A low flat tax will lead to investment, growth and jobs
According to Statistics South Africa, our economy grew at a paltry rate of 0.9 per cent in the first quarter of 2013. Many analysts were shocked by the figures released by Stats SA as they had believed our economy was growing at a rate of 1.9 per cent. If our economy continues to grow at a constant rate of 0.9 per cent, it will take 80 years to double in size. South Africa’s fastest ever recorded growth rate in recent times (1965) was 8.9 per cent – if the economy had continued to grow constantly at this rate, it would have doubled in size in a mere 8 years. What causes growth? This is a question that has vexed economists for many years
Plaudits must go to Reserve bank Governor Gill Marcus for her statement that, “Domestically, we are facing challenges of crisis proportions that require a co-ordinated and coherent range of policy responses, which are largely beyond the scope of monetary and macroprudential policies alone to deal with”.
There is a common misconception that government intervention through fiscal and monetary policy can be used to “stimulate” the economy and boost economic growth. The simple reason government spending fails to end recessions is because every rand the government “injects” into the economy must first be taxed or borrowed out of it. Government merely redistributes money from the productive to the non-productive sectors of the economy. No new income and, therefore, no new demand for goods and services is created.
It is not government but private firms that generate wealth and are the engines of economic growth. Government cannot create new purchasing power out of thin air. The mistaken view that fiscal stimulus can pull economies out of recession persists because the jobs created through government ‘make-work’ programmes are clearly visible. What we cannot see are the jobs that would have been created elsewhere in the economy with that same money had it not been taxed or borrowed by government.
Similarly, monetary policy has its limitations. At best, it is simply a lever that can be adjusted to influence growth in the short-run. Consider what happens when the Reserve Bank cuts interest rates beyond what would have occurred if interest rates were freely determined by the interactions between the demand and supply of credit. When interest rates are cut too far, the capital allocation in the economy is skewed because capital is allocated to marginal activities. For example, if real interest rates are negative or zero, it would be unwise to hold cash balances because the investment will not earn a return. In this case investors would look for alternative places to invest. In low interest rate environments, these alternatives might be marginal activities that normally would not attract investment. When interest rates are forced to rise because of increasing inflation, marginal investments are exposed and the economy is likely to relapse into another period of recession.
Thebest way to “stimulate” growth is to allow people to work, save and invest. Unfortunately, our labour policies in this country discourage the hiring of low and unskilled workers and high marginal tax rates and other pernicious taxes discourage savings and investment. When we combine all taxes, many people are paying upwards of 40 per cent of their annual earnings. Typically, these are the individuals who would fund new investment in the economy, which, in turn, would create the essential new jobs we so desperately need. A lack of investment retards capital accumulation. A lower capital to labour ratio reduces real wages and perpetuates the poor savings and investment cycle. In simple terms, without investments to fund and establish new ventures that create jobs, the smaller the economy and the lower the economic growth rate will be.
An additional justification for a policy that removes pernicious taxes such as estate duties, transfer duties, taxes on retirement funds, capital gains taxes, etc, is that it eliminates currently pervasive double taxation. Double taxation occurs because personal and corporate incomes are taxed and then whatever returns derive from these savings and investments are taxed again. One of the South African government’s first priorities should be to eliminate taxes on savings and investments.
In addition to removing all taxes that constitute a double taxation, government could encourage savings and investment by flattening personal income tax. A flat tax would reduce the large cost of tax compliance and encourage greater investment and work effort. A ‘true’ flat tax makes no allowances for deductions and provides no special dispensation for low-income earners. However, for both compassionate and practical reasons, there is no merit whatsoever in taxing the poor. The compassionate reasons are obvious while the practical reason is that, below a certain level of income, the cost of collecting taxes from the poor will exceed the amount collected. Low-income earners, therefore, should be exempt from paying any tax on personal income.
The government should consider simplifying the tax dispensation by having a zero rate for individuals below a certain threshold and a tax of perhaps 15 per cent for everyone else, including companies. Apart from the efficiency gains that SARS will enjoy by exempting the poor from tax and administering one tax rate, as a result of this simple policy proposal, the income tax base will be widened because there will be a higher level of compliance and employment will increase as a result of greater returns from savings and investment.
These are some relatively simple tax reforms that should receive approval from all quarters: business, labour, civil society and, most importantly, South African citizens. It is time for SouthAfrica’s leaders to realise that the role of government is to pursue policies that promote economic growth and not to prevent people from working by enforcing job destroying policies.
This article may be republished without prior consent but with acknowledgement to the author. The views expressed in the article are the author’s and are not necessarily shared by the members of the Foundation.