Why the DSD Basic Income Subsidy Report is flawed

The Department for Social Development (DSD) published a model report on basic security in South Africa on Tuesday.

Empirical work on transfers is very important to inform the public debate about the policy options to tackle poverty, inequality and unemployment.

However, there are several aspects of the study that limit its usefulness as a basis for this discussion.

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“Significantly higher expenses in the long term”

Models of the type used in this study have a major flaw: they cannot estimate the long-term effects of policy changes, nor include in their analysis the inevitable impact of the policy changes being assessed on interest rates, inflation, or investment.

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

Although this point is recognized by the Panel (in bullet 37 of the report), this does not prevent them from proposing permanent policy changes for which their modeling approach cannot provide reliable information.

The policy proposals in the DSD paper imply significantly higher spending in the long term.

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

Our modelling, which allows for a long-term assessment of the impact of the fiscal environment on interest rates and the macroeconomy, suggests that incorporating the proposed transfer increases would require a combination of funding forms.

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

Tax increases of this estimated magnitude would likely lead to significant job losses and dominate any expansionary effects of higher transfers.

Why the DSD Basic Income Subsidy Report is flawed
Source: the author

Here are the simple sums

Let’s use some “simple sums” to demonstrate the impact on taxpayers of persistently higher spending.

With 7.4 million taxpayers and 10.5 million potential R350 SRD recipients, this means there are approximately 1.5 grant recipients for every taxpayer in South Africa. Thus, each taxpayer must contribute 1.5 times the value of the subsidy to balance the budget.

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

For the average taxpayer, this equates to a tax increase of around 9%.

The average taxpayer in the largest tax bracket (R500,000 to R750,000) pays R11,855 more per year in tax.

Although extending the SRD grant is fiscally feasible, proposals for enhanced social support must consider the long-term viability of higher spending, debt and taxes.

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

Our modeling suggests that the tax hikes needed to fund higher spending would result in fewer jobs and slower economic growth.

Sustained public spending expansion of the proposed magnitude over the long term would require either a clear, credible commitment to cut other spending or structurally higher economic growth.

Economic models often disagree about the likely impact of policy changes. However, such framework conditions are important cross-checks of the sustainability of political attitudes. Macroeconomic assessments of policy changes need to consider the impact on borrowing costs and growth over at least a five to ten year horizon.

The recent financial market turmoil following the UK’s announcement of unfunded expansionary policy highlights the dangers of trying to pursue unsustainable economic policies.

dr Daan Steenkamp is CEO of Codera Analytics.

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This article originally appeared on Moneyweb and has been republished with permission.
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