Covid-19

Op-Ed

Unprecedented tax collapse endangers post-Covid recovery

The usually busy Long Street in the Cape Town city centre during the national lockdown. (Photo: EPA-EFE / Nic Bothma)

The consequence of near-total cessation of economic activity and then a somewhat haphazard partial opening up of the economy is wreaking havoc with South Africa’s tax base.

The serious economic impact of the lockdown policy response to the Covid-19 pandemic has understandably generated substantial policy debate in the media and in academia. Conspicuously absent from most of these discussions is an acknowledgement of an imminent tax collapse, which is not only unprecedented in modern South African fiscal history, but also poses huge economic challenges for the country. 

In a report to Parliament on 5 May 2020, Edward Kieswetter, the commissioner of the South Africa Revenue Services (SARS), estimates that revenue losses of 15 to 20% of tax revenue are anticipated, amounting to R285-billion in fiscal year 2020/21. This is roughly in line with forecasts by the Bureau of Economic Research of R280-billion.

Given the highly uncertain nature of the trajectory of the pandemic (with the Department of Health expecting the infection rate to peak only in September) and the duration and nature of the risk-adjusted lockdown, this tax loss estimate could very well be a material understatement, with actual losses approaching R300-billion or more. 

Much debate has focussed on the finance requirement of a comprehensive Covid-19 response package. Regrettably, many of the contributions to this debate have completely ignored the additional financing requirement consequent to the tax collapse, as well as the unfunded revenue requirements carried over from previous years, which will further swell the deficit and debt to GDP ratio, and render a fiscal trajectory which was already unsustainable pre-Covid-19 even more so.

The longer the lockdown continues in its present form, or by way of a  possible reintroduction, the greater the negative impact on the tax system and the greater probability of drawing down government cash balances, a debt standstill and resorting to month-by-month cash rationing in a worst-case scenario. 

At the end of February 2020, National Treasury reported that cash balances stood at R304.5-billion. These comprise sterilisation deposits held at the SARB and other cash balances on the public sector balance sheet, which could be drawn down as bridging finance.

The prime objective of South Africa’s coronavirus response must be to manage infections and save lives by preventing the public health system from being overwhelmed. But the consequence of near-total cessation of economic activity and then a somewhat haphazard partial opening up of the economy is wreaking havoc with South Africa’s tax base. 

A heated controversy had centred on whether South Africa would compromise its sovereignty by acceding to IMF conditionality on its loans. The sort of facilities for which South Africa has applied are not contingent on particularly onerous conditionalities. Whatever the merits of such a source of finance, the heart of a country’s sovereignty lies in its tax base. Unlike many other developing countries dependent on donor funds, South Africa has had a fairly robust and resilient, diversified (albeit shrinking) tax base on which to draw. Tax proceeds are critical for financing the progressive realisation of socio-economic rights and sustained levels of social relief. These are the unfulfilled promises of the transformative constitutional project. 

The Covid-19 public health response highlights the shameful fact that the right to water and food, enshrined in the Bill of Rights, holds far too little of substance for the vast majority of the population. The coronavirus pandemic and the lockdown response did not cause poverty and inequality, but it will amplify it further, as jobs and livelihoods are destroyed.  

The disgraceful neglect in overcoming the problem of apartheid spatial geography has meant that any lockdown is unlikely to be effective over a sustained period, with the majority of the country living in crowded, insalubrious conditions of a kind that, for all too many, have changed little in the 26 years of democracy.

As the fiscus becomes more and more dependent on borrowing at the risk-premium driven high interest rates required to compensate foreign investors to invest in South Africa’s junk bonds, the proportion of interest spending in the Budget will escalate sharply, crowding out social expenditure and infrastructure investment. In turn, this will make it even more difficult to vindicate the promises contained in the Constitution.

 

With every day of lockdown, the probability of a V-shaped recovery recedes further, as the short-term cash flow problems of companies which may be a symptom of illiquidity, crystalise into insolvencies and permanent job losses.

