2018 Budget: Parliamentary Budget Office & FFC briefing

Meeting report

Ms Phosa welcomed everyone and noted that following the tabling of the 2018 Budget during the previous week, together with the pre-Budget briefing by the Parliamentary Budget Office (PBO) and the post-Budget briefing by the Minister of Finance, the Joint Committee was now in the midst of the legislative process of considering and adopting the Budget as part of Parliament’s mandate as enshrined in the Constitution. There were formidable challenges such as low economic growth and the precarious position of State-Owned Entities which had to be engaged upon.

Financial and Fiscal Commission presentation

Dr Daniel Plaatjies, Chairperson: Financial and Fiscal Commission (FFC), took the Joint Committee through a presentation on 2018 fiscal framework and revenue proposals. Three key factors had predominantly shaped the 2018 fiscal framework, namely: muted economic growth outlook, anticipation of a significant revenue shortfall (amounting to R48.2 billion in 2017/18) which had negatively affected the budget deficit, and the post-Medium Term Budget Policy Statement (MTBP) announcement of fee-free higher education and training for households earning below R350 000. Together these factors had precipitated the need for expenditure cuts, a revision and reprioritisation of spending plans and adjustment of the state’s tax instruments. A key risk to address from the Commission’s perspective was threat to the stability of the fiscal system as an unstable fiscal framework compromises subnational governments.

Dr Ramos Mabugu, Director for Research: FFC, outlined the 2018 economic outlook. He indicated that improved sentiment around the country’s growth prospects was expected to boost 2018 real GDP by 0.4%, higher than anticipated in the October 2017 mid-term budget. While welcomed, growth prospects remained muted in face of positive developments in global economy. Although there were improvements in commodity prices and notably strong recovery of agricultural sector, South Africa remained unable to leverage on inter-linkages with growing global economy. Slow growth will see South Africa lagging behind its emerging market peers. There were various underlying constraints to growth. These include rigidities hindering export growth due to lack of committed implementation of policies aimed at addressing key competitiveness factors; consumption weakness owing to domestic demand that was insufficient to pick up slack in external demand; and declining domestic savings slowing which are too low to finance additional investment as households and government spend more than their income.

National government debt remained higher than average. By the end of the 2018 Medium-Term Expenditure Framework (MTEF) period, net loan debt will reach R3.03 trillion which translated into 52.2% of GDP. Whilst domestic loans comprise 90% of total loan debt, the main driver of growth were foreign-denominated loans which were set to grow by a real annual average of 6.6% over 2018 MTEF. Within the domestic loans category: long-term loans dominate whilst the inflation-linked loans were the fastest growing and projected to grow by real annual average of 6.3% over the same period. Unemployment also remained high as growth in wages outpace productivity. Economic growth remained too low to generate sufficient employment opportunities. Job creation was significantly outpaced by the expansion of the labour force. Also, relatively high living costs, skills shortages and a unionised workers biased collective bargaining system meant that wages are growing faster than productivity in many sectors. A higher wage meant that unit cost of labour was also high thus impacting negatively on employment.

Mr Ghalieb Dawood, Program Manager: Provincial Budget Analysis Unit, FFC, gave an overview of 2018 fiscal framework. Revenue was expected to show strong real growth of 4.5% in 2018/19, before evening out to 2.3% in 2019/20 and 2.2% in 2020/21. On the expenditure side, the driver of growth was debt service costs which were set to grow by a real annual average of 4.6% over the 2018 MTEF period – considerably higher than the 1.7% real annual average growth projected for non-interest expenditure (which comprises funding for the three spheres). Poor revenue collection performance, resulted in widening of deficit to 4.3% of GDP in 2017/18, significantly overshooting 2017 Budget projections of a 3.1% of GDP deficit. 2018 Budget suggested a stronger emphasis on fiscal consolidation efforts that should see narrowing of the deficit through reigning in of expenditure and tax policy adjustments.

