Report of the Portfolio Committee on Finance on the Appropriation Bill 2007/8, dated 9 March 2007:

The Portfolio Committee on Finance, having considered and examined the Appropriation Bill [B2 – 2007] (National Assembly – Sec. 77) and its related documents, referred to it, and classified by the Joint Tagging Mechanism as a Section 77 Bill, reports as follows:

1. Introduction

The Minister of Finance tabled the Budget for 2007/8, including the MTEF for the 2008/9 and 2009/10, on 22 February 2007.

On 22 February 2007, the Committee, in a joint sitting with the Joint Budget Committee was briefed on the Budget for 2007/8 and the MTEF forecast by the Minister of Finance, together with the Director-General of National Treasury and the Commissioner of the South African Revenue Services (SARS).

Between 27 February and 2 March 2007 the Committee received further submissions from National Treasury and SARS, economists and a tax specialist, as well as organised labour and business. These submissions dealt with the full range of issues raised in Budget 2007/8, as well as other related issues.

The report is structured around the following main themes that emerged throughout the hearings:

Macroeconomic framework
Fiscal Policy, Revenue trends and tax proposals
Other issues

2. Macroeconomic Framework

There was general agreement amongst the panellists that South Africa is currently enjoying the longest sustained period of economic growth, with the current upswing in the business cycle in its seventh year. The establishment of economic stability and sound macroeconomic management over the last years provided the foundation for this continued upswing.

The Committee commends Government on the fact that the 2007/8 Budget continues to build on the sound and prudent macro-economic policies reflected in a robust economy, reinforced by the high levels of business optimism. The Budget provides for further channelling of the benefits of economic expansion to increase savings, economic and employment growth, and contributes to transformation and poverty alleviation.

The 2007/8 Budget identifies the need to accelerate growth at a more rapid pace to further reduce poverty, unemployment, to eliminate inequality, modernising service delivery institutions, investing in long-term security, and protecting the vulnerable. It supports the structural development of the economy with increased expenditure in economic and social infrastructure investment, which would have a long-term positive effect on the economy. There was consensus among the panellists that the Budget identified the need for stronger exports performance through the development of a growth orientated trade and industrial policy, as it seeks to address the constraints to a higher economic growth path. Mr Jorge Maia from the Industrial Corporation of South Africa (IDC) highlighted that although we have seen a remarkable recovery of South Africa’s overall economic performance since 1994 it did not translate into significant job creation in the formal non-agricultural sectors of the economy, and the economy has become less labour intensive over the years.

The panellists welcomed the fact that the Budget sought to consolidate and expand economic growth through fiscal policy that sought to avoid the “boom and bust” of past business cycles through prudent management of the current economic upturn. Improved Government savings over the last few years, reducing future debt serving obligations further, highlighted the complimentary fiscal and monetary policies stance underlying a steady improvement in macroeconomic stability. Prudent fiscal policy will ensure the sustainability of current economic upswing. The Committee believes that the planned fiscal surplus could be seen as government’s contribution to the national savings effort.

The panellists were in agreement that the strong economic outlook is supported by global conditions, that although a slow down in the short-term is expected, global conditions remain favourable. Global economic trends remain supportive of sustained growth in developing countries, but global imbalance remains source of economic and financial risks. The reliance on short-term capital inflows, the high level of domestic consumption expenditure, and the growing current account deficit are the major risk factors for South Africa in achieving the desired growth projections over the medium term.

All presenters echoed that business and consumer confidence remains high, providing a good indication of their confidence about the performance and prospects of the economy, despite inflationary pressures and high imports. Pieter Laubscher alluded to the fact that the current buoyant economic conditions are cyclical, and a result of favourable global conditions that might change. National Treasury viewed the continued buoyancy of tax revenues as a signed of strong economic growth as tax receipts grew at a faster rate than reported GDP. This would imply a tax multiplier and the average value of the tax multiplier had gone through significant peak and troughs. National Treasury implied that this was due cyclical factors, such as swings in commodity prices, the external value of the currency and shifts in the business cycle.

2.1. Domestic economic outlook

Panellists welcomed South Africa’s improving economic growth performance and highlighted the strong dominance by the non-agricultural service related sectors. According to Jorge Maia (IDC) although the pace of growth by the manufacturing sector was below the economic average, it recorded substantial improvement in its growth performance with an average of 3% p.a. versus the 0.5% p.a. in the preceding years. He further argues that the key driver behind the sectors recovery was the strong domestic demand. Recent figures published would indicate an improvement within the sector, with construction, electricity and telecommunication sectors the major drivers. Panellists agreed that the primary sectors contribution to GDP has been substantially reduced, with National Treasury arguing that if one excludes mining and agriculture the economy would be growing at more than 6%, well within the target for 2010.

The growth rate has substantially increased to an average of 5% projected over the MTEF period, marginally better that the ASGI-SA target of 4, 5%. Pieter Laubscher, chief economist at the Bureau for Economic Research (BER), concludes that the growth rate is more stable and sustainable and that the growth rate over the last three years was underpin by strong household consumption as well as gross fixed investment of above 9% since 1993.

