Higher tax rates in South Africa

Most countries have increased their sovereign debt levels since the 2008/09 financial crisis to stimulate slowing economies or bail out the greedy bankers who tried to make more money for greedy investors. It is a sad thing really. Now governments are facing probabilities of default (just type in sovereign debt crisis EU in google to understand just how bad things are). To minimise the probability of default governments have to increase tax rates, cut rebates or reduce spending. All these measures have negative consequences for economic growth. The point is that some governments simply don't have a choice as capital to finance expenditure dries up. The Obama administration is letting the Bush tax cuts expire (which effectively means that tax rates increase http://www.thefiscaltimes.com/Columns/2012/12/04/Why-the-GOP-Wont-Admit-Supply-Side-Econ-Has-Failed.aspx#page1). Unfortunately the question about which tools to use to appropriately consolidate the budget deficit is a rather complex one. In economics we learn that fiscal spending and taxes have multiplier effects (i.e. a dollar increase in spending increases economic activity by x dollars). If taxes have a lower multiplier than spending, then increasing taxes will harm the economy less than cutting spending. But calculating the multiplier is a very difficult task and one cannot simply rely on any old estimate. However, there seems to be empirical support that taxes have smaller multipliers than spending.

Let us assume that taxes damage the economy less than spending cuts, what taxes do we change and what rates do we set? This question is also very complex. One has to consider the redistributional preferences of government, the public's aversion towards income inequality, the possibility of tax evasion and tax avoidance and the possibility of immigration. Most undergraduate textbooks show that lump-sum taxes are Pareto efficient (the point where an increase in welfare of one individual cannot take place without decreasing the welfare of another). This tax strategy also assumes that government is efficient in distributing revenue collection efficiently. Unfortunately inequality exists and governments are far from efficient. This is why we have progressive taxes which addresses vertical (people with higher incomes should pay more taxes) and horizontal (people with the same income should pay the same amount of taxes) equity concerns. This unfortunately implies a Pareto-inefficient outcome as the tax liability lies with the minority of the population. This is very true for South Africa!

So, is it at all possible to increase the tax rates of the tax paying population further? Can these people afford a higher tax rate? Most probably yes. It is important to know that there is a difference between the effective tax rate an individual pays and the statutory rate. If person A earns R600 200 per annum he would fall in the top tax bracket. Assume that the cut-off point is R600 000 with a lump sum tax of R100 000 and 40% tax of anything in excess of R600 000. His total tax liability would then be (R100 000+(R600 200-R600 000)*40%) R100 080. Assume that the tax rate would increase to 50%, then his liability would be R100 100 which is only a R20 increase. His effective tax rate before the change is ((R100 000+R80)/R620 000) 16.141%. His effective tax rate after the change is 16.145%. That is why you always need to look at the change in rebates, tax rates and lump-sum taxes when the Budget is revised.

We know from theoretical and empirical (see Mirrlees (1971) and Saes (2012)) work that tax setting depends on:

1. The ability of labourers to shift their productive labour hours when taxes changes. Their preference for hard work diminishes as higher taxes are implemented (Frisch elasticities and labour-supply elasticities)

2. The distribution of tax payers (wealth is usually Pareto distributed)

3. Income and substitution effects. One's income is directly affected by taxes but substitution effects depend on labour-supply decisions. Elastic labour supply means that people can change their labour decisions (either choose more leisure or work harder to maintain a similar income as before the tax change). If the elasticity is larger than one, then increasing the tax rate could result in less revenue collection as more people decide to work less (either by reducing the amount of hours worked or by simply not being as productive while working the same amount of hours). When the elasticity is smaller than one then increasing the tax rate could result in higher revenue collection as people work at the same levels as before (same amount of hours and at the same productivity level).

