Government has painted itself into fiscal corner

Independent Newspapers

Pravin Gordhan, Minister of Finance. Photo: Matthew Jordaan.

Looking ahead at next week’s national budget to be tabled in Parliament against the backdrop of government’s ambitious plans for an increased role for the state in the economy and the implementation of the National Development Plan, one is immediately confronted with the lack of fiscal space to accommodate new policy initiatives. The truth of the matter is that government has painted itself into a fiscal corner in the past four years from which it will take time to escape.

It is tempting to compare South Africa’s fiscal situation with that prevailing in the developed economies and to pat ourselves on the back for not being in the same dire straits in which they find themselves, but that would be misleading – after all we are not struggling with the consequences of a major banking and sovereign debt crisis, but rather with the aftermath of a fairly shallow domestic recession. It would be much more appropriate to judge South Africa’s fiscal position against that of our peer group, middle-income emerging-market countries.

According to the International Monetary Fund’s (IMF’s) latest Fiscal Monitor (October 2012), the average budget deficit for emerging-market countries is projected at 1.5 percent of gross domestic product (GDP) in 2013, compared with 4.9 percent in the advanced economies. In addition, the average debt ratio for emerging-market countries is projected to continue its declining trend to 33.1 percent of GDP, while it will increase further to 113.6 percent in the advanced economies. The notable exception is India, with a projected budget deficit of 9.1 percent of GDP for 2013 and a debt ratio of 66.7 percent.

Relative to these numbers, South Africa finds itself somewhere in the middle, with a projected budget deficit equalling 4.7 percent of GDP for 2013 and a debt ratio of 43.3 percent according to the Fiscal Monitor. The reality is that the leeway that was available four years ago has been absorbed by a sharp increase in government consumption expenditure that cannot by any stretch of the imagination be described as growth and employment enhancing. It hasn’t contributed to addressing the stated objectives of alleviating poverty and inequality in a sustainable manner, apart from bringing some short-term relief through the further extension of social grants.

In fact, general government consumption expenditure as a percentage of GDP has been on a long-term rising trend since the 1960s, with the ratio increasing from 12 percent in 1966 to 20 percent in 1994. The fiscal consolidation programme implemented as part of Gear stabilised that ratio at between 18 percent and 20 percent of GDP, but it has shot up to 22 percent since 2008. Much has been said about the contribution made by the rising public service wage bill to this phenomenon, but the increase in non-wage consumption has been equally striking, rising from 8.7 percent of GDP in 2008 to 9.8 percent in 2012.

One can only hope that the president’s announcement in the State of the Nation address that a Presidential Remuneration Commission will be established to “investigate the appropriateness of the remuneration and conditions of service of all state employees” will result in the government’s wage bill returning to a more appropriate and sustainable level.

However, the comment that the commission’s first task will be to consider the remuneration of teachers with a view to “attracting, motivating and retaining skilled teachers” should probably be interpreted as an indication that higher salaries for teachers are on the cards.

On the revenue side of the budget, tax revenue took a beating from the 2009 recession, declining from R625.1 billion in the 2008/09 fiscal year to R598.7bn in 2009/10, ie by 4.2 percent. However, the fall in revenue was short-lived and the actual outcome for 2010/11 surged to R674.2bn.

Nevertheless, the recovery in tax receipts has lagged the recovery in nominal GDP and the tax-to-GDP ratio is therefore still lagging its pre-recession level by two percentage points.

The tardiness in tax revenue is mostly due to the weak recovery in tax receipts from companies, which is expected to return to its pre-recession level only in the next fiscal year. This serves as a sharp reminder of the importance for the health of the economy of businesses being profitable and therefore the need for government to create a favourable business environment. Attempts at coercing business into adopting social objectives that will result in reduced profits may yet come back to bite government.

The minister of finance has already indicated in previous budget speeches that increased taxes could be on the way if the fiscal consolidation programme does not proceed as desired. However, the current state of the economy and the need to accelerate growth do not lend themselves to an increased tax burden. In this regard the announcement in the State of the Nation address that the minister of finance will later this year commission “a study of our current tax policies, to make sure that we have an appropriate revenue base to support public spending” does not sound promising. Furthermore, there is no mention of co-ordinating the tax policy study with the long-term fiscal report that will assess the sustainability of spending options announced in the 2012 Medium Term Budget Policy Statement.

The scope of the planned tax policy study is unclear – all we know is that it will include a review of mining taxes. Apparently it will not be as comprehensive as is normally the case with full commissions of inquiry into tax policy, the last of which was the so-called Katz Commission in the 1990s. The risk is that a trimmed study could result in piecemeal changes to taxes with unintended and distortionary consequences. The minister should provide more details on the planned tax study in the budget and hopefully this will not only focus on raising more revenue for the state, but also on the correct structure and level of taxes to promote economic growth and employment.

In summary, it appears as if government is well aware of the lack of fiscal space and the poor implementation capacity within the public sector. It appears that it intends to escape from the fiscal constraints it faces by increasing taxes and getting the private sector to assume responsibility for public sector tasks.

As for the budget, national budgets tend to overflow with good intentions – instead of adding more, actual delivery on past promises should be the focus.

Jac Laubscher is Sanlam’s group economist.