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Markets & economy

‘Hopeful Budget’ may strike right notes, but tax clarity and economic reforms are needed

This year’s Budget speech, set to be delivered on 23 February by Finance Minister Enoch Godongwana, is likely to strike an optimistic chord thanks to a number of recent tailwinds responsible for positive economic uptick. However, questions remain on how government is to respond to taxes for individuals and corporates.

This is the view of Thalia Petousis, fund manager, and Komil Gordhan, tax manager at Allan Gray.

Windfalls for the country’s coffers

“Despite the economy facing serious problems like stagnation with low growth and high unemployment, there has been strong revenue collection, particularly owing to robust corporate income tax collection in December, which may reduce the 2022 budget deficit by approximately R80bn from previous projections, to closer to R300bn, which is about 5% of GDP,” explains Petousis.

Gordhan says that these positive developments overshoot the Medium-Term Budget Policy predictions from 2021, which provides Godongwana with a little breathing room.

“The South African economic recovery has been quicker than expected, with output expected to return to pre-pandemic levels by 2022. This is a year earlier than expected previously,” says Gordhan.

For Petousis, the one caveat to this statement is that the faster pace is chiefly due to price increases in key commodities, like platinum, that South African miners export, as opposed to greater efficiency at SA ports, rails, and in local electricity generation – which is what is sorely needed to achieve stable economic growth. The economic recovery is also highly uneven, with the tourism and leisure industry, as well as the household and consumer industry, in a very feeble state. That said, the continued reforms that President Cyril Ramaphosa announced during the State of the Nation Address around the liberalisation of the electric power industry and private sector partnerships in catalytic rail projects are positive if they are to be executed properly and with some haste.

“For now, strong commodity prices should continue to lead to revenue overruns sufficient to fund the additional expenditure that government will spend on an extension of the social relief distress grants,” Petousis notes. She adds that this year has also kicked off with some sizeable inflows from foreigners into the local bond market. 

“This is bullish for South African bonds in the short-to-medium term and implies that there might be scope for National Treasury to reduce the size of their weekly bond and Treasury bill issuances,” says Petousis.

Gordhan says that given the recent positive economic developments, together with better-than-expected revenue collection, the finance minister may just have some good news for parliament and taxpayers this year. “However, challenges in reducing government debt remain ahead of us, due to notable difficulties in tackling public sector wages, Eskom's weak operational and financial state, and low GDP growth potential.”

Managing the budget deficit, with or without tax rates?

Gordhan says that it is unlikely that the large budget deficit will be solved by tax hikes.

“Godongwana noted in his Medium-Term Budget in November 2021 that stabilising the debt burden is an essential target for fiscal sustainability. It was also acknowledged that tax increases over the recent past have had an adverse effect on economic growth rather than spending reductions. Therefore, any further tax increases are not desirable, regardless of the debt burden, as they will have a negative impact on the economic recovery reform.”

She says that neither corporates nor individuals are likely to carry the tax burden this year. “Instead, the focus is anticipated to be on broadening the tax base whilst lowering tax rates, a journey that is already underway – with the proposed reduction of the corporate income tax rate from 28% to 27% in 2021. This is being accompanied by expanding the application of interest deduction limitation rules and the limitation on the use of assessed losses to aid in widening the tax base for corporate taxpayers.”

She also says that raising taxes on individuals will have a negative impact on the economy, especially as taxpayers are in desperate need of tax relief to help cope with rising food and fuel costs, rising interest rates, and to cushion the blow from the COVID-19 pandemic.

“National Treasury has also recognised that both personal income tax as a percentage of GDP, as well as the country’s marginal tax rate, are higher than other comparable countries.”

The good news, Petousis says, is that while a deficit closer to R300bn will still be a large amount for the domestic savings pool and local banks to fund, it is more manageable than that of the previous financial year. 

“We expect that the Budget will reflect the intention by government to revive the economy through providing continued tax relief, added focus on accelerating reforms in the country and no major tax increases as South Africans begin to emerge from the pandemic and its negative impact. We should not be despondent if a conservative approach, without tax breaks, achieves the aim of stimulating the country’s economic recovery,” concludes Gordhan.

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