Finance minister Tito Mboweni has called on South Africans to provide advice on how to get the economy growing again. Faced with falling revenues, mounting debt and a bleak economic outlook, to supposedly soften the looming fiscal catastrophe the government may be tempted to increase taxes to bolster its coffers. This should be avoided at all costs. Instead, Mboweni should reduce expenditure on an already bloated state and institute policies that are known to lead to greater levels of economic growth.
Many economic and market analysts are predicting a rise in VAT from 15% to 16%. However, any increase in the VAT rate would be devastating for the poorest and most vulnerable members of society and plunge them into deeper levels of poverty. VAT is a regressive tax that disproportionably affects the poorest members of society. The tax burden on a given product, which is the same for the rich and the poor, consumes a larger share of a poor person’s income than that of a rich person. If the goal is to help the poor, raising VAT is counterproductive.
The government may also be tempted to increase taxes on the rich and redistribute some of this wealth to the poor. Indeed, the idea of taxing the wealthy and redistributing the proceeds resonates with many South Africans grappling to understand why, after almost 26 years of democracy, income inequality and poverty remain stubbornly high. However, scapegoating the rich and focusing on income inequality misdiagnoses the problem and shifts attention away from the real reason millions remain poor. To permanently help the poor, history has demonstrated that what is required is greater levels of economic growth. The proven and surest path to increased economic prosperity is through less government intervention — not more.Deirdre McCloskey, professor of economic history at the University of Illinois in Chicago, says: “What permanently helps the poor is what we have done in the past two centuries — make the global wealth pie bigger. How much bigger? A factor of anywhere from 30 to 100 times. The poor — your ancestors and mine, for example — got better off, radically so, not by redistribution or trade unions or regulation, but by economic growth on a unique and immense scale.”
Politicians may win votes with promises of imposing punishingly high taxes on the wealthy and corporations, but this does untold harm. It reduces incentives to produce goods and services and hire labour to achieve those objectives. Taxes penalise a targeted activity. Taxes on alcohol, cigarettes, fuel or imports for example 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 of entrepreneurs to risk capital and sacrifice time and energy, they interfere with the ability of individuals to pursue their goals, they 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.
In this tough economic climate many South Africans are feeling the pinch as their household debt rises and disposable incomes fall. An overtaxed middle class is feeling cheated as it is being forced to fork out increasing amounts of tax. In 1972, for every rand of tax taken by the government taxpayers kept R3.33, whereas nowadays we keep only R1.58 — less than half.
A mountain of evidence demonstrates that, beyond the amount needed for keeping order, providing justice and solving co-ordination problems, increased government size tends to slow economic growth. For an economy the size of SA’s, the government is larger than necessary. The vast amount of revenue spent on government consumption alone is especially detrimental to growth.
Dampening effect
By international standards SA has too many government enterprises, many of which do things private enterprise can do better, and too many that are large loss-makers regularly subsidised with taxpayers’ money.
Why is the trend towards larger government bad? If a government is already too big for optimum growth, getting even bigger will only make things worse. SA’s tax-to-GDP ratio has grown steadily from 17.2% in 1972 to 27.1% nowadays. This ratio is significantly higher than the average of all upper middle-income countries of 11.7%, and the world average of 14.2%. As long as this trend continues we can expect to suffer from the extra dampening effect it will have on our economic growth.
To lower the tax-to-GDP ratio and create the incentives to save and invest, Mboweni should consider removing pernicious taxes such as estate duties, transfer duties, taxes on retirement funds and capital gains taxes, which will eliminate the pervasive double taxation. Double taxation occurs because personal and corporate incomes are taxed and then whatever returns are derived from these savings and investments are taxed again.
Mboweni should also consider lowering taxes on corporations. Companies do not pay taxes. People pay taxes. Most large corporations are owned by shareholders (people) and groups of people such as government employees through their pension funds. Since pension and mutual funds are collections of the savings of millions of middle-and low-income individuals, when proponents for increased corporate taxes agitate for higher tax rates, or complain that companies are not paying their “fair share”, they are in fact calling for reduced dividends and pension fund payouts. High corporate tax rates reduce the returns on the investments and life savings of individuals.
Most studies show that a portion of corporate tax affects workers too, in the form of lower wages and benefits. Future wages are also adversely affected because high corporate tax rates retard capital formation and decrease overall investment. Inevitably, this has a negative effect on future labour productivity and wages. Recognising the punitive effects of high corporate tax rates, SA’s neighbour, Eswatini, has announced that it will slash its corporate tax rate from 27.5% to 12.5% to boost growth and address the country’s youth unemployment rate of more than 40%.
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 everyone in the country.
Economic growth is the key to reducing poverty and inequality and expanding opportunities for the unemployed.
Contrary to the view of proponents that the state should play a greater role in the economy, history has repeatedly demonstrated 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 be more prosperous.
• Urbach is a director of the Free Market Foundation of Southern Africa.
This article was first published on BDLive on 24 February 2020