REPORT OF THE PORTFOLIO COMMITTEE ON FINANCE ON THE APPROPRIATION BILL 2005/6, DATED 8 MARCH 2005:
The Portfolio Committee on Finance, having considered and examined the Appropriation Bill [B7 – 2005] (National Assembly – sec. 77), and its related documents, referred to it, and classified by the JTM as a section 77 Bill, reports as follows:
The Minister of Finance tabled the Budget for 2005/06, including the MTEF for 2006/07 and 2007/08, on 23 February 2005 before Parliament.
On 24 February, the Committee in a joint sitting with the Select Committee of Finance and the Joint Budget Committee was briefed on the Budget for 2005/06 and the MTEF forecasts by the Minister of Finance, together with the Director General of the Treasury and the Commissioner of the South African Revenue Service (SARS).
Between 1 and 4 March the Committee received further submissions from National Treasury, SARS, invited economists and tax specialists, as well as organised labour and business. These submissions dealt with the full range of issues raised in the Budget for 2005/06, as well as certain other related issues.
This report is structured around the following main themes, which emerged from the abovementioned briefings and hearings, and the Committee’s own discussions:
The Committee’s specific recommendations are presented at the end of each section in a shaded box. The recommendations are numbered sequentially across sections for ease of reference.
There was general agreement with the National Treasury’s macro-economic thrust and forecasts for the current year and MTEF period. It was generally acknowledged that the more stable macro-economic environment had fostered growing confidence in the South African economy and that the expansionary stance adopted in the budget was appropriate in the light of the challenges of placing the economy on a sustainable higher growth path and reducing unemployment and poverty.
Most panellists agree that there has been an encouraging step-up in South Africa’s economic growth from the 2 – 3.5% range experienced over the past number of years, to forecast growth rates in the range 3.8 – 4.4% over the MTEF. While some of the panellists disputed the forecasts underlying the budget by a few tenths of a per cent, all agreed that the economy is on track to maintain growth rates of above 4% over the MTEF period.
There was general agreement among our panellists that the current positive economic growth outlook is the product of and supported by:
Concerns were, however, raised around certain of the factors currently driving economic growth, and the relatively poor performance of certain economic sectors. These issues are discussed below:
Several of our panellists noted the exceptionally rapid growth in domestic consumption expenditure, and the fact that it appeared to be the overriding factor driving economic growth in 2004, and going forward. Goolam Ballim estimated that in 2002 consumer spending contributed 2% to a growth rate of 3.6%, in 2003 it contributed 2.2% to a growth rate of 2.8%, and in 2004 the contribution of consumer spending matched the growth rate of 3.7%. This was corroborated by the BUSA submission.
It was pointed out that although in sectoral terms GDP growth had been fairly broad based, the contribution from the manufacturing sector has been relatively muted. Although better than the previous year, the 2.6% growth in manufacturing was significantly less than half the 5.7% growth in domestic consumption. This shortfall in the domestic supply-side response has been compensated for by a very rapid rise in imports, which grew at 18% in 2004. This implies that South African manufacturers are not capturing a significant portion of the benefit of the consumption boom: instead the benefit is being exported via the growth in consumer imports, particularly of vehicles, electronic goods and textiles.
Most panellists agreed that household debt is still at affordable levels, and that interest rates are expected to remain stable over the MTEF. Several panellists, however, pointed to a growth in household debt and the implications this may have on households directly (future consumption and insolvencies), and on overall consumption expenditure should there be an increase in the interest rate in the medium term.
While rising economic growth in South Africa has traditionally been accompanied by rising imports of machinery, chemicals and other productive inputs, the current growth cycle has seen a shift in the composition of imports. Machinery and chemicals’ contribution to total imports have fallen by 3.7% since 2002, while that of vehicles has increased by 3.8%. There has also been significant growth in the imports of textiles, electronic goods and processed foodstuffs.
The above changes can probably be largely attributed to the systematic lowering of import tariffs, the strengthening of the Rand (both of which make imports more competitive), and an increasing propensity to import as the number households with middle and high incomes increases. Nevertheless, there is concern that South African producers have to compete with imports from:
The National Treasury expects export performance to improve, as the global economy continues to grow and the real trade weighted Rand weakens moderately. However, Goolam Ballim argued that the 4.7% growth in exports in 2005 projected by National Treasury was overly optimistic. He suggested that exports could grow by as little as 1% in 2005, primarily as a result of anticipated continued significant dollar weakness, which would lead to a strengthening Rand. This would reduce the competitiveness of South African exports and cause a drop in the Rand value of exports.
