Budget Challenges III: Revenue And Expenditure

Introduction

The starting point for a discussion of Budget revenue and expenditure options is the October 2018 Medium Term Budget Policy Statement, covering the fiscal years from 2018/19 to 2021/22. Salient features of the MTBPS are presented in the Appendix, from which a number of points can be made. Line numbers in the text refer to the Appendix.

1. Low growth[1]. The MTBPS projects real annual growth of 0.9% per annum from 2018 to 2021. The IMF projects it a 0.1%. In current prices, GDP growth between 2018/19 and 2021/22 rises by 7.6% per annum in the MTBPS and 7.1% according to the IMF.
   
   In order to attract investments and ignite growth, the IMF advocates structural reforms through increased competition in product markets, greater labour market flexibility, addressing skill shortages, tackling corruption and leveraging digitization. But the likelihood of major structural reforms in an election year is unlikely.[2]
   
   Also highlighted was the need for greater policy certainty.[3] According to the IMF, corruption has consistently ranked as one of the top factors deterring investment, and that proper implementation of the Public Finance Management Act would prove a substantial deterrence against corruption.[4] Studies show that a 10 point improvement in a country’s corruption perception index can increase GDP growth per capita by around 1 percent. South Africa’s currently scores 43 – just below the word average of 44.3.[5]
   
   
2. Taxation[6]. Aggregate taxation is projected to rise by 8.3% per annum over the MTBPS, faster than nominal GDP. The highest increases are in personal income taxes and VAT. We expect that there will again only be partial adjustment of income tax rates to counteract bracket creep this year. The VAT projection implies another rate increase by 2021/22, but given the furore over the VAT rate increase last year and the coming election, we do not expect a rate increase this year. Equally, we do not expect a cut in the VAT rate, though an expansion of zero-rated goods will be a possible sop. The government dare not raise the corporate income tax rate while the economy remains weak, and growth from this revenue source is projected to grow more slowly than nominal GDP.
   
   Revenue collection has declined over the past four years. Higher than expected VAT refunds has caused tax revenue projections to be revised down by R27.4 billion in 2018/19, R24.7 billion in 2019/20 and R33 billion in 2020/21 relative to the 2018 Budget. Revenue collections in 2017/18 were R0.8 billion lower than estimated in the 2018 Budget. However, revenue collection for the first half of 2018/19 grew by 10.7 per cent compared with the same period last year, but the technical recession experienced in the first half of the year has negative effect on revenue collection, which decreased.
   
   Treasury noted weak economic growth and a once-off payment of overdue VAT refunds, leading to an in-year revenue shortfall now estimated at R27.4 billion, relative to the 2018 Budget estimate. Net VAT collections account for about R20 billion of the in-year revenue shortfall. However, two factors that influenced the revision in net VAT are: The VAT refund estimate has been revised upwards by R9 billion, and about R11 billion will be paid out to clear the accumulation in the VAT credit book (We also note that the accumulation is due to VAT refund that could have been paid). The Davis Tax Committee’s observed that the drop in revenue resulted from past detrimental personnel and policy changes at SARS, culminating in poor compliance by high net worth individuals and multinationals. There were concerns around declining tax morality as a result of unimproved public services. There is room for improved tax administration to reduce profit shifting and transfer pricing.[7]
   
   
3. The pattern of government spending[8]. Non-interest government expenditure is projected to rise by 7.4% per annum, which falls between the Treasury’s and the IMF’s nominal GDP growth projections. Total expenditure on social programmes, running at just above 60% of total non-interest expenditure is projected to rise faster than other non-interest expenditure. Expenditure on post-school education, the only regressive[9] component of social spending rises the fastest. Real per capita expenditure on peace and security and general public service is projected to drop. Real per capita expenditure on economic development is projected to remain constant.
   
   The budget allocations made over the Medium-Term Expenditure Framework period provide an agreed-upon upper limit within which departments prepare their budgets. The ceiling for the current year and the next two years remains unchanged from the 2018 Budget, but in-year adjustments provides an additional R17.4 billion to spending, which includes recapitalisation of South African Airways (R5 billion) and the South African Post Office (R2.9 billion). South African Express Airways receives funding amounting to R1.2 billion. Funding is also allocated to drought relief and education infrastructure. These additions to spending are fully offset by the use of the contingency reserve, provisional allocations, projected underspending and declared unspent funds.
   
