Report of the Portfolio Committee on Finance on the Appropriation Bill 2006/7, dated 16 March 2006
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The Portfolio Committee on Finance, having considered and examined the Appropriation Bill [B2 – 2006] (National Assembly – sec. 77) and its related documents, referred to it, and classified by the JTM as a section 77 Bill, reports as follows:
1. Introduction
The Minister of Finance tabled the Budget for 2006/7, including the MTEF for the 2007/8 and 2008/9, on 15 February 2006.
On 16 February, the Committee, in a joint sitting with the Select Committee on Finance and the Joint Budget Committee was briefed on the Budget for 2006/7 and the MTEF forecast by the Minister of Finance, together with the Director-General of the National Treasury and the Commissioner of the South African Revenue Services (SARS).
Between 7 and 10 March the Committee received further submissions from National Treasury and SARS, invited economists and tax specialists, as well as organised labour and business. These submissions dealt with the full range of issues raised in Budget 2006/7, as well as certain other related issues.
The reports is structured around the following main themes, which emerged from the abovementioned briefings and hearings, and the Committee’s own discussions.
Macro economic framework
Fiscal Policy
Revenue and tax proposals
Other issues
These hearings took place within the context of an emerging market economy faced with the challenges of the shortage of suitable skilled labour, unemployment and poverty, and the limited uptake of investment opportunities.
2. Economic Policy and outlook
The economic outlook for the (MTEF) period remains positive, and continues to improve. The higher than expected growth rate for 2005, the expected average of 5% over the medium term, and the efficacy of SARS, bodes well for the economy.
The expansionary stance adopted since 2001 continues, with an increase in real expenditure in pursuit of achieving the Accelerated and Shared Growth Initiative South Africa (ASGI-SA) goals. Social Services received real increases in spending of R871bn over the MTEF and R262bn in 2006/7. While social services account for 57%, in the current fiscal year, education receives the single largest expenditure in this category. There are also significant increases in infrastructure development of R372bn over the current MTEF. Infrastructure development represents an annual growth rate of 14.2% with an allocation of R113bn for 20006/7. The renewed commitment to skills development, seeks to address the constraints to growth in the economy recognising that these are some of the pillars of ASGI-SA.
During the hearings Prof S van der Berg highlighted the increase in social spending, noting that fiscal resource shifts did not necessarily translate into real resource shifts. He added that the sustained improvement in poverty reduction, through increased social spending, requires economic growth and investment in human capital. The expanded grant system had an impact on poverty reduction, but not enough jobs were created. Van der Berg points out that despite the increase in resource allocation, the lack of efficient social spending continues to challenge the country. This constraint is also identified in ASGI-SA.
Underscoring the Government’s main policy aims of reconstruction and development is the fiscal stance adopted which offsets the impact of the commodity price cycle and the robust consumption. This is further highlighted through ASGI-SA which identifies that the recent growth, although welcome, is unbalanced as it is based on strong commodity prices, capital inflows and domestic consumer demands, increased imports and strengthened the currency beyond desirable levels.
The risk associated with this unbalanced growth has also been highlighted by the Minister of Finance who pointed out that the current boom in commodity prices is not sustainable in the absence of support on the production side, and that outlook for capital flow going forward is important to maintain the higher growth rates. The policy choices, faced by government, had to take these risk factors into account with an anti-cyclical fiscal stance that supports growth, while moderating the impact of consumption expenditure and commodity prices on growth.
Both economists who appeared before the Committee, Prof B Smit and Mr Jac Laubscher, identified these risks as constraints to growth. Mr Laubscher argued, that historically, economic growth has been followed by a period of recession where commodity prices and capital inflows was the major catalyst for growth. The recessions in 1981 and 1994 were due to a fall in commodity prices, and capital outflows.
2.1 Higher growth path
In the MTBPS, government presented an optimistic view of economic growth for the years 2006/7, 2007/8, and 2008/9. The higher than expected growth rate for 2005/6 of 5%, the growth trajectory of 5% and CPIX expected to remain within the target range of 3-6 per cent over the MTEF, further underlines that the economy is on a structurally stronger growth path.
A number of factors underpin government’s positive economic outlook:
Sound and sustainable macroeconomic platform;
Favourable global economic conditions, particularly the recovery in Japan, (significant for South African exports) strong growth in China (an average of 8,9% to GDP over the last three years and a significant importer of commodities), and robust growth in Africa;
Improved policy coordination between National Treasury and the Reserve Bank in keeping inflation within the target range, moderate interest rates and reduced cost of capital; and
Rise in commodity prices.
