Godongwana playing a dangerous game

Finance Minister Enoch Godongwana has overseen a steady expansion of the personal income tax (PIT) burden to patch up the government’s finances. 

This has largely worked, in conjunction with fiscal consolidation, to slow the growth of the state’s debt, with it likely peaking in the current financial year at over 77% of GDP. 

However, the increasing tax burden is being borne by an alarmingly small number of taxpayers, with any further measures to raise PIT revenue likely to meet strong opposition or result in declining revenue. 

This is feedback from PwC tax experts Simangaliso Manyumwa and Kyle Mandy, who recently analysed how South Africa’s PIT burden has steadily increased over the past 20 years.

This increasing burden has been exacerbated in recent years as Godongwana has opted not to adjust PIT brackets in line with inflation to bring in more revenue for the state.

Manyumwa and Mandy explained that this disproves the myth that the PIT burden has declined over the past 20 years, which is often argued by pointing to effective tax rates dropping over that period. 

However, this argument does not take into account that the government has steadily increased the income that is subject to tax and limited relief in the form of rebates and deductions. 

This includes actions from the state, such as capping the value of tax-free medical aid contributions, limiting retirement fund deductions, tightening travel allowances, and scrapping various reductions. 

When incorporating these factors into the analysis, the effective tax rate of South Africans paying PIT has increased over the past 20 years. 

“The story of South Africa’s PIT system is one of a relentless, quiet expansion of the tax burden. This burden is shouldered by a dangerously small number of taxpayers,” Manuymwa and Mandy said. 

The National Treasury’s data shows that only 533,000 taxpayers earning over R1 million are projected to pay 47.5% of all PIT for the current financial year. 

These taxpayers only represent 6% of the entire registered taxpayer pool above the threshold. It is these taxpayers that the National Treasury has been squeezing for more revenue. 

Manyumwa and Mandy explained that this is a result of a pivot from the government to focus on PIT revenue in the aftermath of the Global Financial Crisis. 

As government spending increased, tax revenue remained flat due to a stagnant economy and falling corporate profits. To alleviate this pressure, the state turned to PIT to raise revenue. 

PIT is the largest and most stable source of state revenue, with corporate income tax (CIT) proving to be volatile, particularly in South Africa, when much of this is reliant on commodity prices. 

The VAT alternative

The alternative to raising revenue through PIT and CIT is increasing the VAT rate in South Africa, as it is the only other source of revenue that can make a meaningful, sustained difference to the state’s finances. 

South Africa cannot afford to raise PIT and CIT rates, as it is already over the Laffer Curve with regard to these taxes, with an extremely small number of taxpayers footing the majority of the bill. 

This means that any increases to the PIT and CIT rates are likely to result in less revenue as individuals and companies look to minimise their tax burden. 

“Evidence suggests that raising the top marginal tax rate would have a limited impact due to Laffer curve effects,” the Organisation for Economic Cooperation and Development (OECD) said.

Increased tax rates are also likely to result in further reductions in investment, limiting growth, and, thus, state revenue in future.

However, there is still room for the National Treasury to raise the VAT rate in South Africa as it is a broad-based tax, with everyone paying it in some form. 

Furthermore, South Africa’s VAT rate is relatively low compared to other emerging markets and developing economies. It is also relatively easy to administer and collect. 

According to OECD data, VAT in South Africa contributed 35.4% of total tax revenue in the previous financial year, but remains below the average for members of the organisation. 

This suggests there is room to increase both the tax rate and its base while alleviating the impact on the most vulnerable, the OECD said. 

To maximise the impact of any increase in the VAT rate, it is key to adopt complementary reforms to enhance collection. Otherwise, there would be a risk that revenue gains may fall short of expectations.

Despite this, imposing a VAT hike is deeply unpopular politically, with no party wanting to be seen supporting such an increase in a stagnant economy.