Budget 2008: opinions of a Panel of Economists

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Finance Standing Committee

25 February 2008
Chairperson: Mr N Nene (ANC)
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Meeting Summary

The Industrial Development Corporation said that the global economy had expanded rapidly in the last five years mainly due to strong growth in emerging markets such as China, India and Brazil. Another key feature had been the relative decline in significance of the US economy as a factor in world economic growth. According to the International Monetary Fund the risk to the global growth outlook was tilted to the downside.

In South Africa a solid growth performance had been driven by strong domestic demand but that this had moderated recently. The domestic outlook was characterised by rising inflation, reduced consumer consumption, production capacity constraints and a rising balance of payments deficit.

Against this background the 2008 Budget had striven to underpin government policy on economic growth, job creation, infrastructure investment, boosting exports, small business development, skills upgrading, public service delivery, public infrastructure spending and national savings. The Budget therefore planned for a continuing strong revenue stream, supply side measures to support economic growth, a surplus of 0.7% of GDP over the MTEF, tax relief for households of R7.7 billion, real growth in non-interest expenditure of 6.1% and support for the Eskom capex programme of R60 billion.

Sanlam said that despite the global and domestic constraints such as declining growth, the electricity crisis and post Polokwane uncertainty around the future direction of government economic policy, the Budget had been ‘bold, remarkable and oozing with confidence’. It had affirmed the vision of long-term sustainable growth, embraced globalisation and showed commitment to the modernisation of the State. They concluded that the Budget had contributed to the acceleration of growth, advancing social development and reducing inequality.

Regional Business Analytics said that the Budget was moving the economy in the right direction but that it had not gone far enough. In particular, it had not done enough to create a significantly more positive environment in which small businesses could flourish by, for example, reducing the administrative burden of VAT by raising the threshold for tri-annual VAT payments to R5 million bringing it in line with BEE requirements.

Government expenditure on infrastructure investment in recent years continued to be insufficient and in part this had contributed to the current economic problems facing South Africa. The tax to GDP percentage ratio remained unacceptably high and there was continuing inefficiency in terms of expenditure in relation to outcomes.

Meeting report

 

Industrial Development Corporation Presentation
Mr Lumkile Mondi, Chief Economist, said that global economic growth had declined in 2007 and would decline further in 2008. Since the 1990s the growth rates of developing economies had overtaken those of the advanced economies. The influence of the US economy on global growth had declined while the importance of emerging markets such as China, India and Brazil had increased.

South Africa’s export basket 2007 showed that 52.4% went to the US, Japan and the EU, markets whose GDP growth was in relative decline, while only 13.6% went to Africa, an expanding market. Other countries combined accounted for the remaining 34%.

The US economy was facing a possible recession in 2008. In South Africa, the small decline in real GDP growth in 2007 was forecast to be more pronounced in 2008. While the contribution to real GDP growth of domestic consumption and net exports was expected to decline further, the key driver of growth was expected to be fixed investment. The IDC forecast for total GDP growth, at 3.4%, was slightly lower than the Treasury prediction of 4%.

Domestic demand had exceeded domestic supply since 2003 at an ever-increasing annual rate and this has resulted in a widening output gap. While a recent moderation in demand has been observed, domestic supply must be augmented, notwithstanding current production capacity constraints.

Inflation increased sharply in 2007, reaching a four-year high of 8.6% in December. The major contributors were rising food and fuel prices. Although the growth in demand for private sector credit had slowed in recent months, a number of upside risks to the inflation outlook remained, including a weaker currency and higher global inflation. The IDC forecast on CPIX up to 2010 was slightly higher than that of the Treasury at just over 5%.

The balance of payments deficit was set to increase over the next three years, mainly due to imports associated with fixed investment activity – especially relating to intermediate goods such as cement, steel and timber- and domestic consumption. The IDC forecast was similar to the Treasury at 8% of GDP or just under R220 billion by 2010.

The key objectives of the 2008/09 Budget were robust economic growth, job creation, investment in infrastructure and productive capacity, export growth, a more enabling environment for small business, skills development, improved public service delivery and maintaining the fiscal surplus.

Total government revenue as a percentage of GDP was forecast to rise slightly from 28.4% in 2007/08 to 28.6% in 2010/11, despite the stated aim of eventually reducing this rate to 25%. The budget balance as a percentage of GDP was expected to fall slightly from 1% in 2007/08 to 0.7% in 2010/11. Debt service costs as a percentage of GDP were expected to fall from 2.6% to 1.9% in the same period.

