With a maximum pay-as-you-earn (Paye) threshold of 50%, value added tax (VAT) at 15% and a plethora of other taxes and levies, have you ever felt that you are paying a larger proportion of your earnings to the government in one form of tax or another? Have you also ever wondered how governments raise money and whether such money is being put to good use?
in the money with NESBERT RUWO & JOTHAM MAKARUDZE
There are basically three dominant sources of revenue for government — taxation, borrowing and printing money.
Taxes in one form or another are collected from the populace through the Paye system, corporate tax, investment taxes etc. You also pay tax when you buy say groceries (VAT) or when you fill your car with fuel (levies) or pay fees (e.g. licence fees). While these are the three main sources, it is not unusual for some governments to generate income from profits from state-owned enterprises, if these enterprises are profitable.
A quick squeeze at the 2017 national budget shows 91,8% of budgeted revenue of $3,7 billion coming from taxes, with 28% from VAT, 21% personal income tax. A high contribution of 18% comes from excise duties, while companies’ tax is expected to add only 9% to the revenue base. The effectiveness of taxation as a revenue source is dependent on whether the economy is doing well, and who is being taxed and how much they are being taxed.
While theoretically the government has the power to raise tax rates, the reality is that it can only do so until a certain level. You cannot kill the goose that lays the golden egg.
If the economy is doing well, some form of taxation can be a very effective means of controlling inflation. In an economy not doing so well, a tax hike decreases consumption and investment. Economies perform poorly when either consumption and/or investment is weak. While a government may be trying to raise its revenue base in weak economic environment, a tax hike during such a time could actually prolong the economic recovery process.
This leads to the all-important question, how should government raise money when the economy is depressed, such that any money it appropriates through taxation does not further depress consumption or investment?
Recent research conducted by Dr. Nic Cheeseman, University Lecturer in African Politics at the University of Oxford, has shown that by providing high-quality, high-profile public services such as roads, health clinics, schools and police service, and other public services, governments can generate widespread popular support for tax payment. The populace is generally suspicious at the new range of taxes, levies and fees, especially in an environment where governments have had a history of corruption, inefficiency, and incompetence. Too many local and national governments have raised taxes before persuading people the taxes are needed.
With only $520 million (3,6% of GDP) of the 2017 $4,1 billion expenditure budget going to capital expenditure, it is very clear that investment in infrastructure and for future growth is seriously constrained as much of the budgeted revenues will be gobbled by government wage bill of $3,0 billion in 2017.
As we have come to know, tax revenue is not always enough. Governments have tended to borrow to plug the revenue gap. Government borrowing can be from own citizens (domestic debt) or from foreigners (external debt). The process of borrowing takes capital from one party with savings to a party with a capital deficit, and is normally channelled towards fixed capital investment, unless it is utilised to fund recurrent (day-to-day) expenditure. It is not always wise to borrow for recurrent expenditure. If governments borrow to invest in fixed capital formation, everyone will be happy — the investors/government bondholders will feel secure (theoretically) in holding government securities while the citizens will benefit from government investment in infrastructure etc. through job creation, better living conditions and service delivery.
There are a number of ways that governments can retire its debt burden without raising taxes. These include economic growth, inflation and currency devaluation. When an economy grows at a rate above budget deficit, the economy will grow faster than debt, thereby shrinking the economy’s leverage (size of debt relative to GDP). With inflation, the government slowly usurps away the value of debt in real terms, while a currency devaluation could support export revenue generation.
Governments could also raise money through printing money and putting it into the government’s coffers either directly or indirectly. Central banks do this all the time (that is, increase money supply) by lowering benchmark interest rates, buying bank instruments and encouraging banks to lend more money out. Theoretically, a government can print as much money as it can. But if the economy is seriously depressed, the central bank may exhaust its ability to further lower rates, particularly below the zero percentage point mark. However, in reality and the experience of 2008 hyperinflation tells us otherwise — excessive money supply damages public confidence in the stability, value and existence of a currency.
Not all of the revenue sources may be available to our government — without a substantive currency, the government may not be able to “print” a convertible currency that enjoys citizenry buy-in, and neither can the government devalue its currency. Its capacity to borrow externally is currently constrained. It is clear in our minds that in an economy that is struggling, the scope to continue adding on the citizenry’s tax burden may now be limited given the high tax, levy and fee levels. What could make sense is to create an environment of increasing wealth and prosperity where people become more productive. This calls for elements like political stability and continuity, clarity on property ownership, and relevant institutional structures etc. We also think that the government should turn its focus towards improving its operational efficiencies and taking corruption head-on while creating an environment where people find the need to pay taxes.
Nesbert Ruwo (CFA) and Jotham Makarudze (CFA) are investment professionals based in South Africa. They can be contacted on firstname.lastname@example.org