Budget 2020 Iceberg Ahead: Indecision Leads To Decision In Time

When an iceberg is spotted, the captain of the ship must make some very quick decisions which will have serious consequences. These decisions are informed by the distance from the iceberg, the speed of the ship, and the knowledge that the iceberg visible above the water is only a third of it. The rest cannot be seen but he needs to cater for it.

Any indecision by the captain to steer the ship away from the iceberg will lead to the ship hitting the iceberg. South Africa’s fiscal health is like such an iceberg, and our President as captain and our Finance Minister as his navigator need to make drastic decisions quickly with the knowledge that they can’t see the full iceberg but need to budget for it.

The tip of the iceberg is R326,6 billion and we need to reduce that figure to R0 to start reducing debt effectively. Concomitantly, the speed at which the debt increases equates to the speed of the ship. The iceberg under water remains, for example our imploding water infrastructure (including sewage and river systems), state debt guarantees that are becoming state debt, and imploding municipalities, the main income of which is from water and electricity, commodities which are being lost quickly.

SAICA’s main concern remains the continual increase in public expenditure in an economic environment that does not match its tax collections. Since 2008, debt was used as an interim measure to smooth over this difference, but soon after 2010 it became apparent that government did not have the fiscal discipline to match its reality. The economy was structurally faltering.

In the main, Budget 2020 does follow the same recipe as previous years by making nominal spending cuts and financing the difference through debt. We also do not see more measures in holding officials accountable for spending and also providing more value for spending. These remain a serious concern.

Two of the largest factors in our economic implosion remain unaddressed, namely a coherent policy framework (not just macroeconomic) and significant reduction in crime. The latter is even more important as you cannot implement policy and legislation changes that no one adheres to or many actively undermine. No small business, whether in retail, manufacturing or tourism, can survive in our crime-ridden country where you cannot connect goods and services to customers in all areas. No child can learn in an unsafe environment where schools are looted and destroyed, funds misappropriated, children robbed and murdered, all whilst living in the dark.

We require a proper, coherent plan in this regard across all of government, and a will to implement this.

In this regard, there are positive signs in Budget 2020 that the Minister and the President have started to listen and implement change which include:

Moving to a low-rate broad-based fiscal policy with enhanced tax simplicity. Ireland and New Zealand have both migrated from fiscal disaster in the 1980s to good and stable finances based on these principles.

Fairly burdening taxpayers. In this regard, we welcome no substantial tax increases.

Creating certainty and transparency in the macroeconomic framework. We hope that broad consultation will inform this.

Reducing borrowing costs by reducing debt. Although R156 billion over three years is too low, it is double the previous ‘austerity measures’.

Reducing the wage bill by R160 billion over three years is welcomed. In reality, this is less than a 10% reduction of the consolidated wage bill, with R37 billion already in next year. SAICA does hope that trade unions do constructively engage and participate, contrary to what has been happening at the SAA. SAICA also hopes that, structurally, the staffing in government is addressed and that agreement is reached with trade unions to implement a skills audit. (For example,, if we have five administrative assistances and one engineer, reducing the one engineer reduces the wage bill but does not structurally fix the problem.)

While government is definitely making more of the right sounds, looking at the again revised estimates for national expenditure and its R23,5 billion increase Moody’s does not appear to be convinced that South Africa has the fiscal discipline and political will to implement these plans.

In a research report on Thursday evening, the night after the Budget Speech was delivered, Moody’s noted that potential contingent liabilities from SOEs and uncertainty as to whether government could successfully negotiate with unions to reduce the public sector wage bill elevates risks to South Africa’s budget forecasts. Some economists are speculating that Moody’s will downgrade South Africa to ‘junk’ status either in March or November this year. Currently, Moody’s is the one rating agency that has kept South Africa just one notch above junk status.

National government should lead by example and SAICA has started analysing expenditure by ministry to determine where we are spending, what we are spending on, and are we getting value for money. This has provided some insights to these questions but does pose significant questions which we hope Parliament can also explore in the appropriations process.

Revenue collection

For various reasons, revenue collection in relation to estimates continues to decline.

