MICHAEL SACHS | Income support is fated, but making it work will take political courage

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The macroeconomic modelling conducted for the DSD report was not suited to the analysis of macro-fiscal dynamics and no attempt was made to model the consequences of basic income support for debt sustainability, interest rates or investment behaviour. The PEAC is also right to caution that the tax modelling in the DSD report is rudimentary. No behavioural responses were modelled on the tax side and further consideration of the tax policy implications is required before government acts.

However, more rigorous modelling undertaken in 2021 reached positive conclusions about extending the Covid SRD grant, with a related discussion paper, Recovering from Covid-19: Economic Scenarios for South Africa, saying  “even in the most aggressive scenario financed by reduced government savings, the government debt-to-GDP ratio declines, as higher GDP and higher tax collections more than fully offset the increment to government debt”. This modelling is based on a social accounting matrix. PEAC correctly points out, and this is acknowledged by the modellers, that such modelling has limitations. Most important for the fiscal discussion is the absence of macro-financial dynamics or interest rate impacts. In a simple Keynesian closed-economy model (which appears to inform most of the noisy condemnations of the PEAC one reads in the popular press) this might not be important. But in the real world of globalised and financialised capitalism such considerations are central for macro policymaking, especially in a small emerging economy with uber-integrated financial markets.

Global conditions now enable SA to sustain its chronic and worsening fiscal position. Rising commodity prices mean corporate tax revenues from mining and finance are temporarily elevated. Easy monetary conditions underpin the flow of portfolio capital in support of the domestic bond market. These factors enable the country to continue along a clearly unsustainable path and the political leadership is determined to make hay while the sun still shines.

It would be foolish to rely on the continuation of these conditions. When times change for the worse tax revenues will fall and interest rates will rise further. Financial markets are aware of these dynamics and the damage to the credibility of government’s fiscal position implied by the additional spending will be anticipated, putting upward pressure on bond yields.

But judgments about fiscal sustainability depend on the overall state of public finances, not the wisdom of this or that programme. The debt to GDP ratio is rising, interest rates are higher than the rate of economic growth, the extent of fiscal consolidation needed to stabilise it does not look politically feasible and government lacks a credible strategy to raise the pace of growth. Basic income support will not fundamentally change these conditions.

The grant could have positive multiplier effects on growth during the recovery from Covid-19 and lockdowns. Adverse macro-financial responses may lead to rising bond yields in the short term and a fall in savings, investment and growth over time. Government needs to think about how it will limit the potential for these negative outcomes. This means clearly signalling that the new grants will be paid out of new taxes.

New spending means new taxes, not warm feelings

For many years National Treasury has correctly argued that structural increases in spending must be backed by structural increases in taxation. Taxes are not the only means through which government can extract economic value from society on a permanent basis. But taxation is the most transparent, accountable, progressive and efficient mechanism. It has also proven to be the only mechanism that is compatible with sustained growth, especially in large social states.  

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