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Why the DSD’s basic income grant report is flawed

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The Department of Social Development (DSD) launched a modelling report on basic income support in South Africa on Tuesday.

Empirical work on the issue of transfers is very important for informing public debate on the policy options for addressing poverty, inequality and unemployment.

However, there are several aspects of the study that limit its usefulness in informing this discussion.

Read: Raise income tax for the rich to fund permanent R350 grant, say experts

Models of the type used in that study have a major shortcoming: they cannot assess the long-term implications of policy changes or incorporate the inevitable effects of the assessed policy changes on interest rates, inflation or investment in their analysis.

This limits the ability of the framework used to assess the costs and benefits associated with changes in basic income support that require meaningful changes in fiscal settings or their impacts on macroeconomic stability.

Although this point is acknowledged by the panel (in bullet 37 in the report), this does not stop them from proposing permanent policy changes that their modelling approach cannot be used to reliably inform.

The policy proposals in the DSD paper imply meaningfully higher expenditure over the long term.

We estimate that an extension of the SRD grant would cost an additional 0.8% of GDP per annum, while the proposed extension to the lower bound poverty line would cost 2.3% of GDP per annum.

Our modelling, which allows for assessment of the impacts of fiscal settings on interest rates and the macro economy over the long term, suggests that accommodating the proposed increases in transfers would require a combination of several forms of funding.

These would include government debt increases of between about 3 and 8 percentage points of GDP, VAT increases of between 0.2 and around 0.6 percentage points, personal tax increases of between 2 and about 5.5 percentage points, and see between 0.25 and around 0.5 percentage point higher corporate tax rates.

Tax increases of these estimated magnitudes would likely lead to meaningful job losses and would dominate any expansionary effects from higher transfers.

Dr Daan Steenkamp, Codera Analytics, basic income grant, income grants,

Source: The author

Let us use some ‘simple sums’ to demonstrate the implications of permanently higher expenditure for taxpayers.

Having 7.4 million taxpayers and 10.5 million potential R350 SRD recipients implies about 1.5 grant recipients for every taxpayer in South Africa. Thus each taxpayer needs to contribute 1.5 times the value of the grant to balance the budget.

The SRD expansion proposed in the DSD paper amounts to the average taxpayer paying an additional R6 800 per year.

For the average taxpayer, this is around a 9% increase in tax.

The average taxpayer in the biggest tax bracket by number (R500 000 to R750 000) will pay R11 855 per year more in tax.

Although extending the SRD grant is fiscally feasible, proposals for enhanced social support need to consider the long-term sustainability of higher expenditure, debt and taxes.

As we argue in our paper, South Africa has a small tax base with limited fiscal space for expansionary policies.

Our modelling suggests the tax increases required to finance increased spending would imply fewer jobs and slower economic growth.

Sustaining extensions of public spending of the size proposed over the long-term would require either a clear, credible commitment to cutting other spending, or structurally higher economic growth.

Economic models often disagree about likely impacts of policy changes. But such frameworks are important cross-checks of the sustainability of policy settings. Macroeconomic assessments of policy changes need to consider the impact on borrowing costs and growth over at least a five- to 10-year horizon.

The recent financial market turbulence after the UK’s announcement of unfunded expansionary policy demonstrates the danger of trying to pursue unsustainable economic policies.

Dr Daan Steenkamp is CEO of Codera Analytics.

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