The revenue collections shortfall increased to R63,3 billion compared to the 2019 Budget estimate of R52.5 billion – that is, an increase in the expected shortfall between October and now, by R10,8 billion. Total tax collections is estimated at around R1,4 trillion for the year.

National Treasury has attributed the shortfall to the following factors:

Weaker-than-expected economic growth affecting business profitability, wages and consumption, resulted in lower than estimated corporate and personal income tax collections as well as poor VAT collections due to reduced spending. These three taxes contribute 80% of total revenue collections.

Growth in VAT collections has stabilised following an initial increase as a result of the 1% increase in the VAT rate a couple of years ago. There has been an increase in payments of outstanding VAT refunds which SARS committed to in the prior year and this has also resulted in lower overall ‘collections’. It is concerning that as a result of the increased refund payments, there has been increasing incidents of fraudulent VAT claims. It is therefore expected that VAT refund payments will stabilise given the SARS audits and criminal investigations in respect of potential fraudulent claims.

Collections from dividends tax was lower than expected due to the economic recession experienced since 2018, resulting in lower corporate profits available for distribution.

Poor tax administration continues to be of concern and is also regarded as being a factor in lower than expected collections.

The ongoing revenue shortfalls as well as additional expenditure over the last few years have resulted in significant tax increases. It is notable that despite significant increases in tax rates over the last five years, the difference between expected and actual revenue collections just got larger as a result of the persistent slowdown in economic growth, as well as an ineffective SARS. For example, from a growth perspective − while the 2019 Budget forecast real economic growth in 2019 at 1,5%, the revised forecast is actually as low as 0,3%. Treasury has acknowledged that increasing tax rates in the current economic climate will therefore be counter-productive and is not envisaged in the 2020/21 Budget.

Tax proposals

In the short term, there is relief for individual taxpayers through an above-inflation increase in tax brackets and rebates − resulting in R2 billion relief in respect of personal income tax. This will be directly offset by collections in respect of indirect taxes − specifically carbon tax and the plastic bag levy.

Looking forward, there are plans to increase the overall tax base by reconsidering incentives currently available, restricting interest expenditure claimable by corporates, and restricting the use of assessed losses carried forward by corporates. Consideration will be given to decrease the corporate tax rate in time in order to encourage investment in South Africa and improve economic growth.

In addition to the above, the new SARS Commissioner has taken steps to revive this institution. Those who were implicated in the Nugent Commission have since left SARS and some of the senior SARS officials who were unfairly displaced are returning to their previous positions within SARS. For those who have been paying attention, you would have noted that there have also been increased efforts lately to re-capacitate SARS by filling other senior positions, many of which were left vacant over the last few years. It is believed that these efforts, in the medium term, will go a long way in improving overall revenue collections.

Although, as expected, no major changes are planned, the more significant tax proposals are noted below:

Above-inflation increase in the personal income tax brackets and rebates resulting in relief of R2 billion. The change in the primary rebate increases the tax-free threshold from R79 000 to R83 100 for taxpayers under 65 years old.

Below-inflation adjustments to the medical tax credits to contribute in some way towards funding the NHI in the medium term.

Limiting corporate interest deductions to combat base erosion and profit shifting as well as restricting the ability of companies to fully offset assessed losses from previous years against taxable income.

Increases of 25c per litre to the fuel levy which consists of a 16c per litre increase in the general fuel levy and a 9c per litre increase in the Road Accident Fund levy.

Increase in the annual contribution limit to tax-free savings accounts by R3 000, to R36 000, from 1 March 2020.

The carbon tax rate will increase by 5,6% for the 2020 calendar year. Accordingly, the carbon tax rate will increase from R120 per tonne of carbon dioxide equivalent to R127 per tonne of carbon dioxide equivalent.

Increase in excise duties on alcohol and tobacco by between 4,4% and 7,5%.. Also, government will introduce a new excise duty on heated tobacco products, to be taxed at a rate of 75% of the cigarette excise rate with immediate effect. A tax on e-cigarettes (for example vapes) is also being considered to take effect in 2021, in line with international trends.

The duty-free threshold on the purchase of a residential property will increase from R900 000 to R1 million to take into account inflation. The last time this was adjusted was in 2017.