More than R100 billion in additional revenue has been raised over the last four years, largely due to strong economic growth and more efficient tax collection. Real terms non-interest public spending accelerated by and average of 10% per annum over the last five years, although this will moderate to 6.1% over the coming three years. Government is budgeting for an average surplus of 0.7% of GDP over the next three financial years. A new measure for fiscal stability, the cyclically adjusted budget balance, has been introduced. In the global context, South Africa’s budget balance compares very favourably to most advanced economies, including the US, the EU and emerging markets such as India and Brazil – al of whom are running budget deficits of between -3% and -1%.

Total government debt as a % of GDP has been steadily falling since 1994, largely due to sound fiscal policies. The increasing proportion of foreign debt, albeit from a very low base, has meant less pressure on domestic financial markets. South Africa’s total government debt to GDP ratio of about 24% is well below the global norm of 60%.
The Budget reduced the corporate tax rate to 28% and the Secondary Tax on Companies (STC) was switched to a 10% withholding tax on dividends, thus reducing the corporate tax rate substantially. The tax regime for small businesses was simplified, raising the VAT threshold to R1million for general companies, and to R1.5 million for farmers and businesses submitting bi-annually or tri-annually. Tax relief for individuals amounted to R7; 7 billion bringing the total tax relief to R10.5 billion and the tax threshold for annual income was increased to R46, 000 (R74, 000 for over sixty fives). The tax-free threshold for interest and dividend income was raised to R19, 000 and R27, 000 for under and over sixty fives respectively.

An electricity levy of two cents per kilowatt-hour was proposed to support energy efficiency and general fuel levies were increased by six cents per litre with an additional five cents per litre for the Road Accident Fund. The Bio diesel fuel tax concession was raised from 40% to 50% while Bioethanol remained outside the fuel tax net but subject to VAT.
The so called ‘sin taxes’ were increased on wine per litre, beer per 340ml and cigarettes per pack of twenty by twelve, five and sixty six cents respectively.

A venture capital tax incentive was introduced to improve access by Small and Medium Enterprises to equity finance and the urban development zone incentive was extended for a further five years to allow more private sector participation.

Personal income tax remained the key source of government revenue although the proportion in relation to tax on companies declined slightly.

Expenditure was increased on road infrastructure development by R13.4 billion. Tax incentives and policy initiatives for industrial development were allocated R5 billion and R2.3 billion respectively. There was significant support for electricity productive capacity in the form of a R60 billion loan to Eskom. The proportion of expenditure on social services overall fell slightly from 51.7% to 49.5%, mainly due to a decline in spending on housing and community development.
There was increased spending to municipalities by R6.5 billion, to provinces by R33.2 billion, on social grants by R12 billion and on HIV/AIDS by R2.1 billion.

Government infrastructure investment will continue to increase strongly in the next three years, rising from 6.1% of GDP in 2007/08 to 7.6% by 2010/11. There was a dramatic increase in the capital expenditure estimates of state owned enterprises (SOEs) from R313.4 billion (2007 to 2012) to R494.5 billion (2008 to 2013), principally in energy (R342.9b) and transport (R78b).

Exchange controls were largely eliminated and replaced with a system of ‘prudential regulation’ to be monitored by the Financial Surveillance Department of the SARB, formerly the Exchange Control Department.
A number of measures were proposed which require further review and analysis before implementation. These include a wage subsidy to encourage job creation, additional taxes on CO2 emissions and incentives to encourage more environmentally friendly technologies.

Of particular interest were the measures on industrial policy support totalling R7.6 billion over the next three years, and the increased expenditure in the Trade and Industry vote on the Customer Sector Programmes, which will be administered by the IDC. Also of interest were the increased budget for land reform and the investment in the Pebble Bed Modular Reactor.

SANLAM Presentation
Mr Jac Laubscher, Group Economist, called the 2008 National Budget ‘a remarkable document’.

In a global context there was uncertainty about the prospects for growth and there were specific concerns about the whether the US economy was heading for a recession. If this was already the case then it might be short lived, as previously.  The FED had taken strong measures to counteract the threat by aggressively cutting interest rates. The conventional wisdom was that cutting rates like this would stimulate the economy since banks were more likely to lend and people were more likely to borrow if money was ‘cheaper’. But this time around the system may not respond like this mainly due to the impact of ‘sub prime crisis’, which meant that the banks might remain reluctant to lend so freely despite the low interest rates. In nay case, since China now accounted for a quarter of world economic growth it was even possible that a recession in the US would not result in a global slump. The continuing high commodity prices reflected the basic strength of the world economy.

