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Wednesday, 25 February 2015 19:24

Nene faces toughest test yet

Written by Wolfe Braude
South African Finance Minister Nhlanhla Nene. South African Finance Minister Nhlanhla Nene. Photo © South African Government

South African Finance Minister Nhlanhla Nene is facing his biggest baptism of fire yet when he delivers his maiden National Budget speech on Wednesday, as the country desperately needs him to plug the gap between national spending and revenue. South Africa’s debt trend is not sustainable.

It gets more complicated – not only does he have to set the country on a new path; he has to do it fairly and reassure the ratings agencies, who clearly have their fingers poised above the ‘downgrade rating’ button. One more ratings downgrade and we’re ‘junk level’, which triggers automatic investment withdrawal by pension fund and other institutional investors.  

Yet the Minister’s tax collection machinery has performed well, considering the economic climate. Within its mandate, the projections made for tax collection have been met. So it’s time to change the rules. Time for someone to pay more. Analysts have suggested traditional routes such as increases to corporate tax, capital gains tax, estate duties, fuel levies, income tax and VAT.

Tax experts and economists have warned that taxing the rich will ironically not bring in much and will discourage investment and activists have warned that increasing VAT will hit the poor disproportionally, and undermine government grants. Not the ideal social or political option in a country with one of the highest levels of inequality globally.

There is hidden treasure still to be dug up though that could potentially let both groups off the hook. It won’t put cash on the table immediately, but it should add significant amounts as it kicks in and may give the Minister the leeway to limit the intensity and duration of whatever emergency tax increases are announced in the 2015 Budget Speech.

It would similarly allow government to dodge any dramatic cut to expenditure or raising of the deficit.

‘Illicit capital flight’

Let’s start by asking why taxing the rich is expected to bring in only around a smallish contribution. It’s because they can and will deploy teams of tax lawyers and accountants to discover and exploit every loophole and ambiguity, in order to minimise their new taxable total. Over the years Sars has played a sophisticated game of hide and seek with society’s most affluent. It’s a game played against both high net-worth individuals and large companies, usually multinationals.

For many decades the worst corporate offenders have been using the equivalent of the ‘find the ball under the cup’ game to minimise tax that must be paid. They simply create dummy companies or listings outside of South Africa (SA), in other words outside of Sars’ jurisdiction, and then shift payments around so that the revenue earned in SA is minimised, and the remainder declared in the other country or territory. Such locations, commonly called tax havens, are chosen because relevant tax is either very low, or at zero.

A haven’s legislation will invariably fiercely protect the identity of all investors. So governments and citizens just usually don’t know what their companies are up to. Many of the top companies in the developed and developing world are engaged in this. The most common tool is called transfer mispricing or trade misinvoicing, whereby the multinational’s subsidiaries under-invoice each other, leading to lower declared revenue, which is then also shuffled and declared across a range of jurisdictions.  

About 60% of ‘illicit capital flight’ from Africa is believed to be the result of this. The remainder is from the traditionally illicit, namely organised crime and government corruption. Globally, such mispricing comprises the bulk of illicit flows.

The G20 Group of States (G20) and OECD call such activities ‘profit shifting’ and their impact ‘base erosion’, or Beps for short.  In other words they erode a country’s tax base.

Logically, whatever is moved overseas in this fashion cannot be taxed, so the pool of taxable revenue is eroded.  In practice this has massive consequences, as it reduces funds for spending on education, health, infrastructure etc., and thereby increases government debt. It further means governments often have little option but to tax the remaining taxpayers more.

The massive scale of the problem has been coming to light. Recent estimates are that between $7trn and $21trn is stashed in such jurisdictions. Within Africa, the AU estimates that about 30% of Africa’s GDP has been moved to tax havens.

Globally, cumulative illicit outflows from developing economies have been conservatively estimated by NGO Global Financial Integrity at $6.6trn between 2003 and 2012. Such flows are calculated to be growing annually at twice the rate of global GDP. SA is estimated to lose about R147bn per year, mainly to trade misinvoicing.  It is ranked 12th for volume of such outflows and 6th for export under-invoicing by the same research.

Such flows are partly to blame for the sharp increases in inequality globally. What allowed the situation to grow in the past was a lack of action by countries that benefitted from flows of liquidity, influenced by powerful voices within each country’s ruling class who benefitted. It’s the unintended or intended, depending on who you speak to, consequences of globalisation again; i.e. the world economy is increasingly integrated, capital is mobile, yet a concurrent globalisation of rules, standards and accountability has not occurred.

Nene must reassure

But the tide may be turning. With their collective budgets and political capital under severe pressure post the 2009 financial crisis, with growth either weak or non-existent, and bills to pay, governments have been urgently looking for any additional revenue and initiatives to defuse increasing anger regarding economic management. This urgency appears to have overcome vested interests for now.

The world’s top economies have started moving against tax havens and related Beps activities. In the last five years the OECD and G20 taken significant steps on tax reform, with practical measures on automatic sharing of information, increased transparency, and standardised transfer pricing rules. SA is already in the forefront of such efforts. It supports the G20 initiatives as a member, already has many elements of anti-Beps legislation in place, and established the Davis Committee on Tax to investigate, amongst other reforms, further action on Beps.

The Committee released its interim report in December 2014, so we’re ready to act. Both globally and at national level though, such reforms have been met with determined counter lobbying and resistance. Oxfam notes the disproportionate voice of business in the shaping of reforms, the limited number of participants (G20 and OECD), and agreements not to make disclosed company information public are also likely to dilute and weaken such reforms. For example, the UK Treasury in 2012 made it easier for multinationals to shift profits out of the UK.

So what can Nene do? He is going to need to increase some taxes, and perhaps a mix with the exception of VAT, would be the wisest for now.

He’ll then need to reassure ratings agencies that government spending will plateau off, perhaps through sharply increased accountability for mismanagement.

To unearth sufficient new treasure though, without comprising the state’s developmental spending or panicking the private sector, he must announce top priority fast tracking of anti-Beps steps, starting with the detailed recommendations of the Davis Committee report, for example requiring relevant multinational companies to publicly disclose tax information on a country-by-country basis and force disclosure of tax mitigation schemes.

He must ensure that anti-Beps actions are also applied to areas not covered sufficiently by the G20/OECD, but of relevance to SA, such as agri-business, extractive industries and telecommunications. He should support this by significantly enhanced state capacity to track misinvoicing or mispricing.

It must be emphasised that these are not radical or anti-business measures – similar measures are being implemented already by the EU and Australia, and have been agreed at the OECD.

The pursuit of riches is not a moral right, and is not a victimless crime if it generates poverty.

The progressiveness of South Africa’s constitution must be matched by the continued progressiveness of its taxation regime. We must take the lead. Throughout history, the powerlessness of the non-rich has only been resolved through bold action. Logically, those engaged in such economic sabotage will simply continue unless stopped, regardless of the damage caused to all our futures, even theirs.

 

Wolfe Braude is a Director at Emet Consulting, a policy research consultancy. He has worked with the South African Institute of International Affairs on issues of taxation and the G20. He writes in his personal capacity. This article was originally published by Fin24.

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