The National Treasury noted that the deficit on the current account of the balance of payments had increased to 2.3% of GDP during 2004, but pointed out that this was more than offset by the surplus on the capital account. Responding to a question about its sustainability, National Treasury indicated that the current level of net foreign portfolio inflows could sustain a doubling of the current account deficit. Treasury therefore had little concern that the current account deficit would be a constraint to the forecast growth rates.
The Committee’s attention was drawn to the low savings rate in South Africa, particularly by households. This coupled with the very rapid increase in household consumption expenditure, and related increases in debt was seen by some panellists as cause for concern.
Various panellists noted the changing sectoral mix of GDP. The declining share of the primary sector is largely expected as the economy shifts away from a reliance on mining. Of concern is the declining share of the secondary sector (which is primarily manufacturing) relative to the very rapid growth in the tertiary sector’s share of GDP since the 1980s. This general picture was confirmed by sectoral trends in employment numbers presented by Haroon Bhorat. Goolam Ballim argued, "South Africa is de-industrialising".
It was noted that these shifts have extensive implications for the kinds of skills being demanded in the economy, and therefore the structure of unemployment. It also has implications for any proposed skills development strategy, as well as for the kinds of qualifications being offered at tertiary education institutions.
Although the forecast economic growth rates for the MTEF period 2005 – 2007 are high relative to rates experienced over the last twenty years in South Africa, Committee members noted that if South Africa is to achieve the target of halving unemployment and poverty by 2014, there needs to be (1) another step-up in the rate of economic growth in future years and (ii) a qualitative shift in the growth path to make it more labour absorbing and pro-poor. These concerns gave rise to a number of questions being raised by panellists around the theme of: ‘What factors are constraining economic growth in South Africa?’
Among the factors that the various panellists raised as possible constraints on raising the rate of economic growth in South Africa were the skills shortage, crime levels (or perceptions thereof) and a number of issues linked to the cost of doing business in South Africa (ranging from infrastructure deficiencies to regulatory "red tape"). Making the growth path more labour absorbing and "pro-poor" in the sense of contributing to reducing poverty and creating many more opportunities to raise incomes through sustainable livelihoods was also widely acknowledged as fundamental to creating a climate conducive to achieving higher levels of economic growth.
|
Committee’s recommendations: |
|
|
|
|
|
|
|
|
|
A central objective of economic policy is to increase the number of jobs in the economy. The Committee notes that despite employment creation being a key policy objective, the National Treasury does not provide any forecasts with regards to employment creation over the MTEF. Nor is specific information given as to the expected benefits in terms of employment creation of the various policy measures introduced in the Budget. For instance, how many jobs are the re-capitalisation programmes of Transnet and Eskom expected to create?
Apart from the dearth of information on employment creation, three further issues emerged as important in the nexus between economic growth and employment, namely:
Evidence presented by Haroon Bhorat showed that between 1995 and 2002 formal sector employment increased by 1.6 million, or at about 2% per year. According to National Treasury, 419 000 jobs were created in the economy between March 2003 and March 2004.
Bhorat thus agreed with National Treasury that South Africa has not been experiencing ‘jobless growth’ i.e. there has been net positive employment creation.
The real issue, however, is that the rate of growth in employment, has not been sufficient to keep pace with the expansion of the labour force. In 1995 the unemployment rate (strict definition) was around 16% of the labour force. This increased to around 31% in 2003 before declining to 27% in 2004.
While there is thus clearly a positive correlation between higher levels of economic growth and employment creation, it is also clear that South Africa has over the past three decades at least been experiencing a problem of structural unemployment resulting from a declining demand across the economy for the kind of cheap unskilled labour on which the growth and development of the South African economy under colonialism and apartheid was based.
What is not clear, in this context, is what impact higher levels of growth alone will have on reducing unemployment and to what degree the unemployment challenge will require structural change.
Haroon Bhorat indicated to the Committee that employment would have needed to grow by about 7% between 1995 and 2002 merely to keep pace with the increase in the labour force. This he further suggested would have required a GDP growth rate of at least 7%.
