RISING TAXES ARE COMING
Author: Barbara Curson
With a yawning deficit in government revenue, it seems inevitable that government will raise taxes. But how can this be done efficiently and fairly? Our article provides a background and proposes some scenarios.
Like The revised budget deficit for 2020/21 is expected to be R761.1 billion. Government is confident that it only needs to raise R5 billion from additional taxes, and the rest of the budget will be funded by cutting expenditure, mainly by cutting wages in the public sector. However, the unions are fighting back.
If government does not manage to cut wages in the public sector, the cash situation will be dire. Taking into account the current economic situation and the expected revenue situation, government will be left with two options: raising debt or raising taxes. More debt will risk strangling the economy with the heavy burden of paying finance costs.
2020 Medium-Term Budget Policy Statement
The South African economy is expected to contract by 7.8% in real terms in 2020. This had a negative impact on the revised budget deficit, which has ballooned to 15.75% of GDP (R761.1 billion). South Africa now has the largest debt-to-GDP ratio in the emerging economies, which is forecast to reach R4 trillion (81.80%) in 2020/21. GDP for 2020 is expected to be between -7.0% and -7.5%. The economy is only expected to recover to 2019 levels in 2024.
However, government is confident that a combination of expenditure and revenue measures will narrow the consolidated deficit from 15.7% of GDP in 2020/21 to 7.3% by 2023/24. Gross national debt is projected to stabilise at 95.3% of GDP by 2025/26.
The key factors affecting in-year revenue collection include the loss of salaries and wages under the lockdown, less VAT and customs duty resulting from reduction in imports, a drop in VAT due to less consumption, less excise duties resulting from a tobacco ban and stronger than expected corporate profitability.
In the broader public sector, several state-owned companies and municipalities have insufficient funds to cover operational expenses. Several state-owned companies have issued promissory notes and bonds, and there is a risk that interest payments may be defaulted. Lenders have called the guarantees of South African Express and the Land Bank, with a negligible effect on the fiscal framework. Larger calls on guaranteed debt are expected unless steps are taken to turn around the most indebted state-owned companies.
The Medium-Term Budget Policy Statement advised that revenue proposals to be announced in the 2021 Budget will amount to R5 billion in 2021/22, R10 billion in 2022/23 and R10 billion in 2023/24.
Government has proposed a five-year fiscal consolidation to narrow the budget deficit and stabilise government debt; expenditure will be cut, and zero based budgeting will be introduced in state-owned entities and municipalities.
Contingent liabilities
The Medium-Term Budget Policy Statement has forecast contingent liabilities to exceed R1 trillion by 2022/23. These liabilities comprise government guarantees to state-owned companies, the Renewable Energy Independent Power Producer Programme, public-private partnerships (PPPs), and obligations to the Road Accident Fund and other social security funds. Government?s guarantees have increased from R680 billion in March 2019 to R693.7 billion in March 2020, and R583.8 billion has already been used. Eskom has been granted a facility of R350 billion.
Guaranteed debt redemptions are expected to average R35.6 billion over the next three years.
Unemployment risk
The unemployment risk has not been mentioned. In a population of 59.6 million, with a labour force of 18.4 million, only 14.1 million workers are employed.
This is unsustainable. Apart from the drop in tax revenue with the loss of some 4 million jobs, 45.5 million people have to be provided for.
The hollowing out of SARS
SARS lacks the capacity and skills to go after the so-called big ticket items. Illicit tobacco trading is rampant. Complex tax cases take many years to get through the courts. Even if SARS has a current pipeline of large complex tax cases, such as transfer pricing, tax avoidance schemes and VAT schemes, it may take three to four years to resolve these matters in a court.
SARS requires the funds to upskill.
The taxing conundrum
In South Africa, as elsewhere in the world, the COVID-19 pandemic has exposed inequality. The pandemic was particularly hard on those with lower incomes, and devastating for those in the informal sector.
It has also created a huge fiscal hole, which has not bottomed out.
In my view, government will be forced to raise more than R5 billion in additional taxes in the 2021 budget. How then will they raise the additional tax revenue?
Below are some possibilities.
Increases of the excise duties on alcohol and tobacco
There is an argument that further increases in excise duties on alcohol and tobacco stimulate the illicit tobacco trade. The local legal tobacco industry also has to recover from the COVID-19 depression and the impact of the ban on tobacco sales, and claw back market lost to illicit tobacco sellers.
The current tobacco stamp is not effective in curtailing the illicit tobacco trade.
Government has not yet ratified the World Health Organisation’s Protocol to Eliminate Illicit Trade in Tobacco Products. It, however, started amending the Custom and Excise Act in 2016 to provide for the marking, tracking and tracing of tobacco products, which should restrict illicit trade. Meanwhile, SARS cancelled the tender bid for a track and trace system.
National Treasury will explore the Minimum Retail Selling Price (MPL) concept for tobacco, where it will be illegal to sell a packet of tobacco at below the amount of excise tax that would have been paid on the packet.