On division of revenue amongst the three spheres which was characterised by muted growth increases over 2018 MTEF, the Commission welcomed real growth in the equitable share allocation to provinces and especially municipalities. However, conditional grant allocations to provinces and municipalities will bear the brunt of government’s need to cut and reprioritise spending. The Commission welcomed concerted efforts to balance the budget through consolidation. It was of concern that capital spending bears a disproportionate burden of consolidation. It accounted for 47 % of expenditure cuts. Capital spending cuts are detrimental to future growth and result in project implementation delays. He emphasized that cuts should be carried out with national developmental goals in mind – particularly unlocking capacity constraints in local economies.

Despite overall real increases in respect of provincial conditional grants and the Provincial Equitable Share (PES) over the 2018 MTEF, significant reductions had been implemented. Over the 2018 MTEF period reductions in both the PES and conditional grants amount to R18.3 billion. Major reductions were in the human settlement, education and health sector – cuts in provincial conditional grants are inconsistent with spending performance. Local government was relatively cushioned from consolidation with expenditure cuts targeted at conditional grants only. The largest cuts will be experienced by four grants: Municipal Infrastructure Grant (MIG), Public Transport Network grant, Integrated National Electrification Programme (INEP) and the Urban Settlement Development Grant (USDG). The four grants account for 93% of total municipal grant reductions over the 2018 MTEF.

Tax buoyance was falling in tandem with slippage in compliance. Tax buoyancy has fallen from a peak of 1.37 in 2014/15 to 1.07 in 2016/17, reflecting that sluggish growth was impacting negatively on tax performance. Tax statistics on assessed data for individual taxpayers showed that percentage of taxpayers that actually submitted their tax returns against taxpayers liable to submit tax returns is declining, implying a slippage in compliance. The tax proposals had several implications. Proposed revenue measures were expected to raise R36 billion in 2018/19 with the largest contribution being R22.9 billion from the one percentage point increase in VAT.

The Commission supports the increase in VAT based on two reasons. Firstly, the Commission had published research demonstrating that a promising avenue for tax change was higher consumption taxes coexisting with a progressive income tax system, combined with more welfare transfers. Secondly, the potential for poverty reduction was more pronounced when VAT revenues are recycled through pro-poor allocations on the expenditure side of the budget to increase the social wage (e.g. through social grants). This would cushion the impact of a VAT increase on low income groups, along with a continued regime of zero rating which was, by and large, well-targeted.

The FFC agreed that the 2018 Budget was crafted under difficult circumstances where government had to balance the funding of expanding policy commitments whilst trying to plug revenue shortfall. The less than ideal sluggish current growth rates meant that significant structural measures were required to narrow the budget deficit, and stabilize the debt-to-GDP ratio over the medium term, while cushioning the negative effects on the poor and funding new priorities such as free higher education. These had come in the form significant tax increases as well as deep expenditure cuts. Unpalatable choices (such as significant increases in personal income tax, corporate income tax and VAT) could no longer be deferred. The crucial point was that these measures should not be seen as once off, but recurring into the foreseeable future as pressures from funding priorities such as free education will not be once off but increase into the future as the program is rolled consecutively into future years. Overall, the cuts to conditional grants and increases in taxes would exert a negative effect on economic growth.

In terms of reigning in expenditure, government had opted to maintaining real increases in equitable share allocations whilst infrastructure-related conditional grants to provinces and specifically, municipalities, had been sacrificed. The rationale or principles underpinning expenditure cuts to conditional grants, especially local government conditional grants, needed to be refined. Cuts seem to be targeted at bigger grants (in terms of value) while ignoring some of the more widely accepted assessment criteria such as historic performance of the grant or contribution to development thrust (growth, poverty or employment impact) of the country. Grants such as the USDG, the Public Transport Network Grant and MIG have been reduced by large proportions despite their relatively good spending performance. While the need for cuts and reprioritisation within the current environment was understood, it was important to note that conditional grants have been key in the funding and provision of infrastructure and reduction of infrastructure backlogs in provinces and municipalities. The disproportionate cutting of these infrastructure-related funding instruments means designing a plan to reprioritise them in coming years need to be put in place simultaneously. Robust economic growth was likely to be the only guarantor of medium to long term fiscal sustainability. In the short term, efforts should focus on restoring confidence, balancing fiscal and political sustainability as this would enable the country to capitalise on the global economic upswing.