In South Africa, growth had declined somewhat, there was a major electricity production crisis and there were also perceptions that government’s economic policies may shift post-Polokwane. Against these global and national contexts his assessment was that the Budget was ‘bold, confident, visionary’. It laid the foundation for sustainable growth while also moving towards the goal of a globalised modern state. The decision on exchange controls was especially bold.

Despite the perceived political pressures post-Polokwane, it was clear that the Budget was anti-cyclical in its stance and did not depart from the long-term strategy adopted in previous years. It was important to distinguish between the cyclical and structural aspects of macroeconomic policy. Unemployment in the US for example, was cyclical in nature whereas unemployment in South Africa was structural in character and that therefore a purely monetary policy approach would prove to be inadequate.

On inflation targeting it had been pointed out that there was a difference between a policy goal and a policy strategy. The goals was stable prices and if there was a better way to achieve this than inflation targeting suggestions were welcome, the Minister had challenged his critics.
Comparing the volatility of interest rates pre -2000, when inflation targeting was introduced, with the relative stability post 2000 could see that the policy had yielded positive results. In the US by contrast, the same average had been achieved but the pattern had been much more erratic.

In terms of policy continuity, it was the case that many of the Polokwane proposals were already part of government policy and that the so-called shift was more perceived than real.

Sanlam’s projections for the key economic indicators were broadly in line with Treasury forecasts. The timing of the relaxation of exchange controls sent out a message of confidence in the South African economy and recent warnings by some of imminent large capital outflows had proved to be an overestimate. The flexible exchange rate would act as a regulator, encouraging two-way trade and offering fund managers enhanced hedging possibilities.
He wondered when the Reserve Bank would reach the point where sufficient reserves had been accumulated. It actually cost the country to hold such large reserves.

On the electricity crisis – there was a strong argument that tariffs should increase. The challenge would be to manage the economic impact. There was a long-term environmentally sensitive energy policy, which would override the short-term electricity supply problems.

Revenue projections were predicted to rise by 12% in 2008/09 and by an average of 10.8% per annum over the next three years. The tax base had been broadened, with an additional 280,000 new individual taxpayers in 2007, largely due to increased employment levels and greater compliance. The simplification of tax compliance for small businesses could also draw more into the formal tax net.

There was pressure from the Treasury on departments and the lower spheres of government to raise performance levels and this was to be welcomed.

The government debt to GDP ratio was declining, as was the interest on public debt as a percentage of GDP. This created room for other public sector borrowers and the PSBR was set to increase.
There was the potential for long-term growth through the measures adopted on corporate tax, infrastructure spending, skills enhancement, industrial policy and the emphasis on productivity and export capacity. But ‘big government’ taking redistribution ‘too far’ and thereby undermining future growth could bedevil this.
He concluded by warmly congratulating the Treasury on its budget and was of the view that it contributed towards accelerating growth, advancing social development and reducing economic inequality.

Regional Business Analytics Presentation

Mr Mike Schussler, independent Economist, said that in general the economy was slowing down as indicated by falling business confidence even before inflation started picking up and the Eskom crisis began. He agreed with Mr Manuel that we were in an economic ‘storm’ but that this was part of the normal business cycle.

It should be remembered, however, that South Africa was relatively rich by African standards and it was by far the largest economy on the continent. But one of the reasons for the storm is the historically low level of investment in infrastructure. Inflation will be higher in the next period, driven by rising energy, food and fuel prices, which will turn out to be much higher than most people have anticipated.

He said that the things he liked about the budget were the low debt to GDP ratio and the projected annual fiscal surpluses; He also liked the tax relief for individuals although it was insufficient to fully offset fiscal drag due to rising inflation. He applauded the small business proposals on VAT thresholds and the easing of administrative burdens but felt they did not go far enough. He suggested that the rules for small businesses need to be simplified even further by for example having only one threshold for all the rules relating to small business. This could take the R5 million annual turnover threshold that applies to BEE as the ‘across the board’ benchmark.
On the negative side, he said the tax revenue to GDP ratio of close to 30%, if local taxes are included, was far too high for a country like South Africa. As a developing economy it was not good that our tax rates were higher than Ireland or Japan and nearly as high as Switzerland. Our corporate tax to GDP ratio was the third highest in the world and it was more common in other countries to use more indirect taxes. He pointed out that as far back as 1997, a corporate tax rate of 25% had been promised, but that we were no nearer to achieving this goal. Only 5.3 million people carried the whole tax burden, while there were 4 million people dependent on social grants. Effectively, each business owner supported up to thirty-four dependents, if you included state employees and those on social grants. This was an unsustainable scenario.