The so-called sin taxes will no doubt again be increased, but it is hoped that SARS steps up its efforts in curtailing the illicit tobacco trade.
VCC tax incentive
The venture capital company (VCC) tax regime was introduced to encourage the establishment and growth of small, medium and micro-enterprises (SMMEs), while creating jobs and addressing inequality. Government is reviewing both the impact of the tax incentive and its possible structural shortcomings. Currently, the sunset clause of June 2021 for the VCC tax incentive remains in place. Government is, however, reviewing the incentive. It is possible that changes to the incentive will be made in 2020/21.
Wealth taxes
?Wealth? is a dangling carrot that many countries have attempted to tax, with little success.
Cynically, placing the wealthy ? the apparent 10% ? in the spotlight is a tried and tested tactic to divert the attention away from unsolvable issues. Therefore, unsurprisingly, talk of a wealth tax has resurfaced.
South Africa already has wealth taxes in the form of transfer duty, estate duty and donations tax. Home owners and land owners already pay rates and taxes on the property valuation (and these valuations are often disputed). There are many policy considerations, such as defining wealth, the threshold level, determining the amount that can be taxed and deciding on an artificial point in time to determine wealth. The exclusions will also have to be determined, such as an acceptable limit for a private residence. It would be unfair to exclude pension and retirement funds, as that would penalise those who have made their own retirement investments.
The pandemic highlights the illogicality of determining the value of shares and companies at a point in time. Consider the impact of the pandemic on valuations of shares and companies in March and April 2020. Within a couple of months, equity prices had recovered.
Would there be any compensation paid to a ?wealth taxpayer? if their wealth disappeared as a result of some calamity?
Will the rewards of introducing a wealth tax exceed the costs (the costs of administering the system as well as the compliance costs). A wealth tax may be complicated to administer: does SARS have the expertise? SARS will no doubt grapple with unpacking basic wealth structures, never mind the valuation of intellectual property, and locating wealth that has been ferreted away in blind trusts and shell companies around the world.
If wealth is to be taxed, taxpayers will divert their savings to other vehicles which will provide protection; there will be a greater incentive to enter into aggressive structures that will disguise wealth.
The drafting of the legislation will be difficult ? it may well be the straw that breaks the camel?s back.
One-off 5% wealth tax
The government could consider a one-off wealth tax, payable on the value of assets over a particular threshold, at a point in time. Certain assets could be excluded, such as a private home. This could even be payable in instalments.
Company tax losses
Government proposes broadening the corporate income tax base by restricting the offset of assessed losses carried forward to 80% of taxable income for years of assessment commencing on or after 1 January 2021.
There is a fine line between raising revenue and disincentivising investment.
At the Tax Indaba 2020 online discussion, Cliffe Dekker Hofmeyr director and national head of tax and exchange control Dr Emil Brincker said SARS and Treasury are in a difficult position. Taxpayers are barely surviving, and the little bit of income they have been making since lockdown should not be paid in tax but be invested back in the business. Brincker emphasised that ?we must do what we can to encourage investment?.
Private equity ? “carried interest” loophole
Carried interest, which is the share of profits over and above the management fees paid to the general partners of a private equity fund, is taxed as a capital gain. This has long been a contentious issue. Are private equity partners entrepreneurs who are taking risks and making a capital gain on their investments? Or are they actively leveraging their investments in a scheme of profit making?
In an environment where we are desperately short of tax revenue, this should be an easy problem for National Treasury to solve. It will also go a long way in taking away a special dispensation given to the wealthy. It will not bring in the billions that we need, though.
Levelling the capital gains tax
Levelling the capital gains tax rate to the average tax will be harsh, and will no doubt have unintended consequences. However, it will put an end to the many tax avoidance schemes that seek to arbitrage the differences between revenue and capital.
Other possibilities
Raising the sugar tax.
Raising VAT by 0.5% (excluding certain foodstuffs); the exclusion from VAT for foodstuffs should be widened.
Raising VAT by 2% on motor vehicles and sports cars that cost over R1.5 million.
Raising fuel taxes, which would be highly inflationary, and have a terrible impact on the poor.
Introduce a withholding tax on advertising paid to offshore companies.
Social contract
In my view government has broken the social contract, by which citizens will pay their fair share of tax because the government has their back. State-owned entities have overpaid their executives and squandered money, with no consequence. The Nugent Commission of Inquiry into Tax Administration and Governance by SARS, the Commission of Inquiry into allegations for impropriety regarding the Public Investment Corporation (the Mpati Commission) and the Commission of Inquiry into State Capture (the Zondo Commission) have opened the public?s eyes to extraordinary examples of state capture, corruption and malfeasance. The total cost to the state?s coffers is as yet unknown.
The question is: what is the cost of the pandemic, and what is the cost of state capture, corruption and malfeasance? Perhaps government should first claw back the cost of state capture, corruption and malfeasance from the perpetrators, before it attempts to pass the cost onto its citizens.
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This article first appeared on Jan/Feb 2021 edition of Taxtalk
