COSATU Submission on the Draft Revenue Laws Amendment Bill, Submitted to the Finance Portfolio and Select Committees, 19 June 2001

COSATU welcomes the opportunity to interact with the Finance Portfolio Committee on the Draft Revenue Laws Amendment Bill. Revenue Laws Amendment Bills are of course Money Bills, which as members are aware Parliament still has no power to amend, due to the ongoing failure of the Department of Finance to table a Money Bills Amendment Procedure Bill. However, given that these hearings are on the Draft Bill and there is still scope for amendments prior to formal introduction in Parliament, we are making a submission today. We hope that stakeholder inputs will be taken seriously in the reformulation of the legislation prior to formal tabling of the Bill itself in Parliament.

The Draft Bill is a long, technical, and complex piece of legislation. We have picked up on three issues which we would like to speak on today: personal tax rates; customs and excise amendments; and the strategic industrial incentives. We thus reserve comment on all the other amendments proposed in the Draft Bill. In relation to personal tax rates, we welcome the tax relief for low and middle-income earners, but argue that the tax relief disproportionately benefits middle to upper income earners and should have been more progressively structured. In terms of the amendments affecting customs and excise, we broadly support the tightening up and propose further measures which would contribute to this. Finally, we make various comments on the proposed strategic industrial incentives as to how we believe they could better contribute to industrial development and job creation.

2. Our approach to tax policy

By way of contextualising our specific comments on the Draft Bill, we will briefly set out our overall approach to tax policy. This speaks not only to what is in the Draft Bill, but what is not in it: we believe that an overhaul of many aspects of our tax system is required, as discussed below. For example, while this year’s budget did not announce any change in the general company tax rate, this comes after several reductions in the rate in previous years and a general shifting of the tax burden away from the corporate sector onto households. COSATU would thus have wanted to see an increase in the effective company tax rate this year.

The general principles underpinning our approach to tax policy are the maximising of revenue for socio-economic expenditure; a shifting of the revenue burden away from individuals onto the corporate sector; and increasing progressivity of the overall system as well as its individual components. By way of summary, COSATU has proposed the following changes in tax policy. A further elaboration of our proposals is contained in the Appendix to this document.

3. Income tax rates

Personal income tax rate changes, as announced in this year’s budget, are given effect to in section 2 of the Draft Bill with the detailed rates contained in Schedule 1 of the legislation.

We welcome the intention to provide tax relief for lower to middle income earners. It is positive that this will increase the disposable income of working people of South Africa, who are under great financial strain (1). However, contrary to popular interpretation of the proposed tax cuts, the lower income brackets will not be the greatest beneficiaries of the cuts. For example, someone earning R24 000 will save

R340, less than a percent-and-a-half of their income, while someone earning R100 000 will save R3 080, over 3% of their income. The chart below illustrates the effects of the tax cuts in terms of different income levels, both in terms of the actual amount to be saved from the 2000/01 rates to the 2001/02 rates, and this saving as a percentage of income. It shows that the nominal savings to taxpayers increase as the income level increases, and that even in terms of tax reductions as a percentage of income the maximum benefits are to income earners in the range of R80 000 to R100 000 rather than the lower income brackets. Even though on aggregate the bulk of tax relief will benefit the lower to middle income brackets, the impact on households and on overall income distribution remains highly inequitable.

Given South Africa’s extremely unequal income distribution, we believe that low income earners should be targeted for the bulk of tax relief, with higher marginal rates for the rich in order to raise more finances for developmental purposes, rather than benefiting from tax cuts as proposed. We do not believe it is correct that someone earning in the order of R200 000 to R1 000 000 a year should benefit from the further tax cuts which have been announced.

Of course, in the context of only the top 20% of income earners being eligible for income tax, income tax cuts only benefit the relatively well-off. A reduction in the VAT rate (discussed in more detail in the Appendix to this submission) would have a far more universal and progressive impact on households.

