EXPLAINER: Government debt and why it matters

Minister of Finance Enoch Godongwana reminded everyone during his budget speech in March: South Africa is spending more than 22c of every rand raised in taxes just to pay interest on government debt.

The debt ratio measures debt as a percentage of gross domestic product (GDP, the total output of goods and services produced in South Africa in a year). At the moment that ratio is more than 76%.

The size of the country’s national debt is not just an abstract figure. Money spent paying back creditors, both in South Africa and abroad, means less money to spend on badly needed government programmes such as social welfare.

This year, for instance, debt service costs - the money the government spends on interest on money it has borrowed - will amount to nearly R390-billion. This is more than is being spent on schools or health.

WHAT IS GOVERNMENT DEBT?

Governments all over the world borrow money to balance their budgets. They do this mostly through short-term loans called Treasury Bills and long-term loans called bonds. These are “IOUs” issued by the government and bought mainly by big financial institutions like insurance companies, banks and retirement funds. About a quarter of South Africa’s debt is held by foreign institutions.

HOW DID WE GET HERE?

The democratic government inherited a debt ratio of 43% in 1994. The ratio started to fall in the late 1990s and began to fall more quickly when economic growth took off in the 2000s (and GDP grew fast), dropping to about 24% in 2007.

But then the world financial crisis hit, growth slumped and the government started spending more than it was collecting in taxes. Corruption and mismanagement added to the problem.

Since 2011, budget policy has been focused on stabilising debt.

STABILISING DEBT

In order to stabilise debt, the government has to narrow the gap between revenue and spending. Every year, if spending exceeds revenue, more has to be borrowed. At present, the budget deficit (spending minus revenue) is about 5% of GDP.

To stabilise the debt-GDP ratio, the budget deficit needs to be reduced to around 3% of GDP. This would result in a “primary surplus” - that is, a surplus of revenue over non-interest expenditure.

Maintaining a primary surplus, Godongwana told Parliament, will lead, over time, to lower spending on debt as a proportion of revenue. This will create more room for increased spending on services and to build up reserves against future economic shocks like the Covid pandemic.

HOW THIS IS DONE

During periods of economic growth, revenue from taxes increases even if tax rates do not change. Businesses make more profit and pay more tax, and more people are employed and taxed. But when the economy is growing slowly or not at all, the only way to build up a surplus is to increase taxes or cut government spending.

That is why the VAT rate will be increased, if Parliament passes the budget, and why there is no tax relief for taxpayers whose salaries have gone up with inflation, putting them in higher tax brackets.

The National Treasury says that moving to sustainable government finances “entails painful choices”. But, the alternative is “far more debilitating: faster inflation and higher interest rates, reduced investment and slower growth, and an increasing risk of crisis that would especially affect” poor people.

Godongwana stopped short of introducing higher corporate taxes or introducing a wealth tax, as some commentators had called on him to do.

NEW RULES

The Treasury is now considering introducing a “fiscal anchor” - a mechanism to ensure big budget deficits don’t develop again. Many countries have such mechanisms, which can be just a set of guidelines and procedures for budgeting, or actual numerical targets set by the Minister or by Parliament for the fiscal deficit, the level of debt, or the rate of growth of government spending.

This article first appeared on GroundUp. Read the original article here.