Redistributing wealth is no way to grow the economy

14 February 2019
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Many South Africans and foreign investors are keenly awaiting finance minister Tito Mboweni’s Budget speech on February 20, probably wondering how he plans to balance the national accounts.

Faced with a widening deficit, mounting debt, and a dismal economic outlook, to supposedly soften the looming fiscal catastrophe the government may well be tempted to raise taxes, particularly on SA’s wealthiest citizens. However, the focus should be on two key issues: significantly cutting expenditure by reducing the size of a bloated state; and broadening the tax base by allowing more people to work.

As the late economist Milton Friedman pointed out, “You cannot reduce the deficit by raising taxes. Increasing taxes only results in more spending, leaving the deficit at the highest level conceivably accepted by the public. Political rule number one is government spends what government receives plus as much more as it can get away with.”

Taxes penalise a targeted activity. For example, taxes on alcohol, cigarettes, fuel, imports and others are imposed to curb the consumption of such items. Similarly, taxes imposed on income and earnings reduce the source of that funding. They diminish the incentives and zeal of entrepreneurs to risk capital and sacrifice time and energy; they interfere with the ability of individuals to pursue their goals; and send workers home with smaller disposable incomes.

Less disposable income means less saving, less saving means less capital formation, less capital formation means lower labour productivity, and lower labour productivity means lower real wages.

Economist Arthur Laffer noted that government revenue is maximised at a rate somewhere between 0% and 100% of income earned by the taxpayer. The famous “Laffer Curve” shows that at the extremes, no tax would be collected. At a level above the “optimal” rate it becomes counterproductive to raise tax rates further since people will evade tax or avoid it.

According to the latest data contained in 2018 Tax Statistics, a joint publication prepared by the National Treasury and Sars, SA has a very narrow personal income tax base. The publication reveals that only 20-million people are registered for personal income tax, government’s main source of tax revenue. Of the 6.4-million people who are liable to submit tax returns, Sars assessed 4.9-million.

If we disaggregate these figures we find that there are about 4.3-million people with taxable incomes in excess R70,000 a year. These individuals account for 99.9% of the total personal income tax. However, if we disaggregate the data further, we find that there are 1.3-million people with taxable incomes in excess of R350,000 a year. These individuals account for 61% of the total personal income tax take. It should be clear that a vanishingly small number of individuals bear almost the entire weight of the SA state on their weary shoulders.

The evidence tells us that the best way to achieve economic and political objectives is not always obvious. Raising taxes on the small group of individuals at the top of the income scale may seem like a “fair” proposal, but there are many unintended consequences. Chiefly, high-income individuals are mobile and may choose to live in a more favourable tax environment. If they decide to remain in SA, a higher tax rate will reduce their incentive to start a new business and invest in this country’s human capital, and may even cause them to financially emigrate.

Higher rates of economic growth are a more certain means to increase the national tax base. History has demonstrated that economies that allow their entrepreneurial and hard-working citizens more freedom to use their skills to the best of their ability and earn a worthwhile reward tend to grow faster and prosper. 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.

Taxing productive individuals and companies to redistribute wealth reduces the incentives to produce goods and services and retards growth. History has demonstrated that it is economic growth that is the key to reducing poverty and expanding opportunities for the unemployed, and not the simple redistribution of wealth.

• Urbach is an economist and director at the Free Market Foundation, where he heads the health policy unit.

This article was first published in City Press on 13 February 2019

 

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