needed support and which did not. Globalisation was experienced, too, with South African welders in the Gulf, and South Africa being supplied by welders from the Philippines. It was a further fact that people did not like to comply with or pay tax, so this kind of growth was hard to measure.

Ms J Fubbs (ANC) agreed with the Minister about sills and globalisation, but said there was also the reality of skilled people between 25 and 35 who had been retrenched. She suggested the need for an audit so that these people could be placed.

Mr Manuel replied that, at the end of the day, there was little the Government could do to force employers to retain employees. It was a difficult issue. It was, however, a fact that once people had had opportunities, it was frequently easier for them to become entrepreneurs.

Ms Fubbs expressed concern about whether the sequence was right in the increase in infrastructure spending. Would the upgrading of the transport sector require a policy change? It would also require materials, and she queried whether those would be available when needed.

Mr Manuel replied that there were no bounds to growth. If South Africa was able to rail more iron ore, China could absorb it all. There was no limit on the demand for goods like cement, steel and ferro alloys. It was important to understand the rate of change, and there were also capacity constraints. This was why the Government was investing now in additional energy capacity.
Ms Fubbs said that a lot had been said about making the climate more conducive to investment, but her concern was its accessibility to the target group. Would there be road shows and other forms of publicity?

Ms Fubbs referred to the use of "short term, medium term and long term", and asked how long each term was, as indicated in the Budget Review.

Mr I Davidson (DA) said that, if the Minister referred to the table mentioned earlier, he would see that the South African growth rate was consistently in the bottom third, and this seemed to indicate that there were constraints. The fact was that there was a large unemployed population so there was a need to look at reducing these constraints, and one possibility was through skills.

Mr Manuel replied that skills were a big issue. It took a long time to produce skills, and there were also value system issues, where school leavers were encouraged to follow an academic career rather than practical training. South Africa was home to about 3 000 people from the Asian subcontinent and he asked why this movement was experienced, and whether there was so little entrepreneurial flair in the country that swathes of commerce were ceded to foreign nationals. There was also always the risk of xenophobia.

Mr Davidson said that the Director General had referred to the OECD study on corporate income tax, and he queried whether this was the correct study to use. It was important to compare the effective tax rate rather than the nominal rate. If the effective tax rate was used, it would be necessary to look at STC and levies. South African should be encouraging companies to save and grow production capacity, not taxing them. It seemed a disincentive to maintain STC.

Mr Manuel replied that the OECD tables compared many countries. Mr Davidson had raised a good point, and it was important to facilitate savings. STC was a tax on distributed income – the Government wanted company owners to invest, rather than distribute.

Mr Davidson expressed concern at past under spending in terms of SETAs. He understood that skills shortages were being addressed in the medium to long term, and suggested that immigration be encouraged in the short term, to ensure that there was capacity to grow. SETAs had not performed adequately, and he referred to a Mail and Guardian study showing only 14% of students emerging. This was a very real problem.

Mr Manuel replied that the numbers were assumptions based on the size of the wage bill and payroll levy. In terms of the Act, SARS allocated this to the relevant SETA and a small amount was left unallocated. Of the total pool, 20% was transferred to the National Skills Fund. The key challenge was to ensure that FETs actually produced those skills required by industry, and he would like to see a closer alignment between FET and the SETAs. He submitted that it would be foolhardy to shut down the SETAs.

Ms B Hogan (ANC) noted that the current balance was now shown in deficit. There were downward trends in all three balances, and she asked what was new.

Mr K Naidoo (Acting Deputy Director General: Budget Division, National Treasury) replied that the graphs had been sloping downwards since 2001/02, and this was part of the Government’s expansionary stance. The Treasury was concerned that the primary balance was negative again. The main reason for this was that current expenditure, particularly the social grants, had grown faster than current revenue. This was not the position that the Treasury wanted to be in, and he believed it would have turned around by the end of the year.

Ms Hogan observed that the division of revenue was now taking administrative duties in respect of social grants from the provinces to National Departments. If provinces overspent because of non-compliance, they would be required to fund this out of their own funds. Given the past problems in respect of provinces and social spending, how confident was the Treasury in this plan and would it yield management information? Was this a learning curve period?

Mr Manuel replied that conditional grants were no longer provincial problems. The Government had a vested interest in securing the administration on the Agency.

Ms Hogan said that the RAF and its contingent liabilities had been one of the first things dealt with by the Standing Committee on Public Accounts (SCOPA) in 1994. The question never seemed to be resolved. What was the understanding of the result of the restructuring of the RAF?

Mr Kganyago replied that there had been a lot of discussions with the RAF and he believed the tide had turned. Focus had previously been on the revenue side, and no one had wanted to deal with the expenditure side. Steps to be taken included some as elementary as eliminating fraud and dealing with distortions. In many other countries, foreign visitors were obliged to have their own insurance, and this was being considered. Efforts were also being made to limit claimable amounts.

Ms Hogan referred to the pebble bed modular reaction (PBMR) and said that she had understood that private sector partners would be funding it. She recalled reading that there would be an initial R500 million from Government. What were the current commitments?

Mr Manuel replied that a lot of work had been done with the private sector and there was now a race to completion. South Africa was a few years ahead of the rest of the world. Private sector commitments had been secured, but they would prefer costs to be socialised and profits privatised. This was a risky endeavour, and was a slow process.

Ms Hogan said that, as an ex political prisoner, she was particularly concerned at the ongoing overcrowding in prisons, although she understood that the Government was trying to add facilities for 12 000 prisoners. Were there plans for spending on any more prisoners, as the country could not afford to wait for justice reforms.

Mr Manuel replied that one of the problems was that some large prisons were seriously under populated, such as Kokstad Prison, because they were too high security. The Government had budgeted to add one person per year for the next ten years, and four privately managed prisons were coming in. The Department of Correctional Services had not been good with capital expenditure, and had under spent by R16 billion last year. He understood that it might not be too different this year.

Mr B Mkongi (ANC) noted that nothing had been said about placement for youth educated in terms of the skills and learnership programmes and asked if there was any strategy for this.

Mr Manuel replied that he felt it was in the interests of the employer to keep a person if he or she was a good worker, but that the Government could not compel employers to retain staff.

Mr Mkongi said that there was a need for funds to be budgeted for the National Youth Service Programme, which aimed to assist in making youth proactive in recruiting. Were there any plans for funding it?

Mr Manuel replied that the process was for Departments to prepare budgets and submit these with business plans. In August of each year, officials would go to the Medium Term Expenditure Committee with their requests. The Committee would look at the quality of the business plan, and this was often where breakdowns occurred. The changes in the Public Finance Management Act (PFMA) required managers to manage, and once budgeted funds were spent, the Departments had to account for them. If no funding had been allocated, it indicated a lack of a business plan.

The meeting was adjourned.


Appendix: 2005 Budget

Errata

Speech

Page 9

The sentence reads Welfare and social assistance, education, land restitution and housing have evolved into strongly redistributive expenditure programmes, bringing the average value of services, of the social wage, that goes to the poorest 40 per cent of households to an estimated R956 a month.

The R956 a month estimate is based on HSRC research using 2002 household survey data. (The estimate includes schooling, health care, housing, social grants and access to subsidised water and electricity.)

Page 30

The sentence reads ‘The increases in alcohol and tobacco product duties will raise R1.6 billion in additional revenue'.

The figure should be R1.3 billion.