SA’s 2011 Tax Freedom Day – Monday, 2 May

On Monday, 2 May, the people of SA start to work for themselves. Until then they will have been working to pay for government.

Tax Freedom Day (TFD) is a measure of how much of the gross domestic product (GDP) a government takes. It is the day after the country has earned enough money to pay for government for the year. It is calculated by dividing general government revenues by GDP at market prices to establish what proportion of the year’s labour goes towards paying for government and expresses this as a proportion of the year. One day is added to designate the first day when citizens are no longer working for the state.

This year, SA’s TFD is 8 days earlier than it was last year. While this may seem good, it is not really. It is earlier because of the economic slump which reduces profit rates and consumption levels and therefore tax revenues. Since government spending is continuing to increase, the deficit and government debt will rise, and future taxes eventually will have to jump to new highs.

Why should ordinary citizens be concerned about the level of government revenue and spending? Well, several studies in the US and Europe have consistently shown that each 10% increase in total government spending as a percentage of GDP reduces the growth rate by around 0.8% and increases the unemployment rate by around 3.6%. If the increase is in government consumption spending then the decline in the growth rate is estimated to be 1.4%. Other studies find that reducing government consumption by 1% immediately increases investment by 0.5% - increasing to 2.7% after 5 years. Estimates of optimum total government spending for maximal productivity place it at 20-23% of GDP.

Clearly governments larger than that are a luxury countries cannot afford. SA’s government spending is at least 14% above this level. Judged by international standards, our government spending is very high - in the top sixth worst in the world for our level of development. Even worse, government consumption spending accounts for most of the bad effects of government costs on the economy and our government is increasingly shifting toward that sort of spending rather than on core functions and capital projects. If we were to reduce our government spending (and tax take) to optimum levels – about a third less than it is now – we would reduce unemployment by 5% (242,000 jobs) while, at the same time, increasing the investment rate by 38% and the growth rate by around 1.7%. These are huge benefits - but huge losses if we do not.

Why do high government expenditure and tax rates have this effect? In a nutshell, high marginal tax rates reduce the incentives for entrepreneurs to risk their capital or sacrifice their time and energy to earn higher incomes and interfere with the ability of individuals to pursue their goals because they result in less disposable incomes. Less disposable income means less saving; less saving means less capital formation; less capital formation means lower labour productivity, and lower labour productivity means lower real wages.

In this economic climate, government, like business, should focus on its core activities. These are largely to ensure that there is sufficient policing, the courts are impartial and efficient, the rule of law is respected and enforced and the country is kept safe from foreign aggression. From the point of view of giving SA the best chance of prospering, anything else government currently does, is a luxury.

Author: Garth Zietsman is a statistician and Council Member of the Free Market Foundation and annually calculates Tax Freedom Day. 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.

FMF Feature Article / 26 April 2011