October/November 2014 Jannie Rossouw

1. South Africa’s fiscal cliff REVISITED:Presentation to the Standing and Select Committees on Appropriations OF THE PARLIAMENT OF THE REPUBLIC OF SOUTH AFRICA October/November 2014 Jannie Rossouw Head: School of Economic and Business Sciences, University of the Witwatersrand Fanie Joubert Department of Economics, University of South Africa Adèle Breytenbach Department of Economics, University of South Africa

2. Introductory summary This presentation analyses: the fiscal cliff facing South Africa social assistance expenditure the remuneration of civil servants tax revenue increases for the South African fiscus This presentation expands the findings of Rossouw, Joubert and Breytenbach (2014) which identified the danger of a fiscal cliff facing South Africa The South African fiscal cliffis described as the point where civil service remuneration plus social grant expenditure equal government revenue

3. Introductory summary By 2012 it was clear that the South government was heading for a fiscal cliff with social assistance expenditure and the remuneration of civil servants exceeding all government revenue by 2026 if allowed to continue unabated Based on trends between 2008 and 2012, not even tax increases to raise revenue could have averted a fiscal cliff

5. Source: Business day, Monday, 27 October 2014

6. SOCIAL GRANTS: SUBSEQUENT DEVELOPMENTS Trends are concerning and confusing (e.g. an expected decline in child support grant post 2020?) Number of grant recipients expected to increase from 16 052 000 (2014/15) to 16 309 000 (2015/16), 16 520 000 (2016/17) and 17 300 000 (2017/18). This is equal to an average growth rate of 2,5% p.a., which shows continued uptake of social grants

7. GRANTS Source: 2014 Budget Review: 44

8. Social ASSISTANCE: COST AND NUMBER OF RECIPIENTS Source: 2014 Budget Review

9. SOCIAL GRANTS Social grant expenditure expected to rise from R120,9 bn (2014/15) to R129,5 bn (2015/16) and R137,6 bn (2016/17). This is equal to an average growth rate of 7,4% p.a. It seems that growth rate in this expenditure item has declined, but it still requires careful monitoring

10. Compensation account of the south african government: SUBSEQUENT AND CURRENT DEVELOPMENTS The number of employees in the public sector (central plus provincial government) increased at a steady rate of some 3,1 per cent per annum since 2005 Although some deceleration in this growth trend was discernible in in the 2012/13-fiscal year, civil service employment has again accelerated in the 2013/14-fiscal year It is still to early to assess the growth rate in the 2014/15 fiscal year, but this growth rate is essential for averting the fiscal cliff (see next slide and 2014 MTBPS)

11. TABLe 2: Public Service employment, 31 march 2005 to 30 June 2014 * These figures do not include local authorities, nor other public-sector enterprises Sources: Breytenbach and Rossouw, 2013, SA Reserve Bank, Statistics SA [S.a.]

12. PublicService COMPENSATION Sources: SA Reserve Bank, Statistics SA [S.a.], own calculations

13. Compensation account of the south african government It is too early to predict an overall decline in the growth trend since 2005 The central government’s compensation account increased from R195,0bn in 2007/08 to a budgeted R440,7bn (MTBPS) in 2014/15, which is equal to an average increase of 12,4 per cent per annum For 2014/15 to 2017/18 the budgeted increase is in the region of 6 to 7 per cent per annum. This seems too low, given recent history. However, the success or otherwise of the MTBPS (and South Africa’s all-over fiscal sustainability) depends on this point

14. Compensation account of the south african government An analysis by Breytenbach and Rossouw (2013) shows that the increase in the government’s compensation account is attributable to: inflation; structural changes in public service compensation and in particular larger compensation increases for senior staff; growth in public service employment on national and provincial levels; annual remuneration increases; notch increases and promotions; and senior appointments from outside due to an expansion in the number of government departments

15. Compensation account of the south african government The following assumptions based on Breytenbach and Rossouw (2013) were used to restate the civil service renumeration budget for the period 2014/15 to 2016/17: Employment growth at 3,1 per cent per annum General remuneration adjustment: Inflation (6 to 6,5 per cent p.a.) plus 1 percentage point (includes some provision for annual notch adjustments, but not for structural adjustments) Restated civil service remuneration budget, based on these assumptions: 2014/15 fiscal year: R448,4 billion, rather than R440,7 billion as is budgeted 2015/16 fiscal year: R493,2 billion, rather R470,6 billion as is budgeted 2016/17 fiscal year: R542,5 billion, rather than R501,8 billion as is budgeted 2017/18 fiscal year: R596,8 billion, rather than R533,5 billion as is budgeted Cumulative expenditure underestimation of some R136 billion over these four fiscal years The implication is clear: South Africa must limit the size and growth of its civil service if it wants to avert a fiscal cliff

16. The baseline analysis accepts the assumption that the take up rate in social grants will increase for the next decade and then level out • It is assumed that the economy will grow as announced by the Minister of Finance and by 3 per cent per annum from 2018 • It is also assumed that government remuneration will increase by 10 per cent p.a., based on: • Inflation adjustment of 6,9% • Number of employees increasing by 3,1% • An extra scenario, the effect of a 15 per cent increase in civil service remuneration (rather than 6,9 per cent) for 2015 to 2017 , is also shown in the result below FISCAL POSITION

17. RESULTS

18. This analysis still shows a fiscal cliff approaching, but further in the distance as in earlier research • It is therefore necessary to contain growth in civil service employment and ideally the size of Cabinet should be reduced to help in achieving this objective • There is no scope to increase civil service remuneration by more than the rate of inflation plus 1 percentage point FISCAL CLIFF AVERTED?