Of even more concern was the low level of government investment, despite the rhetoric of recent years. Mr Schussler argued passionately that if you believe in the future, you invest, and government does not believe in this country’s future. In the 1960s government accounted for 40% of fixed investment, the private sector 53% and state owned enterprises 7%. But by 2000 government only contributed 16%, public enterprises 11% and the private sector 73%. It is the private sector that believes in the future, not government.

The problem was not just under investment by the State, but investment in the wrong things. Spending on housing for example has resulted in a situation where 28% of households are single people and 66% only have three persons or less. There has not been an emphasis on housing families first. The government should rather invest in roads, harbours and power plants. This was why we were experiencing a crisis in electricity production today. Home ownership rates in South Africa were amongst the highest in the world. Yet 26% of the population were living on social grants. In reality, each person in a job was supporting two people on welfare. He did not know of another country in the world where this was the case.
In education, South Africa has one of the lowest ratios of children completing schooling, even when compared to other emerging markets in Africa. Similarly, the percentage of young people achieving a university exemption was very low by global standards. We are not getting value for money from the education system. The world average spend on education as a percentage of GDP was 4.7% but in SA we spent 5.4%. Yet we have fewer teachers per capita at both primary and secondary levels. When compared with the rest of the world, SA has 3% of its workforce educated to degree level, but other developing nations average 9% and the OECD countries have 18%. So while we tax like a rich country our outcomes were far below many developing countries.
He urged the Committee to ensure that future budget reviews also included statistics on whether the ever-increasing level of expenditure was matched by improved outcomes and performance. He concluded by stressing that it was easy to talk about the tax and income side of the national ‘household’ budget but the real challenge was in addressing the expenditure side, and making sure that there were measurable deliverables and outcomes.

Discussion
Mr Mnguni (ANC) asked about small business and trade liberalisation.

Mr Marais (DA) asked about the future direction of industrial policy. SA did not export enough and there was low government investment. How were these issues to be addressed?

Mr Marais asked if SA could afford land reform given a stated goal of 30% transformation by 2014.

Mr Moloto asked what advice the economists had on the VAT rate.

Mr Mondi responded that small businesses below the R1 million VAT threshold could still register with SARS even though they would be exempt from the tax and that this ensured they could participate in tender opportunities.

A member asked about Eskom, social grants and farming.

Mr Laubscher responded that it could be a loan but preferably an equity injection.

Mr Mondi responded that giving a social grant was a short-term strategy but investment was a long term one. SA needed to boost local production capacity but input costs were high. The IDC did not give support to local farmers. This was the mandate of the Land Bank. They only supported sectors with an export potential such as horticulture and abalone farming.

Mr Schussler argued that the government should just give the ten billion rand to Eskom and not make it a loan as this would merely end up as another tax on consumers.
He believed that the payment of social grants could be linked to school attendance of their children. No attendance would mean withdrawal of the grant. A voucher system could be introduced in the education and health sectors to improve consumer choice and raise outcomes. He said that a visionary investment plan was needed, part of which could include a public works programme.

Mr Laubscher responded that the notion of conditional grants was already in the budget review. There was a need to be aware of not increasing the disconnect between the wealth producers and their enjoying the fruits of their labour by over zealous re-distribution policies. In a world where skilled labour was highly mobile there was a risk of accelerating the brain drain even further.

A member asked about the IDC’s successes and failures, tariffs and bond market.

Mr Mondi explained that the IDC had been formed in the 1940s and had, in partnership with the DTI, helped to establish and grow many of the country’s leading companies. But the challenge was to be bold and experimental with investment strategy. He believed in investing to innovate.
He argued that a bolder approach was required on energy production and that tariffs should have been increased by more than 2c/kw to allow for investment in alternative, sustainable and greener energy sources for the health of future generations.

