Treasurers’ Conference – South Africa’s fiscal predicament

Michael Sachs, Adjunct Professor at the Southern Centre for Inequality Studies at the University of the Witwatersrand, describes in detail the precarious position of the South African fiscus and what needs to be addressed as a matter of urgency in order to avoid a crisis.

What underlies South Africa’s fiscal predicament?

The predicament is that South Africa's national debt is not stabilizing and continues to rise. People usually argue that this has to do with high spending, corruption, inefficiency and waste in government others argue that we need to raise taxes rather than reduce spending. These are important arguments, but I want to talk about deeper underlying factors behind the fiscal predicament and those are high inequality, weak state capacity and low growth.

High inequality

If you break up the population in line with household income, you have the affluent top at 10% of the population, the middle at 40% and the bottom at 50%. 72% of taxes are paid by the top 10%, 25% by the middle 45% and 4% of taxes paid by the bottom 50%. If you look at government expenditure, almost 60% of it goes to the bottom 50% compared with only 6% to the top 10%. This is a fiscal lens through which we can see the inequality in South Africa, which leads to political polarisation. There’s usually a strong connection between taxation and politics. The American Revolution was fought under the slogan ‘no taxation without representation’. The idea was that if you're going to tax us, we need our own Parliament. In South Africa, the bottom 50% are the majority of voters. They receive expenditure, but they don't contribute much to taxation. This is because the bottom 50% of the population only receive around 3% of the national income. They can’t pay taxes because they have no income. So, immediately there is a polarization in fiscal policy. If you are confronting a situation like South Africa faces now, and we lower expenditure to reduce debt, whichever way you slice it, it means lowering the quality of life for the bottom 50% who depend overwhelmingly on public services. Raising taxes or lowering taxes is felt only by the top 10% of the population who are a minority in Parliament. This makes political discussion about how to come out of South Africa’s fiscal predicament extremely polarised. Added to this, we have an underlying problem of segregation in the provision of collective goods. We have a dual system of education with public education, which the bottom 50% rely on entirely and private education, which the top 10% rely on entirely and pay for. The same is true of healthcare, security, pensions and housing.

We can think that the way to solve corruption and inefficiency is for the public sector to become more effective and efficient. But there's a large body of literature that says if you have an education system where only the poor send their children, that will inevitably be a weak education system. A strong education system is where you have middle class and poorer, working class people in the same schools.

Segregation also weakens the capacity of the state and weakens those public services, which are fundamentally divided between the affluent and the poor.

Low growth

Nominal GDP growth was very high in the period leading up to about 2011/2 and since then it has collapsed. Over a long period of time, nominal GDP was declining. Between 2005 and 2012 there was a substantial increase in government expenditure. This was very deliberate and well targeted and employed more police officers, teachers, nurses and doctors in the public health system in the hope that sustainable growth would render those decisions right. After raising the levels of expenditure, growth collapsed. Expenditure over the last ten years has been very stable, but we’ve been unable to reduce expenditure to meet the lower rate of economic growth. This is because reducing expenditure impacts directly on the consumption patterns of the poorest in society.

Breaking out of the vicious cycle?

We are in a vicious cycle. High levels of inequality lead to political division and segregation in the provision of collective goods, which leads to weak government and weak public services. As soon as you become affluent, you shift out of the public service and you purchase your own private services. It leads to uncertainty about property rights because of the huge division between the rich and the poor. People start talking about land expropriation without compensation and all of this leads to low growth. Low growth leads to rising unemployment and poverty, increasing strain on public expenditure because the unemployed and the poor depend more on that public expenditure. It slows tax collection and leads to rising public debt. Rising public debt leads to high government interest payments, which is essentially a transfer to the affluent. This leads to rising inequality and ultimately again leads to uncertainty about property rights, because if we begin to imagine that the state may not be able to honour its debts, that is a fundamental fundamentally about property rights. South Africa is in a fiscal predicament. If the fiscal predicament is really an outcome of these realities, without decisive action to break this vicious cycle of inequality and low growth, we are unlikely to escape from the fiscal predicament. Unfortunately overcoming these issues is not on anyone's agenda - neither the government nor affluent South Africans. People tend to be concerned with how we can transform the privately provided services to eliminate the racism that still exists in that sector on the one hand and improve efficiency in the public sector on the other. My contention is that there's a limit to how much efficiency you can get in the public sector when the public sector provides services only to the poor.