Economist Dawie Roodt warned that there is no room to increase taxes as rich people and companies will leave the country if it happens.
Roodt referred to the Laffer curve, which shows the relationship between tax rates and the amount of tax revenue governments collect.
The Laffer curve theory is built upon two extremes.
- If the tax rate is 0%, tax revenue would be 0.
- If the tax rate is 100%, no one will work, and the tax revenue would also be 0.
If the tax rate is incrementally decreased from 100% to 0%, the tax revenue will increase to an optimal point where tax revenue is maximised.
It would decrease to 0 as the tax rate becomes too low to generate tax revenue effectively.
The government’s goal would be to reach the optimal tax rate to generate the highest tax revenue – the revenue maximising point.
When the tax rate is raised beyond this point, individuals have greater incentives to do tax planning and arrange their finances in such a way as to pay as little tax as possible.
As the tax rate continues to increase, productivity would deteriorate as individuals would prefer to stay at lower tax brackets as the reward for hard work would be too low to pursue.
Another problem is that rich people are mobile and may decide to leave a country when the tax burden on them become too high.
High taxes can also put a strain on the economy and limit growth, which in turn results in lower tax collections.
South Africa on the wrong side of the Laffer curve
South Africa will likely miss its primary budget surplus target for the 2023 fiscal year by about R8.9 billion after revenue collections undershot estimates.
The country recorded a primary budget deficit of R1.53 billion in the fiscal year through March 2023, the National Treasury said.
The situation is aggravated by slow economic growth because of load-shedding, poor economic policies, and aligning itself with Russia.
The government may consider raising taxes to make up for the deficit. However, it is not easy, as it can result in even bigger problems.
Roodt said South Africa had surpassed the peak of the Laffer curve, making it difficult for the government to increase taxes.
He said the government may get slightly more money in the short term by increasing income taxes, but it can have negative consequences.
A small number of South Africans pay most taxes in the country. They can easily leave the country and are already doing so.
“Combined with the high crime rate and economic instability, higher income taxes will drive rich people out of the country,” Roodt said.
A second option is to increase company taxes, but the same problem may occur as with personal income taxes.
Only 770 companies pay two-thirds of all company taxes, and they already face some of the highest taxes in the world.
“We cannot increase company taxes. If you push it any higher, companies will simply move to another country,” he said.
Another option for the government is to increase value-added tax (VAT). However, it is politically unpalatable because it will cause unhappiness among the working class and unions.
He said the best option to increase taxes is a higher fuel levy, which is challenging to avoid and easy to collect.
“Simply put, the state must spend less money and focus on increasing economic growth,” Roodt said.