MICHAEL SACHS | Income support is fated, but making it work will take political courage

A small cash grant to the poorest workers was introduced as an ad hoc and temporary response to the collapse of employment induced by the Covid-19 lockdowns. The social relief of distress grant (Covid SRD) operates in terms of national disaster regulations and its financing depends on periodic extensions announced in the national budget.

However, its success has underscored a broad consensus in favour of continuation. The first attempt to withdraw it ended in defeat for the Treasury in the wake of the July unrest. Since then, President Cyril Ramaphosa has clearly warmed to the idea.

The minimum wage helped him forge the coalition of factions that backed him in 2017. Continuing with basic income support may well be necessary to secure his re-election at the 2022 ANC conference and victory for the party in 2024. By then the grant would have been in place for five years and it does not make sense to think of it as temporary.  

The case for income support

This would not be the first time off-the-cuff responses to temporary crises led to permanent social reforms. It now seems clear that income support for the poorest citizens of working age is a new element of SA’s fiscal constitution, a contract on which sustainability of democracy depends. Legislation that defines the beneficiaries and design of the grant will take time to pass. In the meantime, the budget will have to accommodate a structural increase in spending of R50bn to R100bn, or about 1% of GDP.

It is not unreasonable to assume mass unemployment will remain a permanent feature of SA’s economy. This has been the case for the past 25 years and, given the state of politics and the course of technological change, it is hard to see how an effective programme to challenge the structural foundations of inequality and stagnation will emerge. It seems sensible, therefore, to design social policy on the assumption that a large share of workers will remain permanently excluded from formal employment. This is the argument James Ferguson makes for basic income support in Southern Africa in Give a Man a Fish: Reflections on the New Politics of Distribution (Duke University Press). As social policy it is a compelling argument. But does it make economic sense?

Basic income for poor workers comes with many economic and social benefits. It should lead to a material extension of economic opportunity for many, an expansion of human capabilities and a reduction in the daily burden of poverty, hunger and disease that blights politics and society. There are also cogent arguments (and some evidence) to suggest cash transfers to working-age adults have positive impacts on labour market participation and employment. Extending the grant system is likely to complement livelihood strategies and activate economic opportunities for poor households. In a context of risky transformations associated with green industrialisation, some form of basic income support may well be a comparatively efficient way to protect the most vulnerable and bring a sense of justice to the transition.

It is possible to imagine conditions in which government advances policy across a broad front, acting decisively, dealing with difficult choices, committing to clear and unambiguous policies that ignite economic growth. In such circumstances basic income support could be a positive complement to growth in a virtuous cycle of development. But let’s not hold our breath. Policy paralysis is baked deeply into the national condition. On the other hand, we’re good at cash transfers and we have a relatively efficient tax system.

A small grant implies a modest weakening of the fiscal position, which should be set against its considerable benefits. It doesn’t mark a sharp departure from policy, but merely a continuation along the path established after the ANC’s 2007 conference. Previous experiences (for instance, free university education) offer a clear lesson: we should not leave the design, financing and institutional framework of policy to chance on the assumption that politicians do not mean to do as they say. It is quite possible to make a difficult situation significantly worse and so undermine the potential impact of progressive reforms and the arguments in their favour.

Basic income amid economic stagnation

SA’s national income has been stagnating for at least a decade and this looks set to continue. High long-term interest rates, low investment and pedestrian rates of growth are entrenched features of our environment. The claims of true believers that a basic income grant will set in motion a new path of growth and development should be treated with caution.

Demand stimulus may well be required to support recovery from the Covid-19 shock, but it is not the path to sustained growth. Over time, shifting income from the affluent to the poor might generate new investments in retail and expand the scope for production of consumer goods, which may be welcome transformations in economic structure. But SA is a society in which the capital stock, when fully used, employs a fraction of the potential workforce to generate income for a minority of the population. This is offset by fiscal redistributions of income, which are among the largest in the developing world, financed by taxes that are far higher than in other countries with a similar level of income.

Economic growth depends not on temporary fiscal multipliers, but on a credible programme to open new channels for transformative investments that enhance productivity, for instance in the form of green industrial transformation. If such a programme can be agreed on and executed at scale (a big if) SA might experience sustained growth. A condition for success would be macroeconomic policies that constrain consumption so investments can be financed on a sustainable basis. The extension of income to the poor addresses none of these constraints and could well lead to increased consumption, including of imports, combined with a fall in national savings and investment.

The grant will worsen SA’s fiscal position, which is already so chronic it has become a central cause of slow growth and economic stagnation. High interest rates on government debt are a hurdle to fixed investment. The incessant rise in debt service costs — now approaching 5% of national income — crowds out social spending out of tax revenue and shifts the profile of public spending in favour of affluent households. The deficit has been entrenched at about 6% of GDP for more than a decade and there is no clear path to closing it. As these pressures mount, so does the danger of financial and macroeconomic turbulence.  

The introduction of a new R50bn expenditure commitment will aggravate these pressures and weaken the credibility of fiscal policy. Over time, it implies tax increases that will raise the returns required on investment projects. The increased fiscal risks imply higher borrowing costs, which could slow the pace of growth and employment creation. In these circumstances, the Presidential Economic Advisory Council (PEAC) is correct to advise caution about the fiscal risks. Moreover, the report of the department of social development’s (DSD) expert panel on basic income support provides no evidence to dispel these concerns (disclaimer: I was a member of the panel).