4. Customs and excise

Laxity, poor enforcement and corruption at customs and excise have cost many South African workers their jobs. COSATU believes, however, that considerable progress has been made by SARS in the past few years in improving the policing of our borders from illegal entry of goods, and for this we congratulate SARS. In particular, we support the efforts to transform SARS by getting rid of corrupt customs officers, weeding out the massive corruption (for example in the consumer electronics industry), and the crackdown on corruption involving customs and other tax fraud in the clothing and textiles sector.

Our understanding of the amendments relating to customs and excise as contained in the Draft Bill are that they are aimed at tightening up customs and excise, and giving SARS more teeth in the fight against corruption. As such, without going into the detail, we believe that they are a step in the right direction and we generally support the proposed amendments. We would like to take this opportunity to highlight other measures which we believe would further meet the objectives.

In terms of disposal, there should be tighter regulation over goods confiscated at entry points from finding their way back into the domestic or SADC market. Evidence suggests that the prevalence of this has displaced domestically produced goods and led to job losses.

The legislation should be amended to specifically provide that retailers and middlemen caught with goods which have entered the country without the proper payment of duties should be prosecuted and jailed. At the moment they can pay admission of guilt fines and get away with their crimes. It should also be obligatory to disclose the names of guilty parties, even those who pay admission of guilt fines.Beyond amendments to the legislation, further measures which we believe are required are as follows:

This raises what we regard as a key problem constraining SARS from efficiently carrying out its responsibilities, namely a lack of resources. We call on the intervention of the Finance and Select Committees to ensure an increase in the budget allocation of SARS to better capacitate it to properly implement legislation.

5. Strategic Industrial Incentives

The time available for comment on this issue has been particularly limited, which is problematic given the scale of resources involved in the incentives. Given the nature of the issue, it would have been preferable to have had involvement of the Trade and Industry Portfolio Committee and Economic Affairs Select Committee. Furthermore, it would have been appropriate to have had involvement of the NEDLAC Trade and Industry Chamber.

COSATU has advocated an active role for the state in driving industrial policy. We do believe that incentives have a role to play in such a policy. Incentives are tools for promoting particular sectors, ownership forms, regions, or production structures. Incentives should clearly not be used to subsidise activities which would have taken place in any event. Furthermore, given resource scarcity and the fact that incentives are publicly funded (or in the case of tax breaks represent lost revenue to the fiscus), they should obviously only be channelled to subsidising activities which are priorities for industrial and economic development. Incentives should be structured in a way that the benefits are broadly shared and have wider positive effects in the economy. Detailed ongoing monitoring of incentive use is required to ensure that they are not abused and that the desired objectives are indeed met. The role of incentive "carrots" in industrial policy should also be complemented by appropriate "sticks", for example in terms of regulation or tax penalties.

More specifically, given the unemployment crisis facing South Africa, industrial policy needs to be geared primarily towards employment retention and creation. Incentives can contribute to this by favouring relatively labour intensive sectors, promoting labour-intensive production methods within any sector, and building in concrete incentives for quantifiable and sustainable job creation. While there is certainly a role for "mega-projects", some of which may have an inherent bias towards capital intensity (particularly in certain sectors), every effort should be made in the structuring and implementation of the incentive to ensure that employment is a priority rather than an "optional extra".

It is within the above framework that we analyse and comment on the "additional industrial investment allowance in respect of industrial assets used for qualifying strategic industrial projects" proposed in the Draft Bill. Essentially the incentives are aimed at projects exceeding R50 million in industrial assets. Provided these projects meet a range of criteria, they will qualify for tax rebates of up to 100% of the cost of any industrial asset used, up to R600 million per project. This obviously represents a significant revenue loss to the fiscus, and it is crucial that such programmes are structured in a way that South Africa gets "value for money". For this to be a worthwhile investment in industrial development we must be certain that the incentives will lead to gains, which would not have been realised in the absence of the incentives, which will outweigh this lost revenue. The following comments are aimed at better positioning industrial incentives to advance industrial development and job retention and creation.