The cap on the exemption of foreign remuneration earned by South African tax residents will increase to R1,25 million per year from 1 March 2020, when the amendment first takes effect. Given the increase in what has been termed ‘financial emigration’, steps will be taken to curb this practice from 2021.

Expenditure analysis

While there has always been a focus on increasing revenue collections, it is important to acknowledge that there is only so much that can be done in this regard, as can be seen from the results − the gap between actual collections and budgeted collections − and therefore the budget deficit − has grown larger and larger despite significant tax rate increases over the last five years.

For some time now, SAICA’s view has been that rather than focusing on increasing revenue collections, there should be a focus on reducing expenditure and managing debt.

The real challenge lies in reducing expenditure to such an extent as to make a big enough dent in the huge budget deficit. While there has been talk of the significantly high costs of compensation, fruitless and wasteful as well as irregular expenditure, this is really just the tip of the iceberg and one needs to look below the surface and analyse all costs to find some means of identifying what is unnecessary and how to reduce these. Of the R326,6 billion deficit,  a significant contributor is the debt servicing cost, which amounted to R205 billion in 2019/20 and is growing. Again, this is one of the ‘known’ high costs contributing to the deficit. What about the other expenses?

SAICA has started the process of analysing costs at a high level, considering whether these costs incurred are in fact necessary for the running of the particular ministry. We looked at some of the separately disclosed expenses and provide high-level insight on these below.

General concerns on data integrity

Based on our initial analysis, the following is apparent:

Data does not seem to tie up year on year and audited outcomes seem to change significantly each year − for example the audited outcome for 2015 in respect of certain expenses changed from the 2016 report to the 2019 report,  for the exact same financial year. Treasury should be indicating where audited numbers have changed and why these have been adjusted.

There are huge anomalies in the growth of specific expense line items which could be errors or could be correct. However, in most instances, no explanation is provided where there are large increases from one year to the next.

There is insufficient or no explanation as to spending on certain items and outcomes sought.

The numbers reported on are often difficult to analyse. For example, main budget consolidated at national/provincial and consolidated with listed entities do not have the same comparative detail to ensure that data sets can be compare consistently.

The cost incurred in respect of outside consultants, contractors and agencies over the last 12 years caught our attention due to the quantum of the costs. It is questionable as to why these costs are so high when compensation for full-time employees is also high. There seems to be a trend in that the ministries that are consistently incurring high costs in this regard are Environmental Affairs, Cooperative Governance and Traditional Affairs, and Correctional Services. More investigation is required to determine what these costs relate to and whether there is room to reduce these by capacitating the departments with full-time/permanent staff.

For example, the Environmental Affairs ministry, which has more than 400 employees, spends R4,3 billion on outsourcing, which means they could have employed 2 800 people at a salary of R1,5 million per annum. How could they get the human capacity needs so wrong, or did they?

The increase in legal fees, especially in the police, seems to be directly related to competence in performing duties. Why Rural Development, Defence and Military Veterans, and Correctional Services are on this list begs a few questions, for example what exactly is the role and scope of the State Law Advisor, whose website states:

‘MISSION: To provide reliable legal advice, representation, legislation and legislative drafting services to the State in a cost effective and efficient manner.’

National Treasury noted in a prior years that catering costs in respect of some departments need to be reviewed with a view to reducing expenditure in this area. Based on the analysis of the expenditure, it is unclear why departments such Police and Correctional Services are incurring significantly high catering costs. Basic Education, Water and Sanitation, and Environmental Affairs also make unseemly appearances.

Unfortunately, the reports year on year do not provide sufficient details as to what constitutes catering and whether this is used on staff or on other events. For one department the cost of catering per employee amounted to R30 000 a year and who exactly are they catering for? Worrying is that despite ‘austerity’ measures in place, a lot of these ministries show year on year increases or even continual growth.