2.1.1. Consumer led growth
One of the principle drivers of economic growth has been the high level of domestic consumption expenditure. During the MTBPS hearings last year it was identified as a significant weakness of the current growth trend. Government realised that the reliance of household consumption is not sustainable.
The extended upswing of the economy did not have a significant impact on the manufacturing sector. Growth remains modest. Prof B Smit is of the view that the strong currency is the reason for the decline in the manufacturing sector. Mr Jac Laubscher believes that while the strength of the currency has had an impact on this sector, however the effect of globalisation has had a significant negative impact on the manufacturing sector. The upward trajectory is expected to continue within the construction industry.
Commodity Prices
South Africa being a commodity exporter has benefited from the increase in commodity prices. The strong global demand for commodities, as a result of strong global economic growth, is led by developing economies such as China and India.
Mr J Laubscher supports the view of the Minister of Finance that the high commodity prices are not sustainable. He highlighted the fact that China and India could, in the future, become commodity suppliers. He believes that the commodity boom is cyclical. The risk factors to economic growth are the collapse of the housing market in the United States of America (USA), the current account deficit of 6% to GDP (USA), the standoff regarding the Iran nuclear situation and the avian flu pandemic that will cause a global economic slowdown. Any softening of the commodity market prices will affect South Africa, but not to the extent it will have had in the past, said Mr Laubscher.
Taking the history of economic growth into account, the Committee concurred that commodity prices have in the past negatively impacted on economic stability. However it also recognises that the country has shifted from its singular reliance on one or two commodities to a more diversified economy supported by sound macro economic fundamentals.
Accelerated growth and labour participation
Raising the level of economic participation is key to ensuring that government sustain and improve on the growth forecast over the MTEF. Lack of suitable skills has been identified as one of the constraints of the ASGI-SA. The 2006/7 Budget continues to remove constraints on growth through broadening access to economic activity that will encourage the accelerated increase in the creation of new jobs.
R372bn allocated to infrastructure over the MTEF period, which supports a wide range of public sector programmes is seen as part of the new initiative. The allocation of R4bn broadens government’s reach through the expanded public works and employment programmes. The targeted land reform initiatives, the agricultural support programmes, and housing and community investment should further enhance participation.
Current account deficit
The current account deficit has risen to an estimated 4.2% of GDP, the highest since 1980’s. This has been fuelled by the strength of the Rand, growth in imports fuelled by rising incomes and long-term accelerated growth expectation. Although the deficit widened it has been adequately offset by a strong financial account surplus. Both economists raised concerns around the growth of the deficit, as they believe it may have an impact on the ASGI-SA.
Household savings
The Committee is concerned at the low household savings and its impact on the economy. Mr Jac Laubscher concluded that the household savings rate is the lowest since 1952 and national saving the lowest since 1949. He believes that this brings into question government’s ability to achieve the projected growth rates.
Skills
The Minister of Finance, during the hearings, highlighted the importance of investment in infrastructure and human resource development, as key in expanding the growth opportunities for the economy. The capacity constraints limit government’s ability to spend effectively to ensure delivery.
Government commitment to address this constraint is reflected in the significant allocation to social spending that increases by R10bn to R92bn in 2006/7 rising to R110bn in the last year of the MTEF. This priority is also reflected through additional spending in the 23 SETA’s.
Evidence presented to the Committee by Prof van der Berg, not inclusive of data from 2004, suggests that the social outcomes for education have not been achieved. Fiscal resource shifts has taken place, however efficient application of these resources in the process of social delivery should be the focus, he said.
3. Fiscal Policy
All commentators endorsed the expansionary fiscal stance adopted by government. Since 2001 debt service costs have declined significantly, and released resources to expand the social net. The fiscal stance outlines support for growth while moderating the impact on consumption expenditure. This could be referred to as the conservative part of the budget and is in line with government’s anti-cyclical fiscal stance. This seeks to address the concept of a "boom and bust" by taking account of the risk factors inherent in an expansionary budget.
Government must be commended that although they have increased real expenditure, they were mindful of the risk that the current economic conditions present.
3.1 Real increases in expenditure
Government received an endorsement from the Committee for the expansionary fiscal stance adopted. Positive reactions were received to the real increases to allocations to education and skills development, social welfare, R&D, HIV and AIDS, and infrastructure investment.
