According to Statistics South Africa, our economy grew at a paltry rate of 0.9 percent in the first quarter of the year. Many analysts were shocked by the figures released by Stats SA, as they believed our economy was growing at a rate of 1.9 percent.
If our economy continues to grow at a constant rate of 0.9 percent, it will take 80 years to double in size. South Africa’s fastest recorded growth rate in recent times (1965) was 8.9 percent. If the economy had continued to grow constantly at this rate, it would have doubled in size in a mere eight years. What causes growth? This is a question that has vexed economists for many years.
Plaudits must go to SA Reserve Bank Governor Gill Marcus for her statement that, “Domestically, we are facing challenges of crisis proportions that require a co-ordinated and coherent range of policy responses, which are largely beyond the scope of monetary and macroprudential policies alone to deal with”.
A common misconception is that government intervention through fiscal and monetary policy can be used to stimulate the economy and boost growth. The simple reason government spending fails to end recessions is because every rand the government “injects” into the economy must first be taxed or borrowed. The government merely redistributes money from productive to non-productive sectors of the economy. No new income and, therefore, no new demand for goods and services is created.
It is not the government but private firms that generate wealth and are the engines of economic growth. The government cannot create new purchasing power out of thin air. The mistaken view that fiscal stimulus can pull economies out of recession persists because the jobs created through government “make-work” programmes are clearly visible. What we cannot see are the jobs that would have been created elsewhere in the economy with that same money had it not been taxed or borrowed by government.
Similarly, monetary policy has its limitations. At best, it is simply a lever that can be adjusted to influence growth in the short-run. Consider what happens when the Reserve Bank cuts interest rates beyond what would have occurred if interest rates were freely determined by the interactions between the demand and supply of credit. When interest rates are cut too far, the capital allocation in the economy is skewed because capital is allocated to marginal activities. For example, if real interest rates are negative or zero, it would be unwise to hold cash balances because the investment will not earn a return. In this case investors would look for alternative places to invest. In low interest rate environments, these alternatives might be marginal activities that normally would not attract investment. When interest rates are forced to rise because of increasing inflation, marginal investments are exposed and the economy is likely to relapse into another period of recession.
The best way to stimulate growth is to allow people to work, save and invest. Unfortunately, our labour policies discourage the hiring of low and unskilled workers. In addition, high marginal tax rates and other pernicious taxes discourage savings and investment.
When we combine all these taxes, many people are paying more than 40 percent of their annual earnings. Typically, these are the individuals who would fund new investments in the economy, which, in turn, would create the essential new jobs we so desperately need.
A lack of investment retards capital accumulation. A lower capital to labour ratio reduces real wages and perpetuates the poor savings and investment cycle. In simple terms, without investments to fund and establish new ventures that create jobs, the smaller the economy and lower the economic growth rate will be.
An additional justification for a policy that removes pernicious taxes such as estate duties, transfer duties, taxes on retirement funds and capital gains taxes, is that it eliminates pervasive double taxation. Double taxation occurs because personal and corporate incomes are taxed and the returns derived from the savings and investments made from what is left over are taxed again. One of the government’s first priorities should be to eliminate taxes on savings and investments.
In addition to removing all taxes that constitute double taxation, the government could encourage savings and investment by flattening personal income tax. A flat tax would reduce the large cost of tax compliance and encourage greater investment and work effort.
A true flat tax makes no allowances for deductions and provides no special dispensation for low-income earners. However, for both compassionate and practical reasons, there is no merit in taxing the poor. While the compassionate reasons are obvious, the practical reason is that, below a certain level of income, the cost of collecting taxes from the poor will exceed the amount collected. Low-income earners should therefore be exempt from paying tax on personal income.
The government should consider simplifying the tax dispensation by having a zero rate for individuals below a certain threshold and a tax of perhaps 15 percent for everyone else, including companies. Apart from the efficiency gains the SA Revenue Service will enjoy by exempting the poor from tax and administering one tax rate, as a result of this simple policy proposal, the income tax base will be widened because there will be a higher level of compliance and employment will increase as a result of greater returns from savings and investment.
These are some relatively simple tax reforms that should receive approval from all quarters: business, labour, civil society and, most importantly, citizens.
It is time for our leaders to realise that the role of the government is to pursue policies that promote economic growth and not to prevent people from working by enforcing job-destroying policies.
* Jasson Urbach is an economist and director of the Free Market Foundation.
** The views expressed here do not necessarily reflect those of Independent Newspapers
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