He charted the rise of inflation post 2000 starting with escalating commodity prices, credit expansion due to the bringing into the formal financial sector of millions of hitherto unbanked black people and exogenous factors such as global rises in food and fuel. He was at odds here with the SARB Governor regarding the interest rate strategy.

Mr Schussler explained that the current inflation story was due to supply side shocks and it was perhaps inevitable that interest rates would rise still further. He acknowledged that inflation targeting was not a perfect strategy but that it was the best we had and at least it had produced stability in real interest rates since 2000.

A member asked how effective the budget surpluses would be in safeguarding the economy in the face of unexpected ‘shocks’.

Mr Laubscher responded that a shock such as a drastic reduction in revenue projections could be cushioned by such surpluses since the only other way would be to cut government expenditure, something it was not easy to do in the short term. This could be effective therefore as long as the ‘shock’ did not result in a deficit in excess of 3% of GDP.

A member asked about direct versus indirect taxes, VAT rates and tariffs.

Mr Schussler responded that in OECD countries the average VAT rate was about 17% and that raising South Africa’s to this level would enable a reduction in companies tax. Many other countries generated more income from indirect taxes such duties on wines and spirits. Excise duties in SA were also very low by international standards. He warned that the rise in electricity tariffs was an indirect tax and would have about a 1% impact on inflation. He repeated that government should focus attention on improving the infrastructure that helps business to be competitive and efficient such as roads, energy and telecommunications.

Mr L Greyling (ID) noted that the panel wanted a reduction in company tax but also were happy with the cyclical surplus. How then did government find the resources to fund infrastructure investment? He agreed that there was insufficient return on investment in education for example but wondered if it was not the case that we did not under fund departments and then still expect delivery. He disagreed strongly with the proposal to ‘give’ Eskom R10 billion towards its recapitalisation programme especially as this was focussed on unsustainable fossil fuel stations. It would be better to either make it a loan or at least insist that it be used to fund renewable energy programmes. On the question of an experimental and bold industrial policy he was supportive but he wondered if we always picked the ‘winners’ here. He cited Denel and the pebble bed reactor as two examples of ‘losers’.

Ms J Fubbs (ANC) asked from where was the extra cash needed for infrastructure investment to come? On education and value for money, she wondered whether the panel could give an example of a country that had faced similar challenges to South Africa. On home ownership, she argued that most South Africans regarded houses as primary assets. She agreed that small businesses had the potential to create more jobs but wondered how they could do this without being competitive. She also doubted if cutting taxes still further would result in improved competitiveness.

Mr Laubscher responded that it was not necessary to finance infrastructure with cash so it was not really a budgetary issue. It should rather be financed through long-term borrowing.

Mr G Schneeman (ANC) asked what was the role of the private sector in stimulating job creation.

Mr Singh noted the role of social grants for the elderly and infirm but agreed that young people should be encouraged to be self-reliant. He felt that there was often a ‘turf war’ between different departments and agencies in terms of grants and interventions and that there needed to be more co-ordination within government in order to be more effective and not waste resources.

Mr Marais asked again about the ability of the economy to sustain the land reform objectives by 2014.

The Chair asked Mr Schussler to clarify the sources for the data in his presentation.

Mr Schussler responded that UIF data showed that the average firm employed about twelve or thirteen people. These could be categorised as small businesses and these are the firms that need to grow. The Small Business Project survey showed that on average small companies spend about 8-9% of their turnover on the administration of taxes. This area needed simplifying. Sometimes it is more of a burden for small business to deal with the administration of a tax than the tax itself. The source of his data on housing was the StatsSA annual household survey and the UN for international comparisons. Examples of countries that had turned their economic situations around in a relatively short time were the Philippines and Indonesia. They were poorer than many African countries in the 1980s but they are now much richer.

Mr Mondi also referred to the experience of countries such as Taiwan and Malaysia, who took bold measures to industrialise in the 1960s and who are now reaping the benefits of this forward thinking. South Africa needed to be bold and experimental too, despite the risk of failures from time to time. On the issue of inflation targeting he argued that the SARB needed to take the general interests of all the people into account and this might mean a more pragmatic approach.

Mr Schussler concluded that the key issues going forward were raising educational standards and establishing a climate in which business could create more jobs.

Mr Mondi concluded that key issues were raising the level of savings, especially through the formal financial services sector, and the relaxation of exchange controls, which gave a clear signal that the country was confident of maintaining economic growth going forward.

The Chair thanked the panel for their input.

The meeting was adjourned.

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