In South Africa one would, a priori, expect labour supply to be very inelastic (smaller than 1) across income earners. Using StatsSA's Labour Force Surveys (LFS) suggests that the labour supply elasticity is close to zero (even while controlling for other costs such as transport or grants received). That means that one could increase tax rates and collect more revenue. But South Africa's top income earners also have access to other income types, which means that they can shift their labour income to capital which has a lower tax rate. I.e. some top income earners have a lower effective tax rate than middle and low income earners which violates the vertical equity principle. A business owner might not get his benefits in terms of a salary (which is subject to labour income tax), but gets his benefits in the form of higher dividends or company profits (which are subject to much lower rates than labour income tax). Thus raising taxes at the top end of the income distribution might only result in tax shifting. One possible policy remedy would be to increase tax rates on capital. Now this comes close to Lump-sum taxation (which implies Pareto-efficiency). Obviously there are different trade-offs involved in taxing capital such as a decrease in investment incentive.

Setting tax rates are notoriously difficult. Just looking at South African data would suggest that it is possible to increase the top tax bracket, or even introduce a new top income bracket. This would not necessarily result in a significant increase in tax burden as the effective rates are still low. This is definitely one way to close the budget deficit without incurring much harm on the economy overall. The only problem is that South African's do not necessarily get a return on their taxes as spending on education and health in the past has yielded little to be happy about (more on this later).

 

Jobs and technology

Unemployment problems will continue to exist for some time to come. A recent article in the NY Times (http://www.nytimes.com/2012/12/05/business/unionizing-at-the-low-end-of-the-pay-scale.html?partner=rss&emc=rss&_r=1&) discusses how people are now becoming part of unions to earn a higher salary. Technology is not solving the unemployment problem either; fewer workers are necessary to complete a specific task as computers and machines do the job more efficiently. Some economists argue that unemployment exists because some people are simply unemployable, or do not fill the needs of a company. The solution they propose is to improve the levels of education since one's wages should be equivalent to one's ability and skill. This still does not solve long-term unemployment. The rate at which machine and computer efficiency improves exceeds the rate at which education improves. My guess is that the future will have computers do the jobs of even skilled people. Demand for goods and services will not decline necessarily as the few rich people will demand more of these goods and services equivalent to the rise in their income...Capitalism will create market winners which absorb all competitors...in the end capitalism will become a weird perverted form of communism. Maybe Malthus was right...the world is perhaps over populated, or maybe we are focussing our time and energy on all the wrong labour market strategies. Low skilled labourers should work for companies that require a low skill level. Agriculture is one such industry. I find it odd that governments, especially South Africa, has not redesigned its agricultural programmes. More on this topic later.

Have faith and conquer

Do we understand little of life when we cannot put into practice our teachings? Is this a psychological anomaly? Merely having knowledge about the way we ought to conduct ourselves does not necessarily imply that we are able to live life as such. How is it then that man possesses the knowledge of evil, yet fails to resist it? We experience inert urges that rebel against our trained minds. We often yield to these urges and afterwards our guilt condemns these acts. Either we don't truly understand the teachings, or we are simply rebellious. Under the one we are ignorant and under the other we rebel against what we know. Kierkegaard understood this well when he provided a detailed description of despair in The Sickness Unto Death. Although Kierkegaard goes to great lengths to describe why men despair and offers a cure, he does not deal with the origin of every man's sin nor with the continuation of sin. Kierkegaard defines sin as standing before God not wanting to be oneself or wanting to be oneself without the Power that constitutes us (God). In this sense we have all sinned, and still sin. We know, and some truly believe, that Christ has died for us so that we can be free from sin. This means that sin is erased from past, present and future for those who believe in God. Yet if sin is forgiven, no matter the time space, why do churches preach that man should continually repent from sin? Does this mean that man has no faith every time he sins?

Here we are faced with two tough questions? One, why do we continuously sin (or do we?) despite our deepest beliefs about life, and two, does sinning imply that we lose our faith?

