OECD says SA must reform tax and VAT to limit debt fallout

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Interview with David Masondo in his office in the Cape Town Parliament in November 2019 Photo: ESA ALEXANDER/SUNDAY TIMES

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South Africa urgently needs to implement reforms to bring its debt-to-GDP ratio down to a more sustainable level, according to a survey by the Organization for Economic Co-operation and Development (OECD). The organization made several suggestions to revive the economy, increase revenue collection and reduce distortions.

Responding to the report, Deputy Finance Minister David Masondo said government finances were stretched as high debt levels persisted and were expected to stabilize at 75.1% of GDP by 2024. Masondo said added that interest rate costs were the fastest growing part of the budget, crowding out other crucial spending items.

He said:

Public finances reached an unsustainable position before the pandemic and are now overstretched. Failure to contain unsustainable debt and debt service costs will harm the country’s long-term economic prospects… It is for this reason that our government is focused on implementing structural reforms for growth while embarking on the path of stabilizing our debt.

“We recognize the importance of a sustainable fiscal position to manage the cost of borrowing. It is essential that we ensure that the cost of borrowing does not increase this burden further.

“Debt servicing costs limit our capacity and ability as a government to spend on essential social priorities and programs to mitigate the effects of the worst of the current crisis.”

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The country’s economy is expected to experience pre-pandemic growth levels by the end of this year, despite the risks surrounding the Russian-Ukrainian conflict which also pose a risk to global and national economic recovery. The OECD has predicted that the country’s economy will grow by 1.8% this year and 1.3% in 2023.

South Africa’s economy is expected to have contracted in the second quarter due to flooding in KwaZulu-Natal and massive power cuts in recent weeks. Economic growth has been supported by investment, commodity exports and household consumption, which has also hit 30-year lows.

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Household spending should continue to be stimulated by public transfers to low-income people. However, rising inflation is eating away at household disposable income. Inflation hit a new 13-year high in July, climbing to 7.8%. Core inflation is also expected to rise this year and in 2023. This will no doubt force the Reserve Bank – which has already been aggressive in fighting inflation – to raise interest rates further.

The OECD found that Africa’s most developed economy was not as productive and competitive as it should be. Not only was productivity low, but it was found to decline due to a lack of required skills and inadequate academic performance, which would lead to a lower standard of living.

The organization’s acting chief economist, Álvaro Pereira, said that when a country has low productivity, it is likely to negatively affect living standards:

Improved infrastructure, increased competition and better skills are needed to increase productivity and potential growth. So our survey provides recommendations in all of these areas to try to provide policy advice on how South Africa can grow faster and more sustainably.

However, the expected growth will not be accompanied by growth in tax revenues. The organization said tax cuts introduced by the government have only benefited high-income groups. He recommended increasing the VAT – which he said was relatively low – as a way to increase tax revenue.

Acting Director Isabell Koski said:

Once inflation returns to a normal level, South Africa could consider adding revenue from the VAT.

“To mitigate any potential negative redistributive effects and increase the political acceptability of further VAT reform, an increase in the standard VAT rate should be accompanied by an increase in transfers to low-income households.

“Reducing tax allowances, deductions and allowances would increase tax revenue, restore the progressivity of the tax schedule and reduce income inequality, which is currently among the highest in the world. Wealth inequality is even higher than income inequality. Improving existing taxes on wealth transfers along with appropriate taxation of income sources can, over time, limit the intergenerational transmission of wealth and inequality,” she said.

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The OECD said the government could make the R350 social relief grant permanent and fund it by improving procurement procedures. He said that, and saving money from government inefficiencies, could offset the extra costs. This despite the National Treasury’s warning that making it permanent would be costly and have budgetary implications.

Koski added:

The Social Assistance Distress Allowance fills an important gap in the social assistance protection system by providing, for the first time, support for people of working age who have lost their jobs.

“As such, we believe it could be made permanent as support for the unemployed is something that was missing before the crisis in South Africa. The cost is not very high. We estimate that a basic subsidy of R350 per month, for example, would imply an additional expenditure of 0.8% of GDP.

The OECD has pointed to the underperformance of public enterprises and the significant risks they pose to the tax authorities.

Koski added that South Africa needs to establish effective governance of state-owned enterprises and set clear objectives for the company in terms of profitability expectations, cabinet structures and non-financial targets. “In addition, the fight against leakage of public funds and corruption within public entities remains fundamental to restore public finances and the confidence of citizens.”

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Regulatory barriers in many sectors are a brake on economic growth and the planned economic reforms are taking too long to implement.

“It is very important that the announced reforms are implemented. South Africa has been a bit slow in implementing reforms. It takes two or three years for the announced reforms to be implemented.

“There are reforms announced in the management of public enterprises and the appointments of financial directors to the boards of directors of financial rules. What is needed is strong implementation for the financial viability of SOEs to be restored,” the OECD said.


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