There is a general concern that existing incentives do not do enough to promote labour-intensive production and employment generation more generally, and in some cases actually lead to greater capital intensity. The introduction to the proposed legislation states that "industrial projects will be considered strategic only to the extent they have the potential to significantly increase economic growth or employment within the Republic", and section 5 similarly specifies that "the Minister of Trade and Industry must approve a strategic industrial development project if the Minister is satisfied that the project will significantly increase South African growth or employment" [emphases added]. With such formulations employment considerations are often subordinated to the growth objective. We propose that both economic growth and employment generation should be requirements for qualifying projects.

Concretely, this relates to the criteria and allocation of points set out in the Regulations. Points are allocated on various criteria: industry upgrade criteria (including utilising a new process or offering a new product, acting as a key component to related existing projects, and/or containing value-added processes); general business linkage criteria (including acquisition from small businesses and/or provision of additional infrastructure); and employment criteria (for the number of employees per R million in cost of industrial assets). The employment criterion set out in the Regulation is the key, if not the only, way of ensuring that projects benefiting from the incentives do generate employment.

Of the potential 10 points allocated for the above criteria, a project can qualify by achieving four points and will be treated as having preferred status by achieving six out of the potential ten points. This means that projects could benefit from the incentives, even getting "preferred status", without creating any jobs/with minimal job creation. We propose a restructuring of the criteria such that there is a minimum level of job creation that projects must achieve in order to qualify for incentives.

This could alternatively be achieved by giving the employment criterion a stronger points weighting, such that it would be impossible to get the requisite minimum points without achieving at least some employment points. This would also enable the promotion of greater levels of labour-intensity. As currently proposed in the Regulation, a project can start getting employment points by creating 1 job for every R250 000 in cost of industrial assets, and will gain maximum employment points by creating 1 job for every R166 167 in cost of industrial assets – still fairly capital-intensive production. It would more strongly prioritise and promote job creation by awarding additional points for even higher levels of job creation, and adjusting the qualifying points thresholds accordingly.

Points awarded should be for the creation of permanent jobs, to encourage the creation of sustainable and quality jobs rather than casual or temporary job creation. The measurement of jobs in the employment criterion also includes "jobs created from indirect employment [which] will solely consist of jobs added due to the increased sale of goods and services directly acquired by the company". While we support the recognition and encouragement of such downstream job creation, this should not open a loophole for companies to abuse benefits. It is important that there be clear and quantifiable mechanisms for distinguishing net "indirect" job creation arising directly from the project, and possibly placing such jobs in a different category distinct from actual employees of the company.

Given that these projects will be publicly subsidised, there should be an emphasis on training and skills development. This would also enhance the long-term viability of projects. Whilst the incentives are targeted at "industrial assets", and there are other mechanisms such as the Skills Levy targeted at skills development, we believe it would also be strategic to build in particular requirements for skills development for companies receiving these incentives. Furthermore, it should be an explicit requirement that projects benefiting from incentives are in compliance with their statutory obligations in terms of labour legislation and contributions such as Skills Levy, UIF, and Workers’ Compensation. This would avoid a situation where tax Rands subsidise companies which violate our labour legislation.

Section 9 of document 12G sets out conditions under which DTI may withdraw the benefit, such as failure to comply with the specified requirements and criteria. This should also ensure that companies which fail to comply with training requirements, statutory or labour law obligations, or fail to employ the number of people initially projected, should also be subject to withdrawal of the benefit or other appropriate punitive measures.

Section 4(e) of document 12G, and section 4(d) of the Regulations, provide that industrial participation projects (under the National Industry Participation Programme) will not qualify for incentives, and also prohibits concurrent investment incentives provided by any national sphere of government (2). We further propose that projects in terms of counter trade/offset deals should also be excluded from benefits. Where companies or countries are required to invest through such deals, it would be an inappropriate use of public resources for them to further benefit through these incentives.

We propose that the conditions for an industrial project being regarded as strategic (set out in section 4 of the Regulations) as well as the factor criteria for qualifying strategic industrial projects (dealt with in section 5 of document 12G and section 7 of the Regulations) should also include a spatial dimension. An aspect of government’s industrial policy, as well as broader socio-economic policy, is the targeting of particular undeveloped areas. Projects set in such areas could also qualify for additional points. Incentivising anchor projects in such areas could potentially kick-start development there.