The macroeconomic modelling conducted for the DSD report was not suited to the analysis of macro-fiscal dynamics and no attempt was made to model the consequences of basic income support for debt sustainability, interest rates or investment behaviour. The PEAC is also right to caution that the tax modelling in the DSD report is rudimentary. No behavioural responses were modelled on the tax side and further consideration of the tax policy implications is required before government acts.

However, more rigorous modelling undertaken in 2021 reached positive conclusions about extending the Covid SRD grant, with a related discussion paper, Recovering from Covid-19: Economic Scenarios for South Africa, saying  “even in the most aggressive scenario financed by reduced government savings, the government debt-to-GDP ratio declines, as higher GDP and higher tax collections more than fully offset the increment to government debt”. This modelling is based on a social accounting matrix. PEAC correctly points out, and this is acknowledged by the modellers, that such modelling has limitations. Most important for the fiscal discussion is the absence of macro-financial dynamics or interest rate impacts. In a simple Keynesian closed-economy model (which appears to inform most of the noisy condemnations of the PEAC one reads in the popular press) this might not be important. But in the real world of globalised and financialised capitalism such considerations are central for macro policymaking, especially in a small emerging economy with uber-integrated financial markets.

Global conditions now enable SA to sustain its chronic and worsening fiscal position. Rising commodity prices mean corporate tax revenues from mining and finance are temporarily elevated. Easy monetary conditions underpin the flow of portfolio capital in support of the domestic bond market. These factors enable the country to continue along a clearly unsustainable path and the political leadership is determined to make hay while the sun still shines.

It would be foolish to rely on the continuation of these conditions. When times change for the worse tax revenues will fall and interest rates will rise further. Financial markets are aware of these dynamics and the damage to the credibility of government’s fiscal position implied by the additional spending will be anticipated, putting upward pressure on bond yields.

But judgments about fiscal sustainability depend on the overall state of public finances, not the wisdom of this or that programme. The debt to GDP ratio is rising, interest rates are higher than the rate of economic growth, the extent of fiscal consolidation needed to stabilise it does not look politically feasible and government lacks a credible strategy to raise the pace of growth. Basic income support will not fundamentally change these conditions.

The grant could have positive multiplier effects on growth during the recovery from Covid-19 and lockdowns. Adverse macro-financial responses may lead to rising bond yields in the short term and a fall in savings, investment and growth over time. Government needs to think about how it will limit the potential for these negative outcomes. This means clearly signalling that the new grants will be paid out of new taxes.

New spending means new taxes, not warm feelings

For many years National Treasury has correctly argued that structural increases in spending must be backed by structural increases in taxation. Taxes are not the only means through which government can extract economic value from society on a permanent basis. But taxation is the most transparent, accountable, progressive and efficient mechanism. It has also proven to be the only mechanism that is compatible with sustained growth, especially in large social states.  

There are several options that now need to be considered. Removing the tax breaks on retirement savings would raise the effective rate of personal income tax for the most affluent. Government can also step harder on the brake of fiscal drag, which distributes the burden onto the middle strata, but creates inefficiency and perverse incentives. A better approach would be to raise the rate of VAT. In recognition of the permanence of the grant and a host of other fiscal pressures some combination of all these tax measures needs to be placed on the table for discussion as soon as possible.

Tax increases need not be implemented immediately, but must be announced far in advance. Delaying them would help reap the multiplier effects of the new spending. But upfront clarity on plans for increased taxation is needed to limit the deterioration in financial conditions which, if left unchecked, could overwhelm any positive multiplier effects. Tax changes of this magnitude also require extensive public deliberation and policy work to ensure effective design and orderly implementation can take place.

The potential upsides of basic income support will depend on design, institutions and the quality of the social compact that can be negotiated around it. Until now, President Cyril Ramaphosa has been warm and fuzzy about the need for basic income support and public employment programmes. He frequently waxes lyrical about social compacting and the need for government to be generous to its people, especially the poor and unemployed. But he has been largely silent on the question of the trade-offs or the real economic concessions needed to make a social compact work.

Basic income support is not a question of government “being generous”.  The money will be taken from employed citizens and the affluent, and it is they who Ramaphosa should be calling upon to be generous, while explaining clearly why he believes it is necessary they pay higher taxes. Until now, and in stark continuity with his much-maligned predecessor, he appears to believe these awkward details can be left to Treasury.

The trade-offs required to make basic income support sustainable include higher taxes, but also critical compromises on public-sector pay, economic growth and the transformation of energy supply that the ANC has so far refused to swallow. Basic income support also means sacrificing fiscal space for other progressive social policy interventions, potentially for the next generation, and if not handled carefully could accelerate the deterioration in key government services such as basic education, healthcare and policing.

An income support grant that reaches poor and unemployed workers can become an effective and prideful part of our fiscal constitution. It will mean sacrifices from the wealthy, but also from those in secure jobs, including public-sector workers and other unionised insiders. And this will take political courage to push through.