The step-up to a projected average growth rate of 4.2% over the MTEF is thus certainly likely to be positive for employment growth, but unlikely on its own to produce a solution to the continuing problem of unemployment.
Arising from the above, the challenge to raise the level of economic growth needs to be accompanied by the challenge to increase labour absorption. The absorptive capacity of economic growth is closely linked to the sectoral structure of growth, hence the concern expressed above regarding:
Another dimension of the debate relates to the labour intensity of new investments. This has two aspects to it: firstly, the labour intensity of the actual investment expenditure. This is particularly relevant when dealing with infrastructure investments, i.e. will the method used to upgrade the Sishen-Saldanha railway line be labour intensive or capital intensive? While the Minister of Finance announced extensive investment plans for all levels of Government, as well as by various public enterprises, no job creation targets linked to these investment activities were put forward.
The second aspect, relates to the actual labour intensity of the productive processes that result from particular capital investments. In this regard, the relative cost of capital versus labour is important. SAICA notes that the accelerated depreciation allowances for capital investments previously introduced effectively reduced the cost of capital relative to the cost of labour. The consequence is that the capital investment that takes place is often at the expense of jobs. This increases the importance of measures to reduce the bureaucratic costs associated with labour, whether it be in creating jobs (for instance learnerships), managing skills development levies and engaging with SETAs, or processes before the CCMA.
Also important is the nature of the capital investment itself: capital-intensive investments generally tend to create fewer jobs, and these jobs usually require skilled workers. By contrast, investments that are labour intensive tend to create more jobs for unskilled and semi-skilled workers. As noted below, South Africa faces a severe skills shortage, but has a surplus of unskilled and semi-skilled labour. This suggests that Government should be encouraging labour intensive investments. The Committee notes a number of policy developments that move in this direction, namely:
During the hearings, all panellists noted that there is a skills shortage in the South African economy. In essence there is a mismatch between the skills of job seekers and the demand for skills in the economy. So while economic growth is needed to create jobs, the skills needed to grow are not available.
Haroon Bhorat illustrated this problem in a number of ways. Firstly, he noted that there has been a significant shift towards employing more skilled workers in most sectors of the economy, at the expense of unskilled workers. Secondly, he showed that the 15% unemployment rate among workers with a tertiary education was very significantly lower than the average unemployment rate of 39.5% in 2002 (using the expanded definition). Thirdly, he presented data giving a breakdown of tertiary unemployment rates by race. This showed that the unemployment rate of white workers with a tertiary education was 4.6% in 2002, compared to 26% for black workers with a tertiary education. He noted that the difference could largely be explained by differences in the nature of the tertiary qualifications of the two groups. Whites were better represented in business, engineering and the sciences, which is where the demand for skills lies. Demographics of skills training
There is also clearly a serious shortage of artisan skills and in fact evidence that training programmes for these trades are falling even further behind other forms of training.
All panellists agreed with the Government’s multi-faceted strategy to addressing the problem and were particularly supportive of real increases in education allocations over the MTEF, particularly the R1 billion for the re-capitalisation of FET collages, the R776 million for NSFAS, and the R6.9 billion to improve salaries of teachers. FEDUSA however noted serious concerns with the performance of SETAs in supporting training, and suggested that there are serious blockages in the system that need to be addressed.
|
Committee’s recommendations: |
|
|
|
|
|
|
|
The expansionary fiscal policy stance within parameters of sound fiscal management was broadly endorsed by most of our panellists. The following issues attracted particular comment:
There was also widespread support for the expansionary stance of the Budget over the MTEF. All panellists were positive about the real increases in the allocations to social grants, teachers and police, FET colleges and NSFAS and initiatives to support micro-enterprises. Most agreed that until job creation has reached sufficient levels, a social security safety net is essential to protect many of our people from abject poverty.
Widespread support was also given to the growth in capital expenditure noted in the Budget, particularly the off-budget investments by Transnet and Eskom. Various panellists noted that while the allocations to investment were welcome, the real challenge for Government was to ensure effective spending.
BUSA noted that financing the very large capital programmes of public enterprises could pose a challenge, especially as these entities are expected to raise funds on the domestic bond market. This would tend to drive up the cost of capital, which would have a crowding out effect on private investment. It would also increase Government’s vulnerability to any increase in interest rates.
FEDUSA called on the Government to ensure that capital investment programmes of public enterprises were labour absorbing and skills enhancing.