The panellists highlighted the fact that the demand side has driven the growth, while the supply side had been fairly muted. Net export made a strong negative contribution to economic growth with a sharp increase in domestic demand resulted in the widening of the output gap.

2.2 Inflation

CPIX inflation has remained within the 3 – 6 % target range for 41 consecutive months averaging at 4.6% in 2006. The rising oil price, along with acceleration in food prices, contributed to the higher inflation rate. The business community welcomed the better coordination between fiscal and monetary policy. The short-term interest rates seemed to have peaked, however, but risks do remain. The panellist agreed that fiscal policy supportive of the need for a higher level of domestic savings would make the implementation of monetary policy easier. The inflation outlook has improved since the end of 2006, and inflationary expectation seems to be well anchored.

2.3 Current Account deficit

The strong expansion of domestic spending and imports over the 2004-2006 period, combined with a poor export performance over the 2002-2006 period, 3% on average per annum, led to the widening of the current account deficit. Government argued, supported by the panellist that the current account deficit not only reflected the imbalance between investment and savings, but that the country was consuming more than it had produced, with the difference being imported.

Pieter Laubscher (BER) further concluded that the strong currency played an important role in constraining manufacturing exports, stimulated by domestic spending and import demand. Prof Ray Parsons said during the hearings that “South Africa is currently having too much investment chasing to little savings” resulting in the widening of the current account deficit. A concern from the business community was how Government would further stimulate the supply side of the economy to address the current imbalance.

Although the current account deficit had risen from 4.2% of GDP to 5,7% of GDP since last year, stimulated by the increase in import levels, high oil prices and sharp increase in South African Customs Union (SACU) payments, Government and business remained optimistic, as this would be offset by strong capital inflows. Factors underpinning this view were the stable macroeconomic climate and the improved economic growth position.

The Committee commends Government on its fiscal stance as it helps to sustain growth by improving Government savings and prioritising spending programmes, thus strengthening the economy. The Committee would caution Government on its reliance on portfolio investments, adding that it needs to attract foreign direct investment to address this imbalance. Pieter Laubscher (BER) cautioned against this reliance as the direction of these inflows was globally determined. Government, however, is committed to improving export performance through appropriate industrial policy initiatives.

2.4 Exchange Control

The Budget contained few announcements with respect to further exchange control relaxation, with the gradual approach still in place. The Committee welcomed the announcement that the current shareholding threshold for foreign direct investment outside of Africa is to be lowered from 50% to 25%. This will make it easier for companies to engage in strategic international partnerships.

3. Fiscal Policy

The continued expansionary fiscal stance adopted received widespread endorsement by all commentators, as it supports the growth momentum. Pieter Laubscher (BER) alluded to the fact that as fiscal policy continued on its expansive phase, Government had to guard against stimulating the consumption side of the economy.

The strong fiscal position underpins the medium term policy objectives of job creation, modernising service delivery institutions, accelerating economic growth and tackling crime. As highlighted in the Budget Review of 2007, the Budget continues to build on the gains of prudent fiscal management to make a further contribution to economic growth and social development.

Expectations are that the economy will to grow 5% a year over the medium term, reaching 5.4 % in 2009 in line with the ASGI-SA target, with inflationary expectations to remain within the target range. The 2007 Budget reflects real growth in non-interest expenditure by an annual average of 7.7% over the medium term.

The Budget reflects quite strong expenditure over the MTEF both in terms of current payment of 11% and wages and salaries of 10%. Dawie Roodt highlighted that Government’s spending trajectory was faster than the rate of economic expansion, with social expenditure (education, housing, health and social development) the main beneficiaries.

Gross fixed investment is forecast to increase rapidly with R410 billion Government infrastructure programmes accompanied by higher levels of private sector fixed investment. Jorge Maia from the IDC highlighted in his presentation the positive spin-offs of infrastructure growth, of increased demand inputs, the manufacturing of capital goods and transport equipment, and the crowding in of private sector investment through effective infrastructure. He further argued that in order to achieve the ASGI-SA targets of 6% GDP growth, fixed investment activity for the economy at large had to accelerate by more than 13% per year over the period 2011 to 2014.

3.1 Budget deficits and surplus

The 2006 Medium Term Budget Policy Statement (MTBPS) announced a projected surplus of 0.5% of GDP for the fiscal year 2007/8. Due to strong revenue growth the revised predictions for 2006/7 forecast a budget surplus of 0.3% to GDP and a surplus of 0.6% of GDP forecast for 2007/8.

Jorge Maia (IDC) argued that prudent fiscal policy and continued improvements in tax collections resulted in a shift in Government balance from progressively lower deficits towards a budget surplus, hence enabling a developmental approach to fiscal expenditure going forward. The broadly balance budget over the MTEF period was welcomed by all commentators, as it is positive from both a confidence and credibility point of view. Pieter Laubscher (BER), although welcoming the budget surplus, cautioned that, from a cyclical perspective, this might stimulate the demand side of the economy.

