Some form of basic income support is central to the South African government’s agenda. The lockdown-induced shocks have added to the crisis of structural mass unemployment and of poverty. There also seems to be broad consensus that basic income support is an essential part of the country’s social compact.
But the fiscal risks it poses to a fragile economy have not diminished. And government faces some hard trade-offs to ensure these risks are minimised and that other social spending is not compromised.
A small cash grant to the poorest workers was introduced as an ad-hoc and temporary response to the collapse of employment induced by the COVID-19 lockdowns. The COVID social relief of distress grant operates in terms of national disaster regulations, and its financing depends on periodic extensions announced in the national budget.
But the success of the grant has underscored a broad consensus in favour of continuation. The first attempt to withdraw it ended in defeat for the Treasury in the wake of the organised unrest of last July. Since then, the president has clearly warmed to the idea. The minimum wage helped him forge the coalition of factions in the African National Congress (ANC) that backed him in 2017.
Continuing with basic income support may well be necessary to secure his re-election at the 2022 ANC conference, and victory for the ANC in 2024. By then the grant would have been in place for five years, and it would not make sense to think of it as temporary.
It now seems clear that income support for the poorest citizens of working age is a new element of South Africa’s fiscal constitution – a contract on which sustainability of democracy depends. Legislation that defines the beneficiaries and design of the grant will take time to pass. In the meantime, the budget will have to accommodate a structural increase in spending of R50 billion to R100 billion, or about 1% of GDP.
But will it happen?
Policy paralysis is baked deeply into the national condition. On the other hand, South Africa is good at cash transfers. And it has a relatively efficient tax system.
Benefits and risks
Basic income for poor workers comes with many economic and social benefits.
It should lead to a material extension of economic opportunity for the many, an expansion of human capabilities and a reduction in the daily burden of poverty, hunger and disease that blights politics and society.
There are also cogent arguments (and some evidence) to suggest that cash transfers to working-age adults have positive impacts on labour market participation and employment.
Extending the grants system is likely to complement livelihood strategies and activate economic opportunities for poor households.
In a context of risky transformations associated with green industrialisation, some form of basic income support may well be a comparatively efficient way to protect the most vulnerable and bring a sense of justice to the transition.
But the claims of true believers that a basic income grant will set in motion a new path of growth and development should be treated with caution.
The extension of income to the poor addresses none of the major constraints facing South Africa’s economy, and could well lead to increased consumption, including of imports, combined with a fall in national savings and investment.
The grant will worsen South Africa’s fiscal position. This is already so chronic that it has itself become a central cause of slow growth and economic stagnation. High interest rates on government debt are a hurdle to fixed investment. The incessant rise in debt service costs – now approaching 5% of national income – crowds social spending out of tax revenue and shifts the profile of public spending in favour of affluent households.
The deficit has been entrenched at around 6% of GDP for more than a decade, and there is no clear path to closing it. As these pressures mount, so does the danger of financial and macroeconomic turbulence.
The introduction of a new R50 billion expenditure commitment will aggravate these pressures and weaken the credibility of fiscal policy. Over time, it implies tax increases that will raise the returns required on investment projects. The increased fiscal risks imply higher borrowing costs, which could slow the pace of growth and employment creation.
In these circumstances, the Presidential Economic Advisory Council is absolutely correct to advise caution about the fiscal risks. Moreover, the report of the Department of Social Development’s Expert Panel on Basic Income Support provides no evidence to dispel these concerns.
Global conditions currently enable South Africa to sustain its chronic and worsening fiscal position. Rising commodity prices mean corporate tax revenues from mining and finance are temporarily elevated. Easy monetary conditions underpin the flow of portfolio capital in support of the domestic bond market. These factors enable South Africa to continue along a clearly unsustainable path, and the political leadership is determined to make hay while the sun still shines.
It would be foolish to rely on the continuation of these conditions. When times change for the worse, tax revenues will fall and interest rates will rise further. Financial markets are aware of these dynamics, and the damage to the credibility of government’s fiscal position implied by the additional spending will be anticipated, putting upward pressure on bond yields.
This means clearly signalling that the new grants will be paid out of new taxes.
New spending means new taxes
For many years National Treasury has correctly argued that structural increases in spending must be backed by structural increases in taxation.
There are several options that now need to be considered. Removing the tax breaks on retirement savings would raise the effective rate of personal income tax for the most affluent. Government can also step harder on the brake of fiscal drag, which distributes the burden onto the middle strata but creates inefficiency and perverse incentives. A better approach would be to raise the rate of value-added tax.
In recognition of the permanence of the grant, some combination of all these tax measures needs to be placed on the table for discussion as soon as possible.
Tax increases need not be implemented immediately but must be announced far in advance. Delaying tax increases would help reap the multiplier effects of the new spending. But upfront clarity on plans for increased taxation is needed to limit the deterioration in financial conditions which, if left unchecked, could overwhelm any positive multiplier effects. Tax changes of this magnitude also require extensive public deliberation and policy work to ensure effective design and orderly implementation can take place.
The potential upsides of basic income support will depend on design, institutions, and the quality of the social compact that can be negotiated around it. Until now, the president has been warm and fuzzy about the need for basic income support and public employment programmes. He frequently waxes lyrical about social compacting and the need for government to be generous to its people, especially the poor and unemployed. But he has been largely silent on the question of the trade-offs, or the real economic concessions needed to make a social compact work.
Basic income support is not a question of government “being generous”. The money will be taken from employed citizens and the affluent, and it is they that the president should be calling upon to be generous, while explaining clearly why he believes it is necessary that they pay higher taxes. Until now, and in stark continuity with his much-maligned predecessor, he appears to believe that these awkward details can be left to Treasury.
An income support grant that reaches poor and unemployed workers can become an effective and admirable part of South Africa’s fiscal constitution. It will mean sacrifices from the wealthy, but also from those in secure jobs, including public-sector workers and other unionised insiders. And this will take political courage to push through.
This is an edited down version of an article that first appeared on the website Econ3x3.
by : Michael Sachs, Adjunct Professor, University of the Witwatersrand