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Raising taxes could result in lower collections while tax incentives could have the opposite effect

25 February 2020
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South Africa’s tax system has arguably reached the tipping point where higher tax rates may well translate into lower tax collections.

Economic theorist, Arthur Laffer, posits that there comes a point where raising taxes results in lower tax collections (the so-called “Laffer Curve”). This is what we seem to be seeing in South Africa, and is one of the reasons why raising taxes again now may not be a good idea.

This trend was already apparent two years ago when VAT, dividends tax and personal taxes were hiked. Revenue collections from personal taxed was expected to increase taxes collected by R16.5 bn in 2018 fiscal year, after marginal tax rates were raised in 2017. However, personal tax collections in 2018 ended R21.2bn below revenue projections.

Among the reasons why tax collections tend to fall despite higher rates of tax is that taxpayers have less money to spend, which means there is less money for the revenue authority to collect in the form of consumption taxes. Also, when tax rates rise beyond that crucial point, taxpayers are incentivised to find ways to trim their tax bills wherever they can (whether legal or not), affecting tax compliance levels.

Not too late to use taxes as a stimulus

That said it is not too late to start using tax as a tool to stimulate the economy.

Although counterintuitive, lower tax rates could result in higher taxes being collected. Taxpayers would have more disposable income to spend or to invest, thus stimulating the economy and driving tax collections. Lower tax rates would make paying the correct amount in taxes more palatable; the incentive to cheat would be reduced.

Further for Government to use tax as a tool to stimulate the economy, it will have to reduce the complexity and administrative burden of tax compliance, and make it easier for taxpayers to access incentives. The South African tax system is extremely complex, disproportionately so for a third world economy, not only for corporates but for SMEs as well. It is almost impossible for businesses of any size to be compliant without seeking professional advice. Simplification is long overdue.

The rules for claiming incentives are anything but straightforward – the youth employment and research and development incentives being cases in point. Furthermore, SARS has a natural inclination to audit those who claim these incentives, often resulting in taxpayers questioning whether it was worth the effort in the first place.