Fiscal policy refers to the choices government makes concerning public spending and taxation. A government budget is a plan of estimated spending and taxes. This article in the popular economics series looks at budgets and fiscal policies in more detail.
Fiscal policies are an important type of macroeconomic policy in which government decisions around spending and taxation have important implications for the economy as a whole. In South Africa, government spending accounts for over 30 percent of the entire gross domestic product (GDP) and public sector employment makes up nearly one-third of all formal sector jobs. The government is therefore a key economic player and its decisions concerning how much to spend and how much to tax have important implications for the economy.
Since the government is such an important part of the economy, increased government spending can increase the amount of total economic activity and employment. Likewise, the level of taxation can influence the amount of money individuals and firms have to spend on consumption and investment. Therefore, fiscal policies can be used to influence the overall growth of the South African economy. Increased spending or lower taxes tend to boost the economy, while decreased spending and higher taxes tend to slow the economy.
Taxation
The government gets most of the money it spends - its revenues - through taxation. Taxes come in many forms - income taxes, value-added taxes (VAT) and profit taxes. Often taxes are classified into two broad categories, progressive taxes and regressive taxes.
Progressive taxes are those taxes in which wealthier people pay a larger share of their income in tax than do poorer people. An example of a progressive tax in South Africa is the income tax. Regressive taxes are those taxes in which poorer people pay a larger share of their income in taxes than do wealthier people. An example of a regressive tax is the value-added tax (VAT).
Taxes can also be classified into taxes which individuals pay (for example, income tax and VAT) and taxes corporations pay. The graph below shows the trend in individual taxation and corporate taxation in South Africa in recent years. Over time, the tax burden has shifted away from mines and corporations and towards individuals living and working in South Africa.
Deficits and debts
When a government spends more than it receives in taxes, it runs a budget deficit. In order to make up the difference between revenues (taxes) and expenditures, it must borrow money. It is important to note the difference between a deficit and the public debt. A deficit is the amount the government must borrow in a particular year. The public debt is the total amount the government owes at any particular time. If the government runs a deficit year after year, the public debt will tend to increase each year.
Whether deficits are good or bad is an important debate in fiscal policy. People who support deficit spending would argue that the increased government spending will boost economic growth and create the resources necessary to repay the debt in the future. Opponents of deficit spending argue that increases in the debt are unsustainable because the amount government would have to pay as interest will continue to increase year after year.
So who is right? The answer depends on how effectively government spending is used to stimulate the economy and how high the interest rates are. When interest rates are extremely high and economic growth is doing poorly, prolonged deficit spending is more likely to be unsustainable. If increased spending increases growth rates while interest rates are lowered, deficit financing is more likely to be sustainable.
The apartheid debt
Prior to the 1994 democratic elections, the apartheid government increased the degree of deficit spending and caused the size of the debt in South Africa to grow.
There was a rapid debt build-up as apartheid-era civil servants were awarded "golden handshakes" in the form of large increases in their pension packages.
Current fiscal policy in South Africa has been constrained by this legacy of the apartheid government. The country's high interest rates mean that interest payments account for 20 percent of the total national and provincial budgets. If this money could be used for delivery of housing, health care, and education instead, important achievements for the country's development could be realised.
The current macroeconomic strategy, however, aims to reduce the burden of the debt by cutting government expenditures and damaging the potential for delivery in the short-term. This is not the only viable strategy for addressing the apartheid debt. Higher rates of more progressive taxes, lower interest rates, and restructuring the debt could all be used as alternative strategies for addressing the issue of the national debt and allowing delivery of basic needs in the short-term.