There was widespread support for the Government’s policy of keeping main budget revenue below 25% of GDP. BUSA did, however, note that the National Treasury’s task in this regard was made easier by the recent definitional changes to GDP that effectively expanded the GDP base.
All panellists noted the slight increase in the deficit the 2005/6 Budget, and the declining trend later in the MTEF. The general view was that the increase to 3.1% of GDP is sustainable given the Government’s success in containing the deficit in the past, and the declining trend in state debt costs as a percentage of GDP over the MTEF. BUSA did, however, note that increasing the deficit during an upswing in economic growth contradicted conventional Keynesian economics, and could constrain the Government’s ability to respond with an expansionary budget when faced by an economic downswing in future.
During its deliberations, the Committee noted that a current deficit is anticipated for 2005/6 meaning that Government is borrowing to finance current expenditure. While CHAMSA expressed some concern about this, the National Treasury indicated that it can largely be attributed to the roll-out of child support grant, and that the aim is to reverse the trend over the MTEF, and ultimately to return to a current surplus thereafter. Most panellists agreed that this was not a cause for major concern.
|
Committee’s recommendations: |
|
As noted above, our panellists generally acknowledged that the Government is managing the macro-economy well, and that the emphasis on investment and the balance in the increased allocations, moves fiscal policy in the right direction. However, various panellists noted that success of the Budget is determined by the quality of implementation. In other words in the micro-management of the large investment and social expenditure allocations made in the Budget.
During the course of its deliberations, the Committee identified a number of other areas where it is exceptionally important to get the micro-economic aspects of policy and implementation right, and aligned to the thrust of macro-economy policy. These include:
The Committee also noted that Parliament and the provincial legislatures have a key role to ensuring effective implementation of the Budget and the various policies it supports through exercising proper oversight at all stages in the planning, budgeting, implementation and reporting cycle.
|
The general response to the Government’s tax proposals set out in the Budget was overwhelmingly positive. Panellists welcomed the rate and threshold adjustments to personnel income tax, the adjustments to the interest exemptions, the scrapping of the RSC levies and particularly the 1% cut in corporate tax. The new tax regime for small businesses attracted a lot of positive comment.
As expected, panellists were less happy with the changes to vehicle allowances and the increases in the two fuel levies. There were also lively debates around the secondary tax on companies and tax on retirement funds. Of interest is the fact that no one commented in the hearings on any of the excises on tobacco and alcohol.
As regards, the Governments ongoing tax policy reforms the following issues emerged:
The Committee took note of the success of the tax broadening initiatives, and the benefits that have accrued to taxpayers.
Linked to the above point, the Committee supports the policy of seeking to lower the overall corporate rate of tax, rather than focus on special tax incentives. CHAMSA and SAICA also expressed support for this approach to corporate taxation.
The Committee supports the National Treasury’s view that given the very high levels of inequality, only moderate reliance can be placed on consumption taxes, most notably VAT.
A number of panellists noted the need for progress to be made on this issue, while expressing appreciation for the reasons why the Minister of Finance did not make any changes to the status quo, namely that any tax reforms of retirement savings would need to be consistent with the any new regulatory framework for prudential investments.
CHAMSA argued that the reform is particularly urgent given the regressive nature of the tax, especially the fact that many individuals who do not qualify to pay personal income tax, have to pay 18% tax on their retirement savings. CHAMSA also argued that the tax has a negative impact on private savings.
The Committee takes note of National Treasury’s undertaking to release a discussion paper on the tax aspects of the pension fund industry, and looks forward to engaging with the issues. We note also that National Treasury indicated that its tax proposal will be related to its broader plans for the restructuring of the retirement industry.
As noted above the tax proposals elicited a lot of positive comment. The following key issues were raised in the course of the hearings and the Committees deliberations:
The proposed concessions for the business sector were seen as probably the most significant measure in the Budget.
SAICA welcomed the inclusion of personal service companies, but noted that the requirement that such companies employ four full-time employees may be counter-productive, since many of these companies have fewer employees in the early years of operation, which is exactly when they require tax relief most to ensure their survival.
SAICA also suggested that consideration should be given to extending the benefit to businesses with turnovers up to R10 million, in recognition of the importance of SMME’s to the South African economy.
While welcoming the initiatives to support small business, CHAMSA noted that care needs to be exercised to ensure that the incentives do not create a barrier to smaller enterprises graduating into larger ones.
