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By now we are all aware that it is more than likely that SARS will miss its 2018 revenue collection target that it set a year ago by R51bn. The budget deficit (i.e. the gap between government expenditure and income) for the first eight months of the tax year from April to November 2017 widened to a record R195 billion as tax collections lagged due to a slowing economy, low business confidence and a possible slippage in compliance by taxpayers. Sadly, there’s no light at the end of the tunnel for the remaining months of the 2018 tax year – in fact, the budget deficit is expected to widen even further due to unplanned expenditure (to the tune of R40-R60 billion rand) as a result of former President Jacob Zuma’s announcement to implement free tertiary education for low income households. In addition, the unexpected expenditure on water infrastructure and maintenance due to the worsening drought in the Western Cape is further adding to the Government’s spending woes.
Amidst all this doom and gloom, Finance Minister Malusi Gigaba will be in the spotlight when he presents his maiden budget speech on Wednesday, 21 February. He has the unenviable task of convincing the country, investors and international rating agencies that he has a feasible plan to grow the economy, reign in government expenditure and curb the budget deficit.
Many would say that he is stuck between a rock and a hard place with nowhere to turn. Let’s look at some of the options available to him.
VAT There is speculation that the VAT rate, which has been unchanged at 14% for the last 25 years will be increased. Experts advise that an upward adjustment of just 1% would result in a gain of R22 billion, while a 2% increase would provide a whopping R48 billion for the fiscus.
The alternative to a uniform rise would be to adjust certain elements of the VAT system, for example, changing the zero-rated status of some items like fuel and certain foodstuffs. However, applying a standard rate of VAT (i.e. 14%) to fuel would immediately drive up the cost of bus and taxi services, which the majority of commuters can ill afford. This increase would wreak havoc on the transport industry – we think it’s too radical an adjustment to make and will not be worth the public outcry that will ensue. Tough times call for tough measures though and so perhaps our optimism is misplaced.
Another option would be to implement a tiered VAT system like in the UK, whereby luxury or non-essential items which are more likely to be consumed by the wealthy (think cigars, alcohol, movies) attract a higher rate. While this approach won’t affect the lower income segment, which is important, it is a complex system to implement and considering the nominal increase in revenue that will result, it probably won’t be worth the pain in the long run.
Although it will be a controversial decision, as it will directly affect the poor, we think an increase in the VAT rate is a distinct possibility. The VAT rate of 14% is relatively low by international standards and a 1% uniform increase is the simplest way to generate the largest amount of revenue needed. Given the enormous pressure Treasury is under, they will need to make some tough decisions, and this may just be one of them. This will affect every citizen, even if you are not an income taxpayer as most of the good you consume will become more expensive.
Capital Gains Tax Capital Gains tax (CGT) inclusion rates were increased in 2016 to 40% inclusion rate for individuals (i.e. maximum effective tax rate of 18%) and 80% inclusion for Companies and Trusts (maximum effective tax rate of 22,4%). Investors breathed a sigh of relief last year, when no changes were made. However, once again this tax, which predominantly affects the wealthy, is under scrutiny. For the 2018/2019 budget the Davis Tax Committee have recommended an increase in the CGT inclusion rate for companies from 80% to 100%, as part of the funding for tertiary education. If this change is made, it seems likely that the inclusion rate for individuals will increase as well, perhaps to 50% meaning a highest effective rate of a whopping 22.5% for taxpayers earning more than R1.5m a year Investors brace yourselves - watch this space! Corporate Tax
The corporate tax rate is currently 28% in South Africa and most analysts do not predict a change here. We agree with this sentiment - an increase would deter foreign investment and hinder economic growth, which South Africa can ill afford. Corporate Tax also raises the least of the 3 big taxes and a higher rate will not help plug the fiscal gap.
Personal Income Tax It is estimated that there are only about 7 million taxpayers in South Africa out of a population of 56 million people (i.e. 13%). This relatively small tax base already faces high tax rates, with limited benefits received. Many middle to high-income earners are under financial pressure due to the additional burden of paying for private medical care and schooling.
Applying more pressure to this group could increase emigration rates and cause a potential slippage in tax compliance, which is already a concern.
In the light of the above, and the fact that the super bracket for the very wealthy (45% for those earning above R1,5m) was introduced just last year, we don’t foresee any major increase in personal income tax rates. Other experts are talking up another 1% increase for the top brackets which would be another way to raise revenue. If this happens, watch for rating agencies to take a good long look at future revenues. Short term gains often have long term losses.
There will be the usual adjustment in the tax brackets for inflation – so, as you earn more, the tax rates are adjusted accordingly so that you are not poorer than you were last year. However, we think Treasury might be unkind to middle to high-income earners by under-compensating for inflation in these brackets to sneak in some additional revenue here. Effectively what this means is that middle and higher income earners will actually be worse off in terms of the real value of their incomes. Lower income earners, usually those earning less than R250 000 should still receive the majority of an inflation change in brackets.
Medical Schemes Tax Credit Medical scheme members currently receive a medical tax credit of R303 per month for the first two beneficiaries and R204 per month for the remaining medical scheme members. Unlike an expense deduction, which reduces taxable income, the medical credit is a direct deduction against the taxpayer’s actual tax liability and therefore is a set amount, which is not dependent upon the taxpayer’s income level. These medical credits cost the fiscus approximately R22bn annually.
Treasury have indicated that they are considering the reduction of this medical tax credit in order to fund the National Health Insurance (NHI). However, experts warn to tread carefully in this area – people are dependent on this credit in order to access private medical care. They are essentially being compensated for not accessing the government health service. The government health system can’t cover everybody and therefore it relies on people seeking alternative (expensive!) private health care and therefore should incentivise taxpayers accordingly.
We think the medical credit is here to stay (for 2018/2019 at least), but there is a possibility it won’t be increased for inflation this year. This will generate approximately R1bn revenue.
We do believe however that for the 2019/2020 year perhaps this tax credit will be eliminated or reformed. The pain may therefore be pushed out a year.
Sin Taxes Taxes on alcohol and tobacco were hard hit in the 2017 budget, and this an area which government usually uses to generate some additional revenue. We can expect some adjustment here again, although probably not as extreme as last year.
Sugar Tax Think twice before you reach for that coke! Sugar tax will be introduced from 1 April 2018 and is expected to raise approximately R1bn for the fiscus.
Fuel and Road Accident Fund (RAF) Levies The General Fuel levy is currently at R3.15 and the Road Accident Fund levy R1.63. Together these levies feed into the cost of fuel and make up about a third of the cost of a litre. The government has increased them above inflation since 2013, with last year’s increase being 9%. We predict an inflationary increase in these levies for 2018 – anything higher would aggrieve motorist and road users even further, when combined with a potential VAT increase.
Wealth Tax A very controversial possibility which we may see in the budget on Wednesday would be a once off Wealth Tax. Talks of charging 1% on the value of assets for those South Africans who are the richest in society is being mooted. This would however only raise revenue for the 2018/2019 tax year and not be a long-term fix to government’s financial woes. Depending on the changes to Income Tax rates and whether government finally bows to pressure and raises the VAT rate, we could see a combination of all 3 in the budget. Our prediction: this would be a last resort measure in the future if the economy does not improve in the medium term.
Follow TaxTim on Twitter and Facebook as we provide real time updates during the budget speech on 21 February. We will be sending out our 2019 updated Salary Calculator as soon as the new rates are announced.