Discussion

Ms S Shope- Sithole (ANC) noted that the FFC had highlighted the need for cost-cutting measures. She asked what could be done to also cut costs in the judicial and legislative arms of government. Focus was only dedicated to the executive. For instance, moving Parliament to a central point and thereby cutting traveling costs had to be considered.

Mr A Lees (DA) sought clarity about FFC’s analysis on the forecasted economic growth rate. It seemed to be way much higher than the 2017 MTBPS projections. He commented on the proposed VAT increase. No matter how much spin was put into it, a VAT increase would hurt the poor. There were surely more options available, and one such would be robust government expenditure cuts.  FFC had to be critical in exploring these options.

Mr A Shaik- Emam (NFP) noted the perception that having zero-rated goods as a way of mitigating VAT increases was good enough. It was not. He emphasized the need for cost cutting measures such as having a moratorium on all government travel expenses among other excesses. There was need to tighten up in all spheres. He suggested reducing government spending by adopting a two-tier system as most of the structures were duplicated. About R200 billion was being lost every year in the current system. There was need for radical and bold steps to streamline the use of scarce resources. He asked about the impact of minimum wage adjustments to labour costs, competitiveness and employment.

Mr F Essack (DA) noted the implementation of fiscal consolidation by government. He felt provincial spending cuts were going to fuel further social unrest. What was to be done to streamline expenditure at local government level without compromising service delivery?

Mr O Terblanche (DA) said the seriousness of the economic situation had to be well understood. He however expressed concern about the reduction of capital expenditures. These were the very areas which could stimulate the economy.

Ms T Tobias (ANC) asked at what point the issue of compensation and wages was going to be discussed. This was a burning point of contention between unions and government. She asked for a comprehensive analysis on the possible impact of the proposed VAT increase and cuts in provincial grants. The possibility of subsidizing VAT paid by consumers for electricity and water services had to be explored as it would benefit the poor directly. She asked for suggestions on how the South African Revenue Service (SARS) could meet its revenue targets without withholding refunds as suggested by the Tax Ombud’s recent report.

Mr M Monakedi (ANC) noted that not much emphasis had been given on the need for accountability. Accountability was the starting point for improving revenue management. Also, nothing had been said about skills development as a means of increasing productivity towards economic growth. He asked whether the VAT increase would have any negative impact on the poor if the zero-rated list was to be expanded.

Mr D Hanekom (ANC) said the budget as presented was an excellent piece of work. However, there was scope for increasing the number of zero-rated items as a means of reducing its negative impact on the poor. The increase had to be minimally regressive; if at all regressive.

Mr De Beer noted that nothing had been said about the Auditor-General’s findings on irregular, fruitless and wasteful expenditure within departments. He reiterated the call to expand the zero-rated basket.

Mr Carrim asked what could be done to reduce the negative effects of the VAT increase on the poor and low-income earners. If such measures were effected, how would it be ensured that they are not equally enjoyed by high-income earners? In theory, if the VAT increase was not to be given a go-ahead, were there other alternatives that could yield equal sums of revenue? Why was adopting a VAT multi-rating system not feasible? Were there additional goods which could possibly be exempted? He suggested that the responses be forwarded to the Joint Committee in writing preferably on the next day.