The first of the above graphs reflect fleet costs for the Top 10 where one can easily see that the costs attributable to the Police Services significantly exceeds that of the other nine in the Top 10. The second graph shows fleet costs in respect of the lower nine of the Top 10 for this expense, making it easier to compare without the distortion caused by the Police minisry costs. The fleet costs for Police are significantly higher than the other departments and it appears that this department acquired a significant number of vehicles over the last four years. However,  in our view this may be justifiable given the focus on reducing crime. It is, however, questionable as to whether the increased fleet costs has led to higher police visibility and a reduction on crime. Crime continues to be a huge concern and one of the significant factors contributing to poor economic growth. Both from a compensation perspective and a fleet perspective, one would expect the Police Services to be more effective in reducing crime.

Anomalous is Defence and Military Veterans and why they would need to purchase so many normal vehicles given their mandate.

As identified in this year’s Budget, travel and subsistence needs to be addressed. Again Police and Defence lead this expenditure and understanding this is crucial. Basic Education and Environmental Affairs may have more difficulty to justify why they are on this list. However, Parliament itself  has not been blameless and travel and subsistence costs continue to grow.

The Minister of Finance noted that staff numbers are decreasing and will make up for the increased compensation. However, what we see is confirmation of stagnant or decreased staff numbers but another increase in the compensation cost − that is, staff wages are increasing faster than the saving from staff leaving. It also means they consume budget for vacancies.

Most of the annual reports note that the high average salary does not mean being overpaid but represents the level of skill. Parliament leads this Top 10. Further, how do we need more skilled people in Basic Education (8th) than in Higher Education (40th) given who they need to consult, manage and create learning environments for?

It is not only the total wage bill that is problematic. As indicated in last year’s Budget, compared to the private sector, public sector wages are overstated. At national level the average salary is R49 551 compared to the private sector at R22 358. What is also interesting is that in the quasi-private sector of Water and Electricity, average salaries are R44 491, 80% more than the rest of the private sector, but very close to the public sector average.

A lot more questions need to be asked regarding how our public sector in its current state can command such salaries and also guaranteed pension benefits. The latter means taxpayers not only incur exorbitant costs while public servants are employed, but will do so for their entire retirement as well where base salary is overstated.

Focus on improving tax administration

As noted in chapter 4 of the Budget Review, as with the prior year the challenges faced with respect to our tax administration contribute partly to poor revenue collection. We agree with the premise that improving collections hinges on capacitating and restoring the efficiency of SARS. SAICA has always maintained that such improvements may be more effective in raising revenue than further substantial tax increases and will go some way to improving taxpayer behaviour.

The Nugent Commission’s main finding is that the failings of SARS stem from a ‘massive failure of governance and integrity’ after the appointment of the entity’s previous Commissioner in 2014. Some of the recommendations made by Judge Nugent and reported on last year have since been implemented. For example, the new Commissioner was appointed last year and the Large Business Unit, which was a major source of tax collection, was reintroduced.

SARS is working on strengthening its IT team and IT systems and this is crucial for tax collection efforts.

The new SARS Commissioner is focusing on stabilising the organisation, re-establishing integrity and compliance functions, and restoring employee confidence and public trust. Revenue recovery plans include assistance from the re-established Davis Tax Committee to address tax leakages, customs fraud, trade mispricing and harmful tax practices, setting up a new centre focused on wealthy individuals who have complex tax arrangements and renewing the focus on illicit and criminal activity, including non-compliance of religious public-benefit organisations.

SARS is also in the process of reviewing its procurement processes. Contracts that did not represent value for money have not been renewed. A number of senior officials implicated by the Nugent Commission have left and experienced staff are returning to roles from which they had been displaced over the last few years. It is believed that strengthening SARS will take time, but will result in improved revenue collections in the years ahead.

Conclusion

The Minister of Finance (together with his team) has had a tough time coming up with suitable proposals in the face of the overwhelming iceberg that looms ahead. However, like the Minister said when he commenced his speech ‘The Aloe ferox survives and thrives when times are tough. It actually prefers less water. It wins even when it seems the odds are against it.’

We are hopeful that with coherent plans and the political will to implement them, South Africa will avoid the looming iceberg ahead and like the Aloe ferox, will thrive not despite of but because of the tough times.

AUTHOR | Somaya Khaki, Project Director: Tax and Pieter Faber, Senior Executive: Tax