You need to prepare for the fact that, from March next year, it is likely that you will be paying more of your hard-earned cash to the government in the form of taxes and duties. Tax revenue is falling far short of expectations, and state spending is unlikely to be curbed in the near future.
The government has a delicate balancing act on its hands, because a point may be reached where increased taxes will have the opposite effect to what is intended, an issue alluded to by Finance Minister Malusi Gigaba in his medium-term budget speech a few weeks ago.
Kyle Mandy, tax policy leader at accounting firm PwC, says the government may be close to its limit in what it can extract from taxpayers through further tax increases.
He says at the last Budget, in February, a number of commentators, including himself, warned National Treasury and Parliament that the tax increases announced in the Budget, particularly on personal income tax, would likely push tax collection very close to the top of the Laffer curve, the point at which tax revenues are maximised and beyond which tax-rate increases actually result in a decrease in tax revenues.
Mandy says the Laffer curve (see graph below) was developed by United States economist Arthur Laffer to illustrate the relationship between tax rates and the amount of tax revenue collected by governments.
“It suggests that, as tax rates increase from low levels, the revenue collected will increase. However, at some point, further tax-rate increases will actually lead to lower tax revenues as the disincentive effects of higher taxes begin to dominate,” he says.
“While Laffer’s primary objective was to illustrate that taxing any economic activity results in less of that economic activity and resultantly lower tax revenues, the Laffer curve also illustrates that higher tax rates result in a greater incentive for tax avoidance and evasion, which could also cause tax revenues to fall. In this regard, it is important to recognise that a tax system does not operate in a vacuum. It is affected by the social, economic, and political environment in which it operates,” he says.
The curve itself is not static. Mandy says: “Where taxpayers perceive a government to be corrupt, inefficient and wasteful, not delivering benefits to taxpayers or the broader citizenry, or when a country is going through tough economic times, the Laffer curve shifts downwards and to the left. This results in the tax system delivering less revenue at a lower maximum rate than in the absence of such conditions.”
He says there have been significant tax increases in the past few years, which saw the tax-to-gross- domestic-product (GDP) ratio increase from 24.5% in 2012/13 to 26% in 2015/16, primarily led by increases in personal income tax. Since then, the tax-to-GDP ratio has stalled at 26%, and it is “not unreasonable” to expect that the ratio for 2017/18 may fall below 26%.
“The stalling of the tax-to-GDP ratio comes despite significant tax increases in each of 2016/17 and 2017/18, which were expected to deliver R18 billion and R28bn of additional tax revenues respectively,” Mandy says.
Priya Naicker, the advice manager at Old Mutual Personal Finance, says although tax increases are generally considered not conducive to economic growth, the government may well deem them necessary to address the projected R51bn tax shortfall, the biggest revenue gap since 2009.
“If an income tax increase or rise in the VAT rate is announced in February 2018, your disposable income will shrink,” Naicker says. “Many South Africans will be forced to further tighten their belts in an attempt to make ends meet and avoid going into, or falling deeper into, debt.
“To prepare for this possibility, you should consider cutting back on spending, particularly on unplanned and unnecessary purchases. Now is the time to focus on reducing your debt and increasing your savings to ensure you are on track to achieve your financial goals (see ‘Reduce your tax burden while building a nest egg’).
“Being proactive and self-disciplined with your money is an essential stepping-stone to financial empowerment. Openly evaluate your expenses and have candid discussions with your family about money management.
“An objective professional, like a financial adviser, can help you evaluate your finances and empower you to make informed decisions. Partner with a financial adviser who can work with you to prepare for a potential tax hike and determine a realistic budget to ensure that you stay on track to meet your medium-and long-term goals,” Naicker says.
WHAT ARE GOVERNMENT'S OPTIONS?
The government has several options when it comes to managing the fiscus, and these are no different from those facing a household under financial pressure: decrease spending, increase income (in the government’s case, tax revenue), or rely more heavily on debt. The third option is only a temporary solution and is always the worst, because you ultimately have to pay back more than you borrow.
Kyle Mandy says that raising income tax is likely to be self-defeating, while hiking other taxes will also have negative consequences.
“Increasing the corporate tax rate would further dent investor confidence and economic growth, while VAT is politically sensitive, notwithstanding that this is the one area where large amounts of revenue could be raised across a broad tax base, while minimising the damage that further tax increases would do to economic growth. Realistically, it is probably the only tax that could be increased and deliver increased tax revenues in the current environment.
“Of course, the other option is to cut expenditure. This aspect of the budget, however, is also inherently political, with significant pressures for increased spending stemming from new initiatives such as National Health Insurance, social security reform and higher education funding, while also having to contend with public-sector wage negotiations and bail-outs of state-owned entities,” Mandy says.
Maarten Ackerman, the chief economist at Citadel, agrees that, at some point, increasing personal tax rates becomes self-defeating. However, he says we often forget that personal tax rates were much higher than they are now in the 1960s and 1970s during the gold crisis and the sanctions era.
Ackerman says Scandinavian countries have high personal tax rates, but people are prepared to pay high taxes if they believe they are getting something in return, such as a high level of health care. It’s when people don’t see any positive results from paying more tax that they start to push back. However, he says that salaried employees, because they have income tax deducted from their pay-cheques, are captive to the system to a large extent.
There are ways people may legitimately avoid paying tax or defer paying it, Ackermann says. For example, if capital gains tax is increased, which is a possibility, people might defer realising their gains, such as postponing selling a property or cashing in an investment.
An additional income tax bracket targeting the wealthy or a mooted wealth tax on assets may see high-net-worth individuals looking at more tax-efficient structures for their money, and they may even consider taking up tax residency in offshore jurisdictions such as Malta and Mauritius, he says.
Ackerman agrees that an increase in VAT will provide the most effective solution, because everyone pays VAT and the government can tap into the informal sector. But such a move will be highly unpopular, so it will probably be the last thing the government would consider. He says a proposal by the Davis Committee on Tax Reform may provide a solution: a variable VAT rate, with lower rates on necessities and higher rates on luxury items.
REDUCE YOUR TAX BURDEN WHILE BUILDING A NEST EGG
Priya Naicker suggests that you consider exploring medium-and long-term tax-efficient savings vehicles to put extra money aside.
For the medium term, a tax-free savings account offers tax-free dividends and interest, and no tax on capital gains. Contributions are limited to R33 000 per person a year and R500 000 over a lifetime. You can withdraw money from a tax-free savings account, but you can’t replace what you withdraw by exceeding your contribution limits.
For the longer term, Naicker says that a retirement annuity (RA), while offering limited liquidity, comes with the added benefit that contributions are tax-deductible. You can deduct contributions to pension, provident and RA funds of 27.5% of the greater of remuneration or taxable income, capped at R350 000 a year.
Growth within a retirement fund is also free of tax.
When accessing your savings at retirement (from age 55), up to a third of the fund value may be taken in cash (unless the total amount in the fund is less than R247 500), which is tax-free up to R500 000 (on all your savings in retirement funds). The balance must be used to buy a pension (annuity).