We know from the book of Romans that the wages of sin are death. We also know that Christ's death paid those wages in full. Thus, when believers sin, they are not subject to death. Yet the church, and the Lord's prayer, teaches us that we should pray for the forgiveness of sins. This would imply that if we did not pray for the forgiveness of sins that we would not be forgiven, and this then would imply that sinning is equivalent to not believing. But this seems at odds with the meaning of Christ's death and its implication for the forgiveness of sin. Or did we perhaps misinterpret the scripture? An answer might be given in our definition of faith, since it is by faith that we are saved. Kierkegaard provides such a definition: It is in the hopeless state of man when he realises that it is impossible to save himself that he cries out to God for help for whom all things are possible. Thus, by asking God to forgive our sins we express our faith in its purest form. We recognise firstly that we are broken, and then subsequently cry out to God to save us from this misery since there is no way that we can escape it by our own means. The reason we sin then is because we are broken. We were broken since birth. And we inherited sin from Adam and Eve. Even new born babies sin (read Augustine's Confessions for examples). So does God then take away our sins? In one way yes, and in another no. Since we are forgiven for our sins through grace by expressing our faith, sin has no power. But, all of us still sin, by lying, gossiping, stealing, lusting, etc. Hopefully we become better the more we come to appreciate what this forgiveness of sin really means. God, knowing how imperfect we are and knowing what imperfect decisions we will make, still chooses to forgive us. There is absolutely nothing that you can do and hence no possibility for you to rectify the mistakes of the past. It is purely by God's grace that you are made clean. It is thus a sin to lament your actions. You are not being pious when you throw ash over yourself, or shave your head as a sign of mourning. Instead you are showing great signs of arrogance. If God forgives you, what gives you the right not to forgive yourself? Of course it is important to repent, since repentance is an expression of faith.

So we know that we continue to sin because we are broken and at times lack faith. But we also know that sin has no hold over us since we are forgiven by God. Now, does sin, in light of believing in God, imply that I do not have faith? This would seem to be the case. Because sinning means to stand before God and rebelling against Him, or not wanting to be yourself. And this means that you put possibility (possibility of earning one's salvation) into your own hands, by thinking that you can find just cause for ill-behaviour. What else does this mean when you lie, murder, cheat, steal, gossip and commit adultery? Yet we cannot simply judge all these acts in a generic manner. We have very little understanding of man's psychology let alone a man's soul. So we leave these things to be judged perfectly by God. So we sin quite a bit after conversion by displaying a lack of faith. That is why every time we sin (whether it be out of ignorance or rebellion) we ask for forgiveness so that we can express our faith and be forgiven. That is why Kierkegaard also says that every unrepented sin is a new sin - i.e. every moment is a new sin while we neglect to ask for forgiveness. While one could argue that all sins are the same (see previous entry), with the exception of the sin against the Holy Spirit, so too can we make a case that faith is different in varying degrees. We have numerous examples in the Bible of people whose faith increased (the impossibility of the self, but the possibility of God: "Father let me become more like You and less of myself"). It is through faith that Abraham could obey God in putting Isaac on the offering altar, it is through faith that David defeated Goliath, it is through faith that Jesus withstood the Devil's temptations and it is through faith that we daily fight evil in this world. This faith needs to be expressed in prayer and in praise.

To sum up: we all sin because we lack faith, but even a little faith is enough for us to be forgiven. We express this faith in prayer and in praise by seeking God's forgiveness.  When our faith increases sin dies. We can boldly express this faith because Jesus died and defeated sin by defeating death.

So do not be disheartened when you sin. We know that there are no more wages of sin. We know that we can ask God to forgive us. We do not need to hang our heads in shame when we sin. We need to acknowledge how fallible we are and how impossible it is to free ourselves from sin's bondage. We need to acknowledge that for God all things are possible. This possibility has freed us from sin's bondage. We can express daily our faith by coming in prayer to God and repenting. We understand that repentance is not just reciting words, but giving over to God every aspect of our lives because we know how hopeless we are.