The Adjudication Committee functions (as per section 14 of document 12G) to inter alia approve projects for incentives and monitor qualifying projects. The draft legislation proposes that the Committee consists of at least three members appointed by the Minister of Finance and three appointed by the Minister of Trade and Industry. We propose that provision be made for labour to also nominate a representative to this structure. This would facilitate the views of a significant constituency being taken on board in decisions which will directly and indirectly affect them.

As discussed above, detailed ongoing monitoring of incentive use is required to ensure that they are not abused and that the desired objectives are indeed met. Independent auditing of projects would be advisable in this regard. Furthermore, given that companies will be benefiting from significant public resources, there should be an explicit requirement for projects to publicly report to stakeholders, including Parliament (of course with due regard to corporate confidentiality) on the use of incentives and benefits arising from them.

Similarly, prior to the granting of incentives to a project there should be an impact analysis in terms of existing production, the environment, jobs, and other socio-economic factors. Such an investigation should include consultation with affected stakeholders. This is particularly important as the Regulations provide (at 4(a)) that the project can displace existing production up to a level of 40% of the production expected from the new project.

Appendix: COSATU proposals for reform of the tax system

VAT restructuring

Multiple VAT rating

As seen earlier in the comparison of VAT structures internationally, multiple VAT rates are common in both developing and developed countries, with those in the available data having an average of three levels of VAT. Differential VAT rates are particularly appropriate for South Africa given the high levels of inequality.

Due to South Africa's vast levels of income inequality, where the wealthiest 10% account for 40% of household income and the poorest 10% accrue less than 1% of total household income, there is a strong argument for multi-tiered VAT rates. A multi-tiered VAT system could incorporate distributional considerations in addition to the usual efficiency concerns.

Labour proposes the institutionalisation of a structure of progressivity in VAT through multiple rates. We propose an increase from our current two-tiered VAT structure to more tiers, including zero-rated, standard, and luxury goods. Our specific proposals on zero-rating and luxury goods are set out below.

VAT zero-rating

The RDP committed to VAT zero-rating, as did the 1999 elections manifesto of the ANC which states clearly that "we are committed to progressive taxation, that lightens the tax burden on most middle income and poor families. There will be special tax exemption on those basic goods which poor families rely upon for survival."

As discussed above, VAT is a highly regressive tax and has an adverse effect on income distribution. To attempt to counter this and ensure that the meeting of basic needs by the poor is more affordable, a number of goods are already zero-rated by government (3). COSATU proposes that additional items which meet basic needs be included in the list of zero-rated goods. The actual choice of additional goods to be zero-rated should be informed by current expenditure patterns (see above analysis), combined with a prioritisation of goods which can substantially contribute to improved social welfare of the poor. Revenue and efficiency considerations also need to be borne in mind.

In general, commodities with a high value would be a relatively low priority for zero-rating from a revenue point of view, while those with high impact on equity and the standard of living of the poor would be a relatively high priority for zero-rating from a welfare point of view. The health impact of goods – both positive and negative – would also influence the choice of items for further VAT zero-rating. For example, although lower income groups spend a greater proportion of their income on tobacco than do the higher income groups, negative health effects would rule out zero-rating it.

As a rule of thumb, exemptions will represent a larger share of poor households’ total expenditures than for the general population if the income elasticity on the good is below one (4). Goods which have an income elasticity less than one in South Africa include maize, bread, cereal, potatoes, beans, fish, milk, fruit and vegetables, oils, sugar, and kerosene. The poor would tend to benefit proportionately more from zero-rating of these goods than would the wealthy.

Using the weighted equity gain ratios cited by the Katz Commission (5) suggests the following goods as prime candidates for zero-rating: paraffin, bread flour, white sugar, matches, candles, coal, coal stoves, and white bread.

COSATU welcomed the announcement of zero-rating of paraffin in this year’s budget, which will have a direct impact on the available household resources for poor families. Zero-rating paraffin is of course not be sufficient, however, as it does not directly address the nutritional and other basic needs of the poor. We hope that next year’s budget will announce further basic goods for zero-rating. For example, over the counter drugs, generic drugs, and items of the government’s essential drugs list which are charged for should also be considered for zero-rating. School clothes and other education-related goods should also be included.