The Committee also welcomed the tax concessions for small business.
The secondary tax on companies (STC) gave rise to some lively discussion during the hearings. The Minister of Finance noted that STC is an efficient and effective tax that encouraged companies to re-invest their profits in productive capacity. He also noted that STC is a tax on dividends and is therefore not a tax on company profits, but a tax on income. He suggested that the alternative to STC would be to tax dividends in the hands of the recipients, which if they were individuals would be at their marginal rate of income tax.
During the National Treasury’s presentation to the Committee there was some debate as to what the effective tax rate on companies is. Reference was made to a report by KPMG, which indicated that the rate was 37.5%. The National Treasury strongly refuted this, on the basis that the KPMG calculation assumed that companies paid out 100% of company profits as dividends – which almost never happens. The National Treasury showed that with a one-third profit distribution and the new company income tax rate of 29% and the current STC rate of 12.5%, the effective tax rate on company profits is between 33 and 34%. The National Treasury noted that in 2003 the effective tax rates on company profits in OECD countries averaged 37.8%, while those in the EU averaged 47.9%.
CHAMSA suggested that STC should be phased out so as to encourage investment by individuals, since its presence leads to the accumulation of large cash balances within companies, and the consequent inefficient use of such funds by the companies.
SAICA viewed the amendments to the travel allowances as unnecessarily harsh, and suggested that they should be at the very least phased in. SAICA noted that abuse of the ‘deemed system’ could have been easily eliminated by requiring logbooks to be kept for business travel, rather than increasing the deemed private kilometres. SAICA also noted that the reductions in the ‘fixed cost’ element in the schedules discriminate against taxpayers who legitimately use their vehicles for business purposes.
The Committee supports the prospective changes to the tax treatment of medical aid contributions, and looks forward to engaging with the National Treasury on the issue.
The Budget Review details an impressive range of measures SARS will be implementing in the coming year to further enhance tax and customs administration. While all panellists welcomed the measures introduced to reduce compliance costs for small businesses, very few commented on SARS’ broader efforts in this regard. Two issues did however, elicit comment:
Various panellists suggested that given the success of the foreign exchange amnesty, the Government may consider re-opening this amnesty, introduce an amnesty for the taxi-industry and possibly also an amnesty for individuals involved in aggressive avoidance schemes. SAICA suggested that a second foreign exchange amnesty may by quite productive in terms of broadening of the tax base, and may yield substantial revenue given that it could be subject to a higher levy.
However, the National Treasury’s current position is that the time for amnesties is past and it is time to begin applying the law. The Committee respects this view. It also supports SARS’ proposed voluntary disclosure dispensation whereby individuals are encouraged to approach SARS so as to regularise their tax affairs on a mutually acceptable basis.
The Committee agrees with the need to counter aggressive tax avoidance, and therefore looks forward to engaging with National Treasury and SARS on the issue, once the discussion of paper on the overhaul of the General Anti-Avoidance Rule is released later this year.
|
Committee’s recommendations: |
|
|
|
|
|
|
|
|
Two further issues worth noting were brought to the Committee’s attention during the course of the hearings:
SAICA argued that the Government should review the Income Tax Act, as well as SARS practice, in the light of the HIV/AIDS pandemic. They pointed to a number of the relevant provisions in their presentation ranging from employers contributions to funds, contributions to PBOs, the requirements for R&D expenditure, the exemption for ill-health retirement, medical expenses deductions and the fact that medical expenses cannot be taken into account when an employer calculates the amount of employees tax to be withheld. Government’s approach is that these matters should be looked at in the context of the tax treatment of the health sector as a whole – a number of changes to which are identified in the Budget Review.
Professor Williams argued that section 8B of the Income Tax Act should be reviewed. This section currently provides significant tax relief for BEE schemes known as Employee Share Ownership Plans (ESOPs). His argument was that the ESOPs in their current format would not promote BEE effectively, as it would be rational for workers to sell their shares as soon as possible. He therefore proposed that section 8B should be changed to allow the transfer of shares to trusts, which would hold the shares for worker’s benefit. He also proposed a number of related provisions that would be necessary to make such a new approach workable.
8. Oral submissions
The following people made oral submissions before the Committee, some in their personal capacity. These submissions are available on request from the Committee Section of Parliament.
__________________
Dr R Davies, MP
Chairperson: PC on Finance
8 March 2005