By: Jasson Urbach, Director at the Free Market Foundation
On 21 February, Finance Minister, Malusi Gigaba, will present his annual budget speech before Parliament. Many South Africans and potential foreign investors are probably wondering how he plans to balance the national accounts. Faced with falling revenues, mounting debt and a dismal economic outlook, to supposedly soften the looming fiscal catastrophe government may well be tempted to raise taxes, particularly on South Africa’s wealthiest citizens. However, the key focus should be on reducing expenditure and an already over bloated state and raising taxes should be avoided at all costs.
Most tax reform discussions and debates lead with the premise that any new tax system must raise roughly as much or more revenue as the one it is to replace. But as Winston Churchill famously quipped, “I contend that for a nation to try to tax itself into prosperity is like a man standing in a bucket and trying to lift himself up by the handle”. Unfortunately for South Africans, government spending has more than doubled in relative terms from less than 10% of GDP in 1960 to over 20% at the end of 2016.
Contrary to the view that the state should play a greater role in the economy, time and time again history has demonstrated that economies that allow their entrepreneurial and hardworking citizens more freedom to use their skills to the best of their ability and earn a worthwhile reward tend to grow faster and prosper.
To have a better chance of raising the amount of funding required, government should be looking for ways to reduce the total tax required, and to do this it is imperative that it gives urgent attention to reducing the expenditure side of its budget.
The best way to “stimulate” growth is to allow people to work, save and invest. Unfortunately, labour policies in this country discourage the hiring of low and unskilled workers. High marginal tax rates and other pernicious taxes discourage savings and investment. When we combine all taxes, many people are paying upwards of 50% of their annual earnings. Typically, these are the individuals who would fund new investment in the economy, which, in turn, would create essential and desperately needed new jobs. In effect, these people are working for government for the first six months of the year.
The late, great Nobel Prize winning economist, Milton Friedman, proposed a flat tax system in the early 1960s to simplify tax collections and to encourage people to work, save and invest. He acknowledged that individuals respond to incentives and take steps to further their interests and argued that highly progressive taxes induce taxpayers to find and exploit tax loopholes to reduce their tax payments by hiding or converting income into other forms, either legally or illegally.
A proportional or flat tax, as opposed to a progressive tax system, is one in which the ratio of tax to taxable income is the same at all levels of income. It replaces the various tax bands that feature in a progressive tax regime with a single rate. A true flat tax makes no provision for exemptions and provides no special dispensation for low-income earners. However, for both compassionate and practical reasons there is no merit whatsoever in taxing the poor. The compassionate reasons are obvious while the practical reason is that below a certain level of income, the costs of collecting taxes from the poor will exceed the amount collected. Low-income earners should therefore be exempt from paying tax on personal income.
Consider for example, if the exempted income is R75,000 per year and the tax rate 15%. A person earning R75,000 would not pay tax, whereas a person earning R100,000 will pay R3,750 (effectively 3.75%). A person earning R5 million per annum would pay R738,750 (effectively 14.78%) in tax. A low flat tax would be fair, broaden the tax base, improve incentives to invest, make tax evasion more difficult and less lucrative, increase economic growth, raise local investment by encouraging capital formation, and create new jobs by increasing real wages and improving incentives to work. It would also encourage taxpayers to be more honest and attract foreign investment.
Once tax rates are increased, it is very difficult to later reduce them, so hopefully, Finance Minister Gigaba will do the right thing and reduce government expenditure and thereby, taxes, which will lighten the load already borne by cash-strapped South Africans. These are some relatively simple tax reforms that should receive approval from all quarters: business, labour, civil society and, most importantly, South African citizens. It is time for South Africa’s leaders to realise that the role of government is to pursue policies that promote economic growth and not to prevent people from working by enforcing job destroying policies.