Identification of additional goods for zero-rating should also take account of equity considerations amongst the poor. Selection should be biased towards goods which are disproportionately consumed by women and by the rural poor. So in summary, the actual selection of goods for zero-rating should be informed by the following criteria:

In terms of process, labour proposes that the NEDLAC Public Finance and Monetary Chamber reach agreement on the principle of zero-rating additional goods. A task force of the Chamber should make a concrete recommendation as to which specific goods should be zero-rated. Our understanding is that the Department of Finance is about to undertake a periodic review into which goods should be zero-rated. The NEDLAC agreement should be incorporated in the Department of Finance’s review. Final agreement should be reached in time for implementation in the 2000/2001 budget.

Luxury taxes

The increase in the number of goods to be zero-rated would obviously have revenue-loss implications. Labour proposes the introduction of higher VAT rates on luxury goods to raise compensating revenue in a redistributional way.

Certain goods tend to be mainly or almost exclusively consumed by the upper income brackets. Raising more income from these goods should raise enough revenue to compensate for VAT zero-rating on basic goods. Furthermore, such goods generally have above-average import ratio. Any suppressed demand from luxury taxes would thus probably not have particularly detrimental effects on the domestic economy, and would actually assist in relieving balance of payments pressures. Where such goods are produced domestically, their production tends to be relatively labour intensive hence minimising potential negative employment effects.

Identification of goods qualifying for luxury taxes should consider the proportion of income spent on the good for different income groups. It is proposed that two lists of goods be agreed upon: those which prima facie qualify for a luxury tax; and those which qualify for a luxury tax above a certain price threshold. The former list could include goods such as photographic plates and film, cameras, video cameras and recorders, decoders, satellite dishes, CD’s, furs, binoculars, lawn trimmers, air conditioners, cordless telephone sets, cellular phones, caravans, yachts and other water leisure equipment, dishwashers, tumble dryers, microwaves, and certain other electric kitchen appliances.

The second list of items which are consumed by different income brackets, but which could be classified as luxury goods above a certain price. This could include cars, motorcycles, fridges, freezers, stoves, radios, TVs, watches, jewellery, sunglasses, cosmetics, and furniture. For each good included in the latter list, a threshold would be set (and price-adjusted on an annual basis) above which the good would be classified as a luxury and subjected to a higher VAT rate. This would ensure that for example basic white goods purchased by the middle class are not subject to the luxury tax. Such a system is already in place in other countries (for example in the United States a car costing over $30 000 is subject to an additional 10% tax on the difference between its price and this threshold).

The efficiency of tax collection should also be a consideration. It would be undesirable to have a system which entails excessive administrative costs. From this point of view it may be preferable to have fewer items subject to luxury tax at a higher rate, rather than a high number of items at a lower rate. We also recommend that a minimum floor (an absolute amount) apply below which no luxury taxes are levied.

As with the zero-rating of additional goods, labour proposes that the Chamber agrees on the principle of subjecting certain goods to a luxury VAT rate and that a task team of the Chamber, operating within a tightly defined timeframe, concretises the actual list(s) of items. This process should be finalised in time for the inclusion of these taxes in the 1999/2000 budget.

The combination of increased VAT zero-rating and increased VAT on luxury goods, as proposed above, should mitigate the regressive burden of VAT and should aim at making VAT progressive or at least distributionally neutral.

Corporate taxation

As discussed earlier, the contribution of companies to total revenue has fallen dramatically over a long period of time. This trend continued with the last budget cutting the company tax applicable to undistributed profits from 35% to 30%, a change expected to lead to a loss to the fiscus of R2.5 billion (6). It should be noted that the period since then has not seen an upsurge in productive investment, but instead there has been a dramatic loss of jobs. The Secondary Tax on companies, originally introduced at a level of 25% with the intention of encouraging companies to invest profits in productive investments rather than in dividends, now sits at just 12.5%. It is worth noting that the stagnation in private sector investment occurred in a period where the corporate share of taxation declined.COSATU has four specific proposals for the raising of more resources, badly needed by socio-economic development, from the corporate sector.