4. Tax Policy

The tax policy framework seeks to broaden the tax base, taking cognisance of societal realities, by minimising the distortionary impact that taxes may have on economic growth and employment creation. The tax reforms support accelerated growth in job creation and poverty alleviation, while at the same time encouraging individual savings. The buoyant tax revenue over the past three years was due to strong economic growth and the broadening of the tax base, coupled with the efficiency of SARS. The broad underpinning principles of the 2007 Budget’s tax proposals are:

Supporting economic growth, investment and job creation, business development and confidence
Promoting financial security of households and reducing their vulnerability through retirement reforms that encourage savings
Supporting macroeconomic policy objectives.

The Budget provides for individual tax relief of R 8.4 billion, which, according to some commentators provide further stimulus for consumer spending, with total net relief of R12.5billion.

As the GEAR policy intention was to maintain a ratio of tax-to-GDP of about 25%, the increase from 26.4% to 27.9% of tax revenue as percentage of GDP was met with concern by certain commentators.

4.1 Corporate Income Tax (CIT) and Secondary Tax on Companies (STC)

Robust debate on the global competitiveness of the South African corporate tax structure was evident during the hearings on the Budget. BUSA/CHAMSA argued that to encourage Foreign Direct Investment (FDI), the CIT should be internationally competitive, as a lower CIT rate would attract investment. Pieter Laubscher argued that CIT had been a major source of the revenue overrun, and that going forward, fiscal policy had to consider the tax burden borne by companies. Tax relief to companies would stimulate the production side of the economy. Government was not convinced that a reduction in CIT would automatically lead to supply side benefits as suggested by business.

The Committee requested that in the debate on the international competitiveness of the tax system, commentators should not be selective in their comparative analysis of international CIT, as information provided by National Treasury and SARS indicated that South Africa compared favourably with other countries. National Treasury was of the view that the current tax system in South Africa is not an impediment to investment and resource allocation had to be based purely on commercial grounds and not tax decisions only.

In supporting and encouraging business development and confidence the Government announced the phase-out of secondary tax on companies and replace it with a dividend tax. This would be two phased approached as the dividend tax would be applied at a rate of 10% down from 12, 5%. The second phase, commencing in 2008, would entail the conversion to a dividend tax on shareholders, with administrative enforcement through a withholding tax at company level. The Committee welcomed this, as it is in line with the international norm, and also would have a stimulatory effect on business.

5. Social Security Reform

Improved economic performance has created the fiscal space that allowed Government to move towards a social security system that provides income security for all. Despite the economic upturn, the Committee recognised that poverty and unemployment remain a major challenge for government. The Committee welcomed the proposal by Government to introduce a broad-based social security framework over the 2001-2010 period. This would involve a broadening of social security reform to include an earnings-related contributory system. If the principles mentioned – those of equity, pooling of risks, mandatory participation, and administrative efficiency - are adhered to, it could be a force for greater social stability and increase the levels of personal savings.

The Committee welcomed the commitment by Government that all details on the earning-related social security tax system, the wage subsidy and revision of retirement industry would be tabled, and an all-inclusive consultative process would be undertaken before the new dispensation was finalised.

5.1 Savings and Retirement fund reform

Over the past two years the Committee has provided a platform for the discussion on retirement fund reforms. The Committee welcomed the recent announcement in the Budget of proposed reforms to retirement funds savings as part of the broader social security reform process. Business supports the proposed reforms and will contribute to the debate as a social partner at NEDLAC.

The Committee, business and labour sectors welcomed the abolition of retirement fund tax, urging trustees to be vigilant in ensuring that the benefits accrue to the intended beneficiaries.

6. Concluding comments

South African is experiencing sustained growth, with the management of public finance creating the fiscal space to step up spending in key areas. The previous Budgets had laid the foundation for future sustained economic growth, job creation and alleviating the plight of the poor.

The growth outlook remains positive over the medium term, strongly supported by investment. Investment would continue to grow underpinned by public corporation’s and departments capital investment programmes. Export growth is expected to exceed 6% over the MTEF as it benefits from significant investment in new capacity and continued international demand.

The projected softening in consumption expenditure and possible moderation in the exchange rate would ease import volume growth. The continued strong investment expenditure means that capital import growth might remain high. This will be good as it contributes to the productive capacity of the economy.

Despite the upward pressure on the CPIX it is expected to remain within the target range. The fiscal stance adopted by Government provides a buffer against economic instability and the fiscal space allows for reforms on the social front.

The proposal to introduce a broad-based social security system will seek to address the legacy of discrimination and inequality, and will work toward the elimination of poverty.


7. 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 L Kganyago, Director-General: National Treasury
Mr P Gordhan, Commissioner of SARS
Mr Pieter Laubscher, BER: Stellenbosch University
Mr D Roodt, Chief Economist: Efficiency Group
Mr Hennie Bester, Director: Mallinicks
Mr J Vilakazi, CEO: BUSA
Prof R Parsons, Business Unity South Africa (BUSA)
Adv A Meiring, BUSA
Mr R Baxter: Chief Economist: CHAMSA
Ms Riefdah Ajam, Federation of Unions of South Africa (FEDUSA)

Report to be considered.