Report urges state to cut BEE premium to reduce VAT

If the government cuts the black economic empowerment premiums it pays on procurement contracts that wastefully inflate the cost of projects, goods and services, it can plough the R150 billion savings into the economy, allowing it to reduce value added tax (VAT) to just 11.5%, new research suggests.

The Institute of Race Relations’s (IRR) February report Blueprint for Growth: Slash Waste, Cut Taxes, by Gabriel Crouse, urges the government to cut BEE premiums, estimated to cost about R17 billion per annum, to simplify procurement and improve transparency.

It says this will improve corruption control to an estimated R150 billion, of which R100 billion could be used to pay for a VAT cut from 15% to 11.5%, with either a further VAT cut to follow or a general fuel levy cut of about R2.20 per litre. 

According to the treasury’s budget review this year, 25.5% of all tax revenue comes from VAT.

“The initial VAT cut is estimated to leave R31 billion in the pockets of the 70% poorest South Africans, where it is likely to be much better spent than by the government. 

“International experience shows that cutting VAT stimulates economic growth,” the report suggests.

It notes that black businesses would benefit directly from a share of roughly R30 billion of the VAT cut, from improved governance and improved consumer demand, outweighing losses from reduced BEE premiums.

The IRR report cites research which shows that the South African state has ballooned in size and spending, and the government is paying inflated prices for BEE contracts, while taxes have increased and the value it offers to citizens has declined.

“Since 2018, South Africa has had the most negative average response rate to international pollster Ipsos’s question, ‘Would you say things in this country are heading in the right direction, or are they off on the wrong track?’ 

“The operating hypothesis is that the most acute direct cause of this negative outlook is unemployment, particularly black unemployment, which has roughly doubled in the BEE era since 2008.”

According to Statistics South Africa, black unemployment has almost doubled on the official definition from roughly 3.6 million to seven million. Using the expanded definition, including discouraged work seekers, black unemployment almost doubled from 5.4 million to 10.7 million between 2009 and 2022. 

This was when public procurement was used as the main incentive to drive black economic empowerment by paying premiums between 2009 and 2022, the IRR report noted.

World Bank data shows that South Africa appeared to improve corruption busting in the mid-2000s but, overall, between 1996 and 2022, it suffered the worst relative decline in corruption control of any major sovereign constitutional democracy, with the worst year of decline being between 2021 and 2022. 

It also suffered the seventh-worst decline in regulatory effectiveness between 1996 and 2022, according to the data.

The IRR noted that the Zondo report connects corruption and state capture to a “problem in the legislative design”, specifically confusion of the “inevitable tension” between preferential procurement, elsewhere known as BEE premiums, and “maximum value for money”. This confusion, it says, subverts accountability.

“Treasury does not provide transparency or cost control on BEE premiums,” the IRR report said.

According to Wits University economist and public finance expert, adjunct professor Alex van den Heever, the government has never appraised the BEE policy systematically.

“There is no systematic analysis of the trade-off between expediting value-based public infrastructure delivery versus BEE project cost loading. In this analysis [to cut premiums] you would need to include the inevitable cost of corruption that results from adding in non-value-based discretionary criteria in tender determinations,” he said.

These costs are not only financial, they include time delays in concluding kick-back deals and the reduced quality of the final product, if it is delivered, Van den Heever added.

“A practice has developed of providing up-front financing to small, inexperienced contractors to ‘assist’ them to build capacity. 

“In practice, however, the up-front fee allows the contractor to walk away without completing the project. This outcome appears to have become systemic — with unfinished projects evident across many cities and municipalities,” he said.

Van den Heever said his research shows VAT increases have significant negative economic consequences, as unavoidable price increases seep into the value chain.

“VAT is a price increase — theoretically targeting value added only — but not necessarily, reducing final consumption expenditure and, with it, GDP. 

“Were the government to efficiently restructure its capital expenditure to focus exclusively on value for money, the explicit knock-on social and economic effects are likely to significantly exceed the unclear and indirect social outcomes of BEE,” he said.

He believes BEE as a “social intervention” is hard to defend as it is “so open to abuse that both the social and economic outcomes are, at best, entirely dissipated or, at worst, result in a net decline in public outputs and with it GDP”.

“The corruption resulting from the collapse of proper procurement processes has cost South Africa millions of jobs and thousands and thousands of small and medium-sized enterprises due to failed procurement of public infrastructure. So much so that the JSE has halved in size with investment drifting systematically out of South Africa,” he said.

“Domestic savings are not directed to domestic investment, as political patronage is sabotaging so much of the economy. No country can withstand this for very long. Well, it can survive — but you subsist as a Zimbabwe or a Somalia.”

He added that government expenditure has increased as a proportion of GDP, while the quality of what it delivers has declined “precipitously”.

“Governments are central to any country’s performance. But, in South Africa, it has become a weight on society. It delivers little but consumes much. 

“The areas where government intervenes appear driven principally by patronage rather than public value. Potentially very productive parts of government lie dormant with no active leadership,” Van den Heever said.

University of Cape Town tax expert Professor Deborah Tickle, who served on the Davis Tax Committee, said while cutting wasteful expenditure is beneficial, the report does not cover how the cost of removing the BEE premium and clamping down on corruption would be covered to release funds ordinarily procured through collecting 15% VAT.

“South Africa has limited tax revenues and high debt. Over 20% of every rand collected, in tax in any form, currently funds the interest cost, before any capital is repaid,” Tickle said.

She questioned how the government would deal with its expenditure obligations should it cut VAT, especially during the time lag before the benefits of the reduction of government costs and the stimulated economy were realised.

While VAT is technically a regressive tax, as highlighted in the report, the majority of actual VAT collected, is paid by affluent consumers with more spending power, Tickle said.

“As was indicated in the Davis Tax Committee macroeconomic report, tax is an important aspect of wealth redistribution which, once tax is collected, occurs through government expenditure in South Africa.”

According to data released last year from the South African Revenue Service and the treasury, just under one million people, or around 1.6% of the population, had a taxable income greater than R500 000 in 2022, but they paid approximately 80% of all the personal income tax.

“Presumably, those same people are spending and paying most of the VAT,” Tickle said.

“The tax base in South Africa is very concentrated and that leaves little room for treasury to manoeuvre … Interestingly, the Davis Tax Committee report concluded that increasing VAT would be less distortionary (to the economy) than increasing personal income tax or corporate income tax. 

“If the converse is true, then the conclusions in the IRR report, that the economy will be sufficiently stimulated to offset the reduction, need to be tested.”