Mr Dawood, in response, said that there was need for conversations on the size and shape of the public service- from national down to local government level. Productivity was a sectorial issue and it was incumbent on Parliament to discuss how these choices impact on appropriations and resource allocations. He indicated that FFC welcomed the announcement on the restructuring of SOEs, towards fiscal sustainability and economic viability. Also, there was need to review the government guarantee system especially in terms of the repayment modalities and its fiscal sustainability. The economic imperatives and developmental orientated objectives of the SOEs had to be clear.

Dr Mabugu commented on the seemingly inflated growth forecasts. FFC did its forecasts based on short-term economic conditions. However, the recent rebound in confidence was expected to improve the forecasts and, in a big way, explained the difference between the current and 2017 MTBPS forecasts. On the VAT increase, the tax should not be viewed in isolation. There was little room to maneuver on other forms of taxes and FFC research showed that a VAT increase would have the least impact on economic growth. He echoed the need to curb illicit financial flows.

Parliamentary Budget Office presentation

Prof Mohammed Jahed, Director: PBO, highlighted the struggle to balance between the country’s service delivery needs, and the need to manage government’s finances. He noted that pre-Budget discussions focused on the progress with policy implementation and the implementation of the 2017 Budget as at 31 December 2017 whereas the post-Budget presentation focused on the response of government to policy, social, economic and fiscal developments since the 2017 main Budget and MTBPS. It also identified concerns and risks for further consideration.

The PBO noted that VAT increase had various potential effects. Research had shown that VAT increase changes consumption patterns. According to Davis Tax Commission (DTC), increase in VAT was more inflationary (short term) compared to hikes in personal income tax (PIT) and corporate income tax (CIT). Increase in VAT leads to slow growth and may increase unemployment, though effects are better compared to increase in PIT and CIT. Overall, VAT would have a greater negative impact on inequality than an increase in PIT or CIT. VAT and other consumption related tax increases were also likely to exaggerate wage bill negotiations, thereby leading to higher than inflation settlements. However, increases in VAT were mitigated by increases in social grants. Fuel taxes had also been found to be regressive as transport costs form a larger share of poorer households’ expenditure due to spatial legacies which increase travel costs for poorer households. By and large, payers of fuel taxes were not always direct beneficiaries. Hence, fuel taxes were less effective at raising revenue. A viable alternative would need to be found in the future.

Expenditure concerns identified included efficiency and effectiveness concerns which undermined the budget-planning process; claims against government including health (medical negligence); duplication of functions; increasing wage bill; and infrastructure spending and reporting. Domestic levels of employment, investment and economic growth could be constrained by: continued high levels of household and corporate debt; allocation of finance to financial and offshore markets; pending support for higher education students from poor households which may not be as effective as hoped for; the financial and operational health of SOEs; effects of drought; and effectiveness of the revenue collection agency.

Discussion

Mr De Beer commented that efficiency and effectiveness in carrying out government programs was key. For instance, the rollout and implementation of the drought relief program was too slow. Such administrative processes must be shortened.  

Ms Shope- Sithole reiterated her call to move Parliament to a central location. She asked the PBO to conduct some studies on the feasibility of moving the Houses to the administrative capital, Pretoria.

Mr M Kwankwa (UDM) said there might be a need to carry out research on a multi-tiered VAT system. He asked if the PBO had considered the impact of the VAT increase on industrial relations. The increase would impact productivity and investor sentiment in the event that labour goes up in arms and resists the move.

Mr Carrim identified the need for expert opinion on the implementation of proposed VAT increase. There was a view that the one percent price increase as a result of the VAT hike was not regressive. Even though some Members were skeptical, there was need for clarity. He implored stakeholders to do further research, the outcomes of which would be incorporated in the Joint Committee’s fiscal framework report.

Dr Dumisani Jantjies, Director: Finance, PBO, said having a multi-tiered VAT system would be a challenge. He agreed with the FFC that the tax system should be analysed holistically rather than considering one tax in isolation. The VAT question was an empirical one which needed to be further investigated. He welcomed the suggestion that comprehensive responses be furnished to the Joint Committee in writing.

The meeting was adjourned.