 

South Africa’s system of multi-level government (national, provincial and local) and its complex intergovernmental fiscal system and medium-term expenditure framework depends crucially on revenue certainty for municipalities and provincial governments. This, in turn, is predicated on a stable fiscal framework, which is ultimately based on the ability of SARS to mobilise the necessary revenue. Any contraction of the tax base has immediate consequences for many fiscally distressed municipal and provincial governments, which have already borne the brunt of fiscal adjustment to finance the profligacy of captured state-owned entities in the Zuma era.  

Judging the impact of the pandemic on the economy – and by extension on the tax system – is by no means easy. For the first time, the South African economy has been hit by real supply and demand shocks originating both domestically and from the external disruption of supply chains in the global economy. There is a very real danger that these shocks to the economy will transmute into a devastating financial crisis at a time when the South African economy has already been bedevilled by a significant secular decline in potential output growth over the last decade, on top of an existing unemployment crisis (particularly among the youth), abject poverty and obscene inequality. 

Given the cross-sector impact on value chains, the full impact on the tax system is difficult to foresee. Certain industries like tourism and the hospitality industries are likely to be decimated so long as the coronavirus poses a threat. But other sectors of the economy may well be more resilient; eg, agriculture with exceptionally good yields in maize and citrus this year, and other sectors that benefit from buoyant prices (such as palladium and rhodium), low oil prices, and strong demand for electronic commerce.

There has been considerable disagreement as to whether the South African economy is likely to see a quick rebound in 2021 (the so called V-shaped recovery) or whether a more protracted malaise is likely (the U-shaped recovery). With every day of lockdown, the probability of a V-shaped recovery recedes further, as the short-term cash flow problems of companies which may be a symptom of illiquidity, crystalise into insolvencies and permanent job losses. What might have been a temporary shock could well become a permanent loss of output potential. And it must be recalled that the economy hardly entered the Covid-19 pandemic in rude health. 

In some cases, tax relief extended to companies will simply defer revenue to the next financial year, a timing issue displacing income into the next financial year. But in other cases, where companies are fortunate enough to survive, they will be able to carry forward their assessed tax losses for many years, drastically reducing revenue flows into the fiscus. Here the trajectory of corporate income tax after the global financial crisis is instructive: it took a decade for corporate income tax proceeds to recover to their pre-crisis levels. Over this period, personal income tax took up much of the slack. But with the pandemic and its response cutting a swathe through employment and livelihood prospects, this is unlikely to recur.

Public discourse on the immediate responses to the pandemic’s economic impact centre on borrowing, reprioritising spending, drawing down cash reserves, lowering interest rates, credit guarantee schemes and judicious application of the South African Reserve Bank’s balance sheet. Whatever their merits, these, however, can only be short-term responses at best. In the medium term, the tax system can be the only sustainable bedrock for post-Covid-19 reconstruction and a shift to a more inclusive, employment creating, climate-friendly recovery trajectory. 

Inclusive growth is the only way South African can dig itself out of this economic hole. And that means an end to economic shibboleths, loved by the populists of both right and left. It means looking beyond the binaries of lockdown or no lockdown, lives or livelihoods, and the total control or libertarian approaches. What is required is a policy that can ensure that those sectors of the economy that can operate successfully, even with the threat of the virus, be promoted (with appropriate risk mitigation measures) and new job-creating sectors such as the green economy be encouraged now. 

To delay can only mean even more rapid economic decline, a frightening collapse of the tax base and an inability to support the millions who from day to day are living desperately vulnerable lives. DM

References:

https://www.fin24.com/Economy/South-Africa/lockdown-stalled-economy-could-mean-tax-loss-of-up-to-r285bn-kieswetter-20200505

Tania Ajam is Associate Professor in Public Policy Finance and Economics  School of Public Leadership Stellenbosch University 

Dennis Davis  is the chair of the Davis Tax  Committee and Judge President of the Competition Appeal Court

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