Economic growth the crux of South Africa’s fiscal constraints

National budgets are inherently political. The fiscal framework — which outlines government spending, revenue, and borrowing — is approved by cabinet and enacted through parliament. The National Treasury plays a central role in ensuring public finances remain sustainable by providing impartial, evidence-based and technically sound guidance within this process.

An important assumption that underpins our advice is that a sound macroeconomic framework lays the foundation for sustainable growth. Prudent fiscal policy, in combination with moderate and stable inflation, reduces uncertainty; lowers borrowing costs, which supports household consumption and investment; and, ultimately, faster economic growth and job creation.

However, maintaining macroeconomic stability requires difficult choices, especially in the face of persistent fiscal constraints. These challenges are shaped by long-standing structural issues and the evolving political landscape, which require adjustments in budget design and implementation. Despite these complexities, the National Treasury remains committed to macroeconomic stability and the long-term sustainability of public finances.

The budget tabled this week sought to balance the need for increased spending — in health, education and other critical public services — with fiscal sustainability. Expanding the public health workforce remains a priority, yet fiscal constraints have limited the ability to hire an estimated 800 unemployed doctors, which would require R2.7bn over three years. Similarly, early childhood development (ECD), the foundation of human capital formation, has faced persistent funding shortfalls, contributing to poor educational outcomes. Increasing the ECD subsidy from R19 to R24 per child per day and expanding services to an additional 700,000 children under four would require R10bn over the medium term. These spending pressures highlight the difficult trade-offs in resource allocation as the government continues to rebuild fiscal credibility.

In the past few weeks, various proposals have been made to resolve this policy dilemma. Some argue that pausing employer contributions to the GEPF could create short-term fiscal space. However, legal and regulatory constraints, as well as risks to pensioners, make this a difficult option. The current legal and regulatory framework does not explicitly provide for a contribution holiday and the GEPF’s funding policy states that trustees should strive to maintain the GEPF’s long-term funding at or above 100%. While the government benefits from the contribution relief, active members do not benefit and pensioners would face increased risks due to the deterioration of the GEPF’s financial position. Because the GEPF is a defined benefit fund, any shortfalls in the fund will require a government bailout. Therefore, diminishing the solvency of the fund may require the GEPF to appear as a contingent liability on the fiscal framework, further weakening the state’s balance sheet. 

Another suggestion was to allocate more resources to Sars, and — on the basis of its recent success in strengthening its capabilities to increase revenue — put higher revenue numbers into the fiscal framework. Recognising the importance of a well-equipped Sars to support the country’s ability to finance development, the current budget makes additions of R7.5bn to further strengthen these capabilities. We will track the additional revenue according to an agreed set of indicators, as part of the technical process in place between National Treasury, Sars and the South African Reserve Bank that produces the revenue numbers reflected in the fiscal framework. Putting those revenue numbers into the fiscal framework before they are fully realised — and allocating spending against them, as some have suggested — is exceptionally risky.

The danger of these proposals is clear: If spending allocations are made against revenue assumptions and these fail to materialise, the government is left with no option but to implement large budget cuts or borrow to fill the gap. Further, permanent spending additions that grow by inflation cannot be matched with temporary funds from the GEPF or temporary revenue additions — because at some point a large fiscal hole will emerge. As tempting as it may be, assuming our way out of difficult fiscal choices, or looking for fiscal short cuts, is neither credible nor sustainable.

This leaves taxes, and given the size of the spending requirement, one or all of the three main tax instruments — personal income tax (PIT), corporate income tax (CIT) and VAT — would need to do the heavy lifting. Our top PIT rate is high at 45% and when it was increased to that level in 2018, taxpayers decreased their reported taxable income in response, which reduced revenues. Our CIT rate is also high at 28% and out of 123 countries reporting to the OECD, companies operating in South Africa contribute the 13th highest in terms of CIT revenue as a percentage of GDP. The approach for this budget was to avoid PIT and CIT rate increases as they hurt growth and induce changes in behaviour, which undermines revenue collection. Instead, for the second year in a row, this budget does not adjust the personal income tax tables for inflation, which raises the majority of additional revenue in 2025/26.

Rate changes for VAT are viewed differently. VAT is the least distortionary revenue raising instrument because it has a lower effect than the other tax options on employment, savings and investment — and subsequently has the least negative effect on growth. It is also an efficient tax as it is more difficult to avoid and is spread across a broad base. However, a VAT increase is indiscriminate and can increase prices of all goods that are not exempt or zero-rated, including items required by lower-income households. An analysis by the organisation Pietermaritzburg Economic Justice and Dignity suggests that a one percentage point increase in VAT would increase the price of a basic food basket by R22 a month. This concern led to the inclusion of above-inflation increases in grants — alongside an expansion of zero rating and fuel levy relief — to cushion the effect on vulnerable households.

To support growth and employment, economic infrastructure is the fastest growing spending item at 10.7%, and the budget advances important infrastructure reforms. Measures to enhance private sector participation include simplifying public-private partnership regulations, and expanding the budget facility for infrastructure to strengthen the pipeline of bankable projects.

There have also been concerns raised that a VAT increase will not yield the revenue estimated by the National Treasury. It is, however, not true that the last VAT increase raised less revenue than expected. The 2018 budget estimated that the increase in the VAT rate from 14% to 15% would raise about R22.9bn. The data from that year indicates that when the additional payouts of previously withheld VAT refunds are excluded, the revenue from the VAT increase would have been broadly in line with the projected amount.

This brings us to the crux of South Africa’s fiscal dilemma: The role of economic growth. In October 2020, the National Treasury and the Presidency launched Operation Vulindlela (OV), a mechanism to accelerate government’s economic reform implementation, precisely because fiscal sustainability is impossible without higher growth. OV phase one unlocked an estimated R500bn in investment and will provide a boost to growth over the medium term. Phase two will continue to transform the electricity sector to achieve energy security; create a world-class logistics system to support export growth; invest in water infrastructure and improve the reliability of water services; and reform the visa system to attract skills and investment. In addition, phase two adds a focus on strengthening local government and improving the delivery of basic services; harnessing digital public infrastructure as a driver of inclusive growth; creating dynamic and integrated cities through investments in commuter rail; and reforms in title deeds, housing finance and the use of land.

To support growth and employment, economic infrastructure is the fastest growing spending item at 10.7%, and the budget advances important infrastructure reforms. Measures to enhance private sector participation include simplifying public-private partnership regulations, and expanding the budget facility for infrastructure to strengthen the pipeline of bankable projects. Among other initiatives, a new credit guarantee vehicle is being developed to de-risk transmission infrastructure, and infrastructure bonds are being introduced to attract untapped capital. Reforms in municipal-owned trading services aim to improve financial sustainability and service delivery.

The combination of an accelerated structural reform agenda and the placement of infrastructure at the centre of South Africa’s reform efforts will ultimately secure the economic and employment growth required to deliver fiscal sustainability. But until these measures bear fruit, the government needs to act to find the resources required to avoid a further deterioration in basic services and pave the way for a higher rate of investment and growth.

• Dr Duncan Pieterse — a UCT and Harvard graduate — is director-general of the National Treasury