19. Government’s revenue needs The 2014 MTBPS reports that government requires spending cuts of R25bn and additional revenue of R44 bn in the period to 2017/18 It is not stated whether these are nominal or real amounts Adjusted for inflation over the three fiscal years, the funding need increases considerably (assuming an inflation rate of 6 per cent per annum): R12,4 billion (rather than R12 billion) in 2015/16, R16,4 billion (rather than R15 billion) in 2016/17 and R19,7 billion (rather than R17 billion) in 2017/18. The total funding need then amounts to R48,5 billion, rather than R44 billion as stated. This implies new and additional taxes to raise the revenue Opportunities for increasing revenue is very limited

20. Government revenue by source 2014/15 – Fiscal year * Specific plus Ad valorem excise duties ** Balancing Item Source: 2014 Budget Review: 132

21. RAISING REVENUE The three main sources of tax revenue are personal income tax, company tax and value-added tax (VAT), which should therefore be the focus of a revenue-raising exercise, but other sources can also make a contribution In the calculation of an increased tax burden a 10 per cent elasticity in the reduction of the tax base owing to the increased tax burden is assumed. Examples of reductions are people working less in response to higher income tax, people driving less in response to increased fuel prices and people spending less in response to increased VAT rates. Possibilities: The introduction of two additional marginal tax brackets: 45 per cent for taxable income above R1 million per annum and 50 per cent for taxable income above R2 million per annum Increases around 10 per cent in other main revenue sources as highlighted below The exception is customs duties: Practically the whole amount collected is paid to Botswana, Lesotho, Namibia and Swaziland, South Africa’s partners in the Southern African Customs Union (SACU) Given South Africa’s own fiscal needs, it is clear that this subsidisation of South Africa’s SACU partners can no longer be afforded

22. Marginal tax rate structure with two proposed extrabrackets (assessment 2014/15) Tax Rebates Primary R12 726 Secondary R7 110 (persons 65 and older) Tertiary R2 367 (persons 75 and older) Source: National Treasury, own calculations

23. Adjusted government revenue by revenue source *Specific plus Ad valorem excise duties. **Balancing item Source: 2014 Budget Review: 132, own calculations

24. FINAL REMARKS AND CONCLUSIONS A fiscal cliff has not yet been averted but is further in the distance than in 2012 It is necessary to contain growth in civil service employment and ideally the size of Cabinet should be reduced to assist in limiting expenditure Limiting government expenditure is preferable to the raising of taxes in an effort to avert a fiscal cliff There is no scope to increase civil service remuneration by more than the rate of inflation plus 1 percentage point. An increase of 15 per cent can simply not be afforded as it will push South Africa over the fiscal cliff The room for raising extra income through increased taxation is very limited An additional tax burden will impact negatively on the economy’s growth performance

25. FINAL REMARKS AND CONCLUSIONS Practically the whole amount collected as customs duties is paid to Botswana, Lesotho, Namibia and Swaziland, South Africa’s partners in the Southern African Customs Union (SACU) Given South Africa’s own fiscal needs, it is clear that this subsidisation of South Africa’s SACU partners can no longer be afforded The 2014 MTBPS indicates that government has taken notice of the nearing fiscal cliff identified by Rossouw, Joubert and Breytenbach (2014) The implication is clear: South Africa must limit the size and growth of its civil service and ideally reduce the size of its Cabinet if it wants to avert a fiscal cliff

26. Questions/discussion Selected References: Breytenbach, A. & Rossouw, J. 2013. ’n Ontleding van vergoedingsneigings in die Suid-Afrikaansestaatsdiens, 2005 tot 2012. TydskrifvirGeesteswetenskappe. Jaargang 53:4. Desember. pp.635-650 BusinessDay. 2014. “Gauteng education MEC mootsexemption of teachersfromincometax”. Availableon: http://www.salabournews.co.za/index.php/component/content/article/70-labour-news/18780-gauteng-education-mec-moots-exemption-of-teachers-from-income-tax.html. [Downloaded on: 14 July 2014] Rapport. 2014. 11 Mei Republic of South Africa. 2014. Budget Review 2014. National Treasury: Pretoria Republic of South Africa. 2014. Estimates of National Expenditure 2014. 26 February. Republic of South Africa. National Treasury: Pretoria Republic of South Africa. 2013. 2013 Budget Speech. Minister of Finance (MrPravinGordhan). 27 February 2013 Rossouw, J., Joubert, S. J. & Breytenbach, A. 2014. Suid-Afrika se fiskaleafgrond: '’n Blik op die aanwending van owerheidshulpbronne. TydskrifvirGeesteswetenskappe, Jaargang 54 No. 1: Maart. pp. 144-162 SA Reserve Bank: Various sources