This approach of a minimum tax on companies has also been advocated in the South African context. The Margo Commission of Inquiry into South Africa’s tax structure recommended that "if the remaining incentives and concessions prove difficult to remove from the tax system, a simplified form of minimum taxation for companies could be considered for South Africa". In 1990, Inland Revenue also recommended consideration of a MTC.

In addition to the above four measures for increasing revenue from corporate taxation, there should be consideration of the merits and disadvantages in introducing progressivity in the corporate tax system based on enterprise size (this could be measured in terms of a range of criteria, including turnover and asset base). This would constitute a reverse of the current situation where tax burden tends to be inversely related to company size. According to the Katz Commission there is considerable evidence to suggest that the compliance burden of taxation falls disproportionately on small enterprises. Small businesses either do not have the necessary expertise to complete tax returns and have to rely on expensive professional assistance or on their own efforts. Those who are unable to afford experts are often not aware of legitimate deductions.

The Ntsika Small Business Review has also made useful recommendations around changes in the tax system which would be conducive for SMME growth. However, such measures, if implemented in isolation, would have a negative effect on aggregate corporate taxation. An overall restructuring of corporate tax rates such that larger corporations pay higher rates of tax could be one way of addressing this. This should obviously be effected in a manner which does not have adverse unintended consequences such as allowing loopholes for arbitrage or creating incentives for small business fronts.

Furthermore, serious consideration should be given to the way tax incentives influence investment decisions and favour one type of production over another. Any incentives which encourage capital-intensive production techniques and the substitution of capital for labour need to be reviewed.

Tax on pension/provident fund

Traditionally the private retirement industry in South Africa was largely used by the wealthy as a means of tax arbitrage. Taxing the trading income of retirement funds is one way to deal with this problem. Another reason for the introduction of tax on pension funds was to equalize the treatment between provident and pension funds. However the taxation of the retirement industry impacts on various income groups differently. The Smith Committee proposed the "top-up" as an incentive to get fund members to preserve their savings. The "top-up" system (as recommended by the Smith Committee) would compensate for the effect of taxation on low-income earners in retirement funds. When taxation of pension funds was introduced, it as agreed with the then Deputy Minister of Finance that this was conditional on the top-up system being implemented. The existing agreement in this regard should be implemented without further delay.

Overall restructuring of the tax system

The South African Revenue Service has, over the past 5 years, made significant progress in making South Africa's tax system more transparent. There have been considerable efficiency gains in terms of income tax collection. Measures have been taken to stem corporate tax evasion and avoidance.

The proposals raised in this submission are geared towards three key objectives: increasing the total revenue available for the reconstruction and development of South Africa; reversing the shift of the tax burden from companies to individuals; and making the entire tax system more progressive and equitable. We should aim at a tax structure which is progressive at every level, which is efficient, and which maximises the welfare of all South Africans. Mechanisms to reach this objective include but are not limited to the proposals discussed above. Other measures could include the following:

COSATU believes that these proposals, combined with those discussed above, will go a long way in making our tax structure more progressive and equitable. Given the extreme levels of inequality, we cannot be content with a tax system which places a heavy burden on working people and the poor and allows companies to carry a diminishing share of the tax burden. South Africa faces massive challenges of reconstruction and development, building on the progress which has already been made. To meet these challenges we will need increased tax revenue.

COSATU Submission on the

Draft Revenue Laws Amendment Bill

Submitted to the Finance Portfolio and Select Committees, 19 June 2001

Table of Contents

1. Introduction

2. Our approach to tax policy

3. Income tax rates

4. Customs and excise

5. Strategic Industrial Incentives

Appendix: COSATU proposals for reform of the tax system

VAT restructuring

Multiple VAT rating

VAT zero-rating

Luxury taxes

Corporate taxation

Tax on pension/provident fund

Overall restructuring of the tax system

Footnotes