Bill Clinton’s successful 1992 presidential campaign famously coined the phrase: “It’s the economy, stupid.”
By account of his State of the Nation Address (SONA) on February 11, President Jacob Zuma seems to be sharing the same notion. In his response to the debate he further cemented this stance by focusing on the economy, stressing the need for the country to avoid being downgraded to “junk status”.
A word density analysis of SONA 2016 highlights a growth focused and investment inclined speech.
Read: Will Gordhan's budget appease investors?
In his speech the president frequently used the words invest, economy, business, and growth. None of these words were present in last year’s top 10 – clearly a notable departure. This sets the scene for the much awaited 2016 Budget speech by returning Finance Minister Pravin Gordhan.
However, it is important to take stock of our current macroeconomic locus. Weak global economic growth since the 2008 recession has rendered the Treasury’s counter-cyclical expenditure programme unable to lift gross domestic product (GDP) growth above 2.5 percent in the last eight years. The International Monetary Fund projects real GDP growth for 2016 will be a paltry 0.7 percent.
In a perfect world increased fiscal multipliers should have provided much needed support for growth and buoyed the tax base, resulting in increased government revenues. Consequently, lack of growth has come at the expense of rising no-interest expenditure, increasing debt and expanding budget deficits – this has left us on the brink of a junk status rating.
No growth
So where will the minister get money to fund government’s expenditure framework? Of all tax revenues 90 percent comes from personal income tax, VAT, corporate income tax, import duties and specific excise duties.
According to Statistics SA, data gross operating surplus – the key driver of corporate income taxes – has failed to register any growth in the first nine months of 2015. In the current weak environment, the minister is unlikely to increase corporate income tax. Such a move might be viewed as uncompetitive as our statutory tax rate is already above the Organisation for Economic Co-operation and Development (OECD) average. While our VAT rate is relatively low, compared with our OECD contemporaries, there is less risk of tax avoidance and tax planning associated with this tax.
An increase in VAT will be seen as punitive on increasingly indebted households. VAT increases will clearly be an unpopular choice among the unions and the general population, especially at the back of drought induced food inflation. Furthermore, disproportionate increases in specific excise/sin taxes might also yield less revenue and encourage parallel market consumption of alcohol and tobacco. In light of a deteriorating rand, the minister will be careful not to increase the cost of import goods by increasing import duties.
Only personal income tax has shown buoyant growth on the back of higher-than-inflation wage increases. The minister has the option of providing sub-inflation tax relief to raise short-term revenue, but failure to give tax relief is highly regressive as lower income groups suffer from an increased tax burden. He also has the option of increasing personal income tax rates. However, is the minister going to adjust income taxes for two consecutive years?
To further compound the problem, growth, or lack thereof, has left the tax base in a fragile state. This leaves the minister with very limited tax options. On the other side of the coin, the minister will be under a lot of pressure to curb government expenditure. The risk of being downgraded to junk by major rating agencies, and increasing interest rates both domestic and international, mean borrowing costs on government-held debt over the medium-term economic framework will rise.
Concomitantly, a deteriorating rand and inflation outlook will result in faster compensation growth on government employees. The government will also be forced to increase its social protection commitments to meaningfully protect the vulnerable.
However, as the president noted, “stronger measures to restore a sustainable fiscal path have been endorsed at the highest levels of government”. We wait in anticipation for Gordhan to respond to these economic challenges.
* Muziwethu Mathema is the senior manager of Financial Risk Management at KPMG.
** The views expressed here do not necessarily reflect those of Independent Media.
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