Pampering of rich is now too costly

Speculation is rife in anticipation of this week’s Budget speech. Will Finance Minister Pravin Gordhan announce tax increases? Might the tax rate for personal income above R617 000 increase to 42 percent? Might it even return to 45 percent for the portion of income exceeding R1 million?

The 42 and 45 percent tax rates were abolished 12 years ago. In addition, the Treasury started to make exaggerated adjustments of tax brackets. Tax brackets have, on average, been adjusted at double the rate of inflation. In the 2005/06 budget year for instance, the highest tax bracket applied only to the portion of income above R400 000, as opposed to R300 000 the previous year. This was an “adjustment” of a whopping 33 percent when inflation stood at less than 4 percent.

Pravin Gordhan, Minister of Finance. Photo: Matthew Jordaan. Credit: Independent Newspapers

The consistent tax cutting policy of the Treasury is marketed under the banner of “adjusting for bracket creep”. Tax brackets have been adjusted upwards “to compensate taxpayers for the effect of inflation”, argue the authors from the Sars and the Treasury in the otherwise excellent publication Tax Statistics. However, they contradict their own tables and diagrams that show radical cuts in personal income tax over two decades. If adjustments were simply for so called “bracket creep” – they would not provide tax relief but, by definition, follow inflation.

They would be “politically neutral” and keep real taxation stable for a given income (or “lifestyle”), whether the year is 1994, 2000 or 2012. If the Treasury hadn’t fiddled politically with the tax brackets, but adjusted them at the rate of inflation, the 40 percent tax rate would today apply to the portion of income above R300 000. Real taxation would then be neither harsher nor lighter than in 2000.

But instead the 40 percent tax bracket today applies for the part of the income above R617 000, illustrating the scope of the Treasury’s tax activism.

For example, from the tables in the 2011 Tax Statistics, it can be deduced that an individual with a taxable income of R850 000 would pay R72 000 more in tax in 2011 if the personal income tax hadn’t been drastically reduced since 1994. This is what an 8.5 percent decrease in personal income tax rate means for that life style. There is no increased tax pressure in South Africa. The absolute contrary is the case.

Using the tax statistics and comparing to 1994, it can be shown that in 2011 alone over R150 billion in personal income tax revenue was forfeited from about 4 million individuals who have high enough incomes to pay personal tax. This is because of the radical tax cuts since the shift of the millennium.

But isn’t the “narrow tax base” an objective obstacle to restoring the 42 and 45 percent top marginal tax rates? Well, if South Africa did not have such an extremely unequal income distribution, then a much greater proportion of the active workforce (close to 14 million people) would pay personal tax. It seems, however, that the same experts who complain about tax pressure on the individual (forgetting that it is getting lower) also defend high levels of inequality by complaining that wages are too high.

It is instructive in this context that in 2011 only about 21 00 individuals were registered with Sars for a taxable income above R5m. Collectively they paid over R7bn in personal income tax that year.

When contacting just one financial institution in 2011, Sars found 30 000 individuals who saved R1m every year. According to Wealth Insight published in Business Report, there are about 44 700 “high net wealth individuals” living in the country. This is a low estimate compared to those compiled by institutes like Credit Suisse and Meryl Lynch.

The first thing to note is that bringing these people into the tax system would only marginally increase the tax base. However, with more than R8m in income and/or more than R80m in wealth – reigning in the tax-dodging super wealthy could potentially lead to tens of billions in increased revenue. That would change the tax to gross domestic product (GDP) ratio and with it the whole Budget – as long as the Treasury does not respond with more tax cuts.

But it seems probable they may, since that was what was logically implied in Gordhan’s Budget speech last year. There he reaffirmed a policy rule from the 1996 Growth, Employment and Redistribution (Gear) document, when saying that “key features of the Budget framework include… tax revenue stabilising at about one-quarter of GDP”, and projected this ratio forward to 2015 in the Budget.

Among the other four key features mentioned in this part of the speech were the aiming for a close to 3 percent budget deficit and a medium-term real growth in non-interest expenditure with 2.6 percent. This part of the Budget speech was directed to the international credit ratings institutes. Claims by a Sars spokesperson that the 25 percent tax to GDP ratio is “not a policy stance” are simply not credible. Save for four years around the political turmoil of Polokwane and the outright drop in GDP in 2008/09, tax revenue has hovered constantly at 25 percent to GDP since 1989.

To increase it, and thereby the capacity of the state relative to the rest of the economy, the Treasury has to do, nothing. It just has to wait for Sars to continue bringing income earners into the tax system and for the growing economy to increase taxable incomes. In a progressive tax system, where at least a part of the population pays taxes according to ability to pay, there will always be a tendency for the tax to GDP ratio to increase. Contrary to what it is claimed in the 2012 Tax Statistics, a constant ratio in such a system is in fact an effect of tax cuts in excess of compensation for inflation.

Why is this important and can an argument for higher taxes hold when the media is filled with reports of corruption and misuse of funds?

This is important because it is impossible for the government to finance a National Health Insurance (and a reform of the health system according to the standards set out by the Department of Health in its 2011 Green Paper), if not increasing the relative size of the public sector in the economy. And while arguments for higher taxes can stumble on the problem of corruption, corruption and waste in South Africa is concentrated where the bloated tender system and price colluding building business meets the incapacity of an underfunded state.

Therefore, a government “of the workers and the poor” should stop cutting taxes and reinstall the 42 and 45 percent tax rates abolished in the early 2000s. Simultaneously, it should forbid state officials and politicians to be involved in business and bid for tenders. Today, that would be the single most important step to take in clamping down on corruption.

Dick Forslund is an economist at Alternative Information and Development Centre in Cape Town. The AIDC report on personal income taxation is available at