3.2 Deficit reduction
The smaller deficit is due to larger than expected revenue collections of government. During the hearings on the MTBPS the Committee suggested that the surplus funds should be utilised to service debt. This is consistent with sound fiscal management that seeks to reduce the deficit during an upswing of the business cycle, allowing itself the necessary space when the economy slows down.
Economists agree that the government is mindful of the risk, through maintaining expenditure at the level as outlined in the MTBPS, and increasing their foreign reserves from US$7.6bn to US$22bn at the end of January 2006.
Some economists have seen the deficit reduction as a measure of government’s success story. Maintaining a low deficit during the boom time allows for space to increase deficit if economic conditions worsen. Maintaining the low deficit is the best indication of government’s intention not to contribute to the boom on the expenditure side, despite the tax relief.
Increase in tax revenue to 26.4% of GDP
Commentators were concerned about the higher than expected increase in revenue of 26.4% as government is committed to keeping it 25% to GDP. This will not necessarily contribute to sustained growth. The Committee recognises that the SARS depends upon other projections especially those published by Statistics South Africa on GDP and the actual performance of the economy and improved tax collections. The projected decline of tax revenue as percentage of GDP over the MTEF is noted. 4. Tax Policy
Tax reforms over the last decade have bolstered government’s revenue raising capacity. These reforms include broadening the tax base, reduction of the marginal tax rate at the lower end, adjustment of brackets to address bracket creep, improving tax administration and building a culture of tax compliance. These successes are the product of sound tax design that took cognisance of societal realities. Increases in resources ensured that allocations infrastructure development and social services have increased while promoting economic growth. 4.1 Tax proposals
The 2006/7 tax proposals will continue to provide the necessary stimuli in ensuring an upward trajectory in economic growth. The tax proposals outlined in the budget continues to build on these achievements and supports the goals of the accelerated and shared economic growth initiatives by promoting long-term retirement savings, small business development, investment in research and technology, skills development, and home ownership.
Commentators, who however raise a number of issues during these hearings, received these tax proposals positively.
4.1.1 Corporate Income Tax (CIT) & Secondary Tax on Companies (STC)
Most commentators supported government’s decision not to reduce the CIT rate. Since 1994 to 2005 the CIT rate dropped from 40% to 29% and compares favourably internationally.
The business community, represented by BUSA and CHAMSA, expressed the view that an expectation is created that since the 1% reduction in the CIT rate last year, government will have adopted a gradual approach of reducing the rate. They argue that to encourage investment the CIT rate should be internationally competitive. The decisions that informed the investor is not only the CIT rate per se, but whether there is an efficient tax administration system that is predictable and reliable. The current tax system in South Africa is not an impediment to investment and resource allocation should be based purely on commercial and not tax decisions.
Prof M Katz supported by National Treasury, believes that the reduction in the CIT rate without a reduction in the maximum marginal rate of individuals will result in tax arbitrage. The combined rate of CIT and STC of 36.9% ensures that the difference remains 3% and eliminates tax arbitrage. The total tax burden on the business community has been reduced with the abolition of the Regional Services Council (RSC) levies.
The Business community calls for a critical re-evaluation of the appropriateness of the STC in the context of international competitiveness of the CIT.
The Committee shared Prof Katz’s view that there is a danger of tax arbitrage if there is a reduction in the CIT rate without reduction in the maximum rate of individual PIT.
4.1.2 Regional Services Council levies
The abolition of the RSC levies is welcomed. The reduction in compliance cost, and lowering the tax burden on key economic activities provides the necessary incentives to ensure long-term economic growth. Business received a significant direct tax relief to the amount R7bn for 2006/7 and totalling R24bn over the MTEF period.
As outlined in the 2005 MTBPS, Treasury is exploring alternative instruments that will replace the RSC levies. Commentators noted that no announcement regarding an alternative has been made, and this provided the business sector with appropriate tax relief. SAICA called for the permanent abolition of the RSC levies, but the business community were in principle not opposed to finding alternative funding arrangements.
4.1.3 Tax relief – Small Business
The Committee recognised the importance of broadening economic participation and creating opportunities for small businesses. Given that this sector contributed to accelerate growth in employment and the Committee welcomes the improvement in the economic environment of small businesses. The adjustment in the monetary tax thresholds will promote job creation and contribute to economic growth. The Committee supports the decision that "cooperatives that operate like small businesses will enjoy the same level of benefits".
The business community raised the concern that no relief is announced to provide tax relief to the small service sector businesses. SAICA and the business community hope that during the review to amend the definitions relating to "small business corporation" and "deemed employee" it will secure a tax regime that will foster the growth of small business in the service sector.
