Cut taxes to boost savings and investment

Finance Minister Nhlanhla Nene will present his inaugural Medium Term Budget Policy Statement (MTBPS) to Parliament next week on 22 October 2014. Nene must be applauded for his statement linking wages to employment. In an interview on the side-lines of the World Bank-International Monetary Fund (IMF) annual meetings held in Washington last weekend, Nene stated, “I have always been saying that if we settle for anything more than 1% above inflation (at public sector wage talks), that will compromise the headcount”.

These sentiments are in stark contrast to those of other senior government officials and the ANC’s communist allies, who vehemently deny any link between the price of labour (wages) and employment. For example, many people who support the minimum wage argue that an artificial increase in wages will have no effect on employment. Either in ignorance or a conscious decision to ignore reality, they discount the fact that employers act rationally. When faced with a legislated increase in wages without a concomitant increase in productivity, employers will refrain from hiring new workers (mainly unskilled), mechanise where possible, cut the number of marginal employees, or, in the extreme case go out of business.

Nene made another statement which should cause South Africans concern. “We are committed to maintaining a moderate increase in headcount (within the public sector)…” About 1.3 million people are employed by government and the public sector wage bill amounts to R439 billion. The last thing government should be doing is committing itself to a “moderate increase in headcount”. It is already over-bloated. Any further increases will simply serve to crowd-out the private sector even more. It is long overdue for all in government to acknowledge that the private sector is the real engine of economic growth in an economy – especially if any effort is to be made to combat the ever increasing enormity of the unemployment problem facing this country.

Government does not have its own money. The money it uses is money it has taxed or borrowed. Jobs “created” by government are clearly visible but what we do not see are the jobs that would have been created in the private sector with that same money if it had not been taxed or borrowed by government. Government is merely a redistributor of money from the productive to the non-productive sectors of the economy. When no new income results, no new demand for goods and services is created, and no growth in the economy is the true outcome.

Also of concern is Nene’s statement that there is a need to look into, “…whether there are any new sources of tax revenue that we should be looking at”. Given the precarious situation of state finances, Nene may be persuaded to raise taxes or even consider introducing some form of “wealth tax” on high net worth individuals and those earning over a R1 million per annum. Let us hope he will lend an ear to the late Nobel Prize winning economist, Gary Becker, who said, “Neither the modern history of high tax rates, economic analysis, or their consequences for the budget deficit and income redistribution indicates that raising taxes on higher income individuals is a good idea”. Raising taxes on the small group of individuals at the top of the South African income scale may appear to be a “fair” proposal to the majority of people in this country, but it will incur many unintended consequences.

High income earners are very mobile individuals and may choose to live in a more favourable tax environment. Should they choose to remain in South Africa, a higher tax rate will reduce any incentive to start a new business and invest in this country’s human capital and may cause them to choose to invest their money elsewhere. In other words, taxes diminish the incentives of entrepreneurs to risk capital and sacrifice time and energy. Taxes interfere with the ability of all individuals to pursue their goalsThe only way to boost economic activity is to reduce taxes and encourage savings and investment.

A lack of investment retards capital accumulation. A lower capital to labour ratio reduces real wages and perpetuates the poor savings and investment cycle. Without investments to fund and establish new ventures that create jobs, the smaller the economy and the lower the economic growth rate will be. Thus the government would do well to avoid inflicting further pain on South Africans by increasing taxes.

The news that government is considering selling-off non-core assets such as its stake in Vodacom should be welcomed because in the current economic climate, government, like business, should focus on its core activities. Government’s core functions include ensuring that there is sufficient policing, the courts are impartial and efficient, and the rule of law is respected and enforced. Security of property rights is essential for economic growth. When individuals know that their land and possessions are secure and protected, it gives them an added economic incentive to go out and earn a living.

Taxing productive individuals and companies is the simplistic notion of how to redistribute wealth. It does wide untold harm because it reduces the incentives to produce goods and services and retards overall economic growth which affects each and every person in the country. History has demonstrated that economic growth is the key to reducing poverty and inequality and expanding opportunities for the unemployed. Nene’s inaugural budget policy statement will reveal whether government is brave enough to choose economic growth as its main priority.

Author Jasson Urbach is an Economist and director of the Free Market Foundation. This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author's and are not necessarily shared by the members of the Foundation.

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