   In order to ensure the expenditure ceiling remains unchanged, and to support policy priorities, Treasury reprioritised some baselines by a total of R32.4 billion over the next three years, stating that funding of non-performing and under-performing areas has been reallocated, baselines have been reduced, the contingency reserve has been drawn down and provisional allocations have been adjusted. Reprioritised resources are said to be in line with the economic stimulus and recovery plan proposed by the President, and some non-discretionary and infrastructure spending pressures. In addition, R14.7 billion has been shifted within grants for upgrading informal settlements. The IMF however argues that the expenditure ceiling should not remain unchanged and instead decreased given the lower than previously expected GDP growth rates.
   
   
4. Public debt[10]. Gross public debt is projected to rise from 55.8% of GDP in 2018/19 to 58.5% in 2021/22. We think that parastatal bailouts will lead to a more rapid increase, with some materialising in 2019/20. The government plans to fund just over three quarters of its borrowing requirement by issue long term domestic bonds.
   
   The main budget deficit for 2018/19 is expected to increase to 4.3 per cent of GDP in comparison to the 2018 Budget estimate of 3.8 percent; primarily due to fall in tax revenue and an increase in expenditure, but also Southern African Customs Union transfers. In the MTBPS, Treasury predicted the primary balance (that is the difference between revenue and non-interest spending) to narrow to 0.2 percent of GDP over the next two years.
   
   The consolidated budget deficit (which includes the main budget and expenditure financed from revenues raised by provinces, social security funds and public entities) is estimated at 4 per cent in 2018/19, in comparison to the 2018 Budget that had a lower projection of 3.6 per cent of GDP. The deficit rises to 4.2 per cent, and then stabilises at 4 per cent in the outer year. The consolidated budget deficit is expected to be 0.6 per cent larger than the 2018 budget estimates over the next two years.
   
   With public debt doubling in the last decade, expenditure flexibility has become limited reducing government’s capacity to smooth business cycles and react to temporary shocks. Debt service costs have seen a six-fold increase over the last decade and is expected to exceed 2018 Budget estimates by R1 billion in 2018/19, R4.9 billion in 2019/20 and R7.9 billion in 2020/21. An estimated 15.1 per cent of the main budget revenue will be used to service debt in the next three years compared with 13.9 per cent in 2018/19.The MTBPS expects the national debt/GDP is to stabilise at 59.6 percent of GDP in 2023/24. In order to stabilize debt at sustainable levels, the IMF points to wage savings in the public sector as the priority, complimented by better targeted education subsidies, SOE downsizing and eliminating irregular and wasteful expenditure. The poor financial position of state owned enterprises is likely to put pressure on the budget over the medium-term. South African Airways and South African Post Office received about R8 billion in bailouts in 2018/19. Default risk, if not addressed, could result in ratings downgrades and an increase in debt service costs.
   
   
5. The public sector wage bill[11]. The public sector wage bill ran at 58.1% of all current payments by the government in 2017/18, having risen from 53.7% in 2006/07. It is projected to grow a little faster than nominal GDP, but its share of current payments is projected to fall slightly. The main driver of increased spending has been large increases in wages and other employee benefits, rather than increases in employment, which has actually declined since 2012/13. The 2018 public-service wage agreement exceeds budgeted baselines by about R30.2 billion through 2020/21. Of the R30.2 billion shortfall across national and provincial government departments, the largest gaps are in defence, the police, provincial health and provincial education. Departments need to fund shortfalls by adjusting within their compensation baselines. This means increasing efficiency, and carefully managing overtime and performance incentives. Stern words, but undermined by the unwillingness of government to hold the line in wage negotiations, and the tendency for inefficiently unspent capital funds to find their way into personnel budgets.

Conclusion

We have become so used to unexpected bombshells from the government over the past few years, that it is hard to imagine that some will not appear in the budget. We are braced for ESKOM, but there may well be surprises coming as well. The government will have to manage these, while trying not to offend any part of its constituency, or alarm investors. We shall see on Budget Day how well they intend to navigate between the various hazards.

Agathe Fonkam
Researcher
agathe@hsf.org.za

Charles Simkins
Head of Research
charles@hsf.org.za