4.1.4 Tax Amnesty – Small Business
The announcement of amnesty to small business amnesty is welcome, as this will afford businesses, currently outside the tax net, with the opportunity to regularise their tax affairs. The Committee is in agreement that this is a bold initiative that will effectively achieve a broadening tax base.
The Committee welcomes this bold initiative that effectively enables small business to take advantage of procurement opportunities in the public and private sector.
Tax on Retirement Fund Industry
In 2004 the Committee provided a public forum to discuss costs associated with retirement fund instruments. This hearing was in response to a paper presented by Mr R Rusconi at the Actuarial Society of South Africa Conference. In 2005 the Committee again provided the necessary forum for the industry and government to engage the draft paper on the Retirement Fund Industry, as it has identified the cost factor as a major concern.
BUSA welcomed the announcement to reduce tax on retirement funds as this tax impacts negatively on the lower end of employees. In its opinion the regressive nature of the tax has a negative impact on private savings and therefore will improve savings. Various other commentators called for the scrapping of tax on retirement funds.
Government also announced that progress has been made with respect to regulatory reforms within the retirement industry. A discussion paper will be released shortly that will propose certain changes to the regulatory environment and tax reforms.
R & D incentives
Broadening of the tax base, minimising expenses, incentives and good taxation should always be the objective of tax policy. Government believes that investment in R & D and innovation is an investment in knowledge and human capital. Providing the necessary incentive to R & D will lead to economic growth through new technologies, and development of new products. The business community welcomed these measures.
Prof M Katz was supportive of R &D initiatives broadly, however he raised a concern about the proposed deduction of 150% on R & D expenditure. He argues that historically, whenever an incentive has been given that gives more than 100% deduction expenditure incurred leads to wasteful expenditure, and abuse. Prof Katz is of the view that R & D support should not be given through the tax system but through the accelerated depreciation allowance for capital expenditure.
Impact of HIV and AIDS on Growth
Prof B Smit informed the Committee that clear benefits are emerging from government implementation of government HIV and AIDS treatment plan. He argues that SA loses 0.5% growth per year, and although this is not likely to have an impact on growth going forward, it gains 0.1% of growth since the provision of the antiretroviral (ARV) drugs to sufferers. The cost of between 15% - 20% is recouped.
Concluding comments
The resources allocated to infrastructure underpin capital expenditure, which is one of the drivers of this expansionary policy. Over the past ten years government macroeconomic policies have developed an environment to encourage investment. The Committee believes that now more than ever the investor community should begin to directly contribute to radical reduction of poverty and unemployment.
The significant reduction in the deficit and utilising the surplus fund in the financial current to increase the foreign reserves rather than simply immediately utilising these funds in unsustainable expenditure was in the Committee’s opinion a wise decision.
Tax amnesty for small businesses including cooperatives operating as small businesses supports their growth in the reduction of unemployment.
Recommendations
Effective oversight on the Appropriation Bill is directly linked to the exercise of oversight on the MTBPS. In future, to exercise oversight effectively, more time should be allocated within the parliamentary programme for both processes.
To ensure efficient expenditure of allocated resources in social services, in particular education and the SETA’s to achieve suitable skills output, requires:
Efficient and effective output targeting, implementation and management of allocated resources;
Regular tracking as well as timely and strategic intervention; and
Integrated implementation of cross-cutting measures;
7.3 The Committee is of the view that the extra 50% proposed incentives for R & D requires further discussion.
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.
Mr T Manuel, Minister of Finance
Mr J Moleketi, Deputy Minister of Finance
Mr L Kganyago, Director-General: National Treasury
Mr P Gordhan, Commissioner of SARS
Mr L Worth, Chief Operating Officer: National Treasury
Mr K Naidoo, Acting Deputy Director-General: Budget Office
Prof S van der Berg, Stellenbosch University
Mr J Laubscher, Chief Economist: Sanlam
Prof B Smit, BER
Ms J Arendse, South African Institute for Chartered Accountants (SAICA)
Mr N Nalliah, SAICA
Prof M Katz, Edward Nathan & Associates
Mr L Verwey, IDASA
Prof R Parsons, Business Unity South Africa (BUSA)
Adv A Meiring, BUSA
Mr D Kruger, CHAMSA
Ms P Drotskie, CHAMAS
Mr K Warren, CHAMSA
Ms G Humphries, Federation of Unions of South Africa (FEDUSA)