The Davis Tax Committee (DTC) recently published its final report on the feasibility of introducing a proposed new wealth tax in South Africa.
This article provides a summary of the DTC key findings and recommendations.
The report had four main objectives:
- Provide an empirical review of the global literature on wealth taxation.
- Describe the current state of wealth inequality in South Africa.
- Evaluate the feasibility of increasing the share of wealth taxes in the overall tax mix in South Africa to achieve the goal of reducing wealth inequality in a way that is economically and administratively efficient.
- Examine the potential contribution of wealth taxes to South Africa’s revenue streams.
The DTC is advisory in nature and makes recommendations to the Minister of Finance. The Minister will take into account the report and recommendations and will make any appropriate announcements as part of the normal budget and legislative processes. As with all tax policy proposals, the proposals will be subject to the normal consultative processes and parliamentary oversight once announced by the Minister of Finance.
The rationale for a wealth tax
Wealth inequality in South Africa is a threat to social stability and inclusive growth
Empirical evidence suggests that in South Africa, wealth inequality (with a Gini coefficient above 0.9) is extremely high and is, in fact, not just higher than income inequality (which has a Gini coefficient of 0.67) but also higher than global wealth inequality. The Gini coefficient is a measure of income inequality, ranging from 0 to 1. A value of 0 represents a perfectly equal society and a value of 1 represents a perfectly unequal society. It is therefore timely for South Africa to consider a range of ways in which wealth inequality can be reduced.
The considerations that arise from an assessment of the existing tax base
We need to take stock of recent developments and the current tax base
The adverse consequences of wealth taxation such as capital migration, disincentives to save, and the effect on entrepreneurship and employment must be thoroughly considered. Income streams arising from wealth are today taxed on a far wider base than 20 years ago, so it is necessary to take stock of recent developments and the existing tax base. Below is a summary of the DTC’s key findings.
- Cash and savings
The after-tax interest rate earned on savings is already below the inflation rate. If subjected to a wealth tax, the real growth rate of savings will fall even further below the inflation rate and will aggravate our already poor savings culture. A wealth tax may result in more retired individuals, who are living on savings, being unable to sustain themselves without exhausting their savings before they die, thereby becoming reliant on the State or others.
- Listed investments and collective investment schemes
The combined emphasis on Capital Gains Tax (CGT) and dividends tax since 2001 causes some concern about imposing a wealth tax on investments.
- Retirement funds
A substantial proportion of South Africa’s wealth is held in retirement funds, and these represent a major component of lower income earners’ wealth. It can be argued that any form of wealth taxation will be largely ineffective if retirement funds are granted complete exemption, but the imposition of wealth tax on retirement funds has every potential to create enormous administrative complexity unless imposed at a flat rate on the gross assets. This, however, would make no distinction between rich and poor retirement fund members. The imposition of wealth tax on retirement funds will have far-reaching implications in the long term, but concessions (like the dividend tax exemption in 2012) granted to retirement funds in recent years are perhaps overly generous.
- Immovable property
Any suggestion about a land tax needs to be considered with an awareness of, and sensitivity to, current debates relating to land ownership, as well as concerns about the vast disparities in wealth in South African society. Taxes are already levied on property, such as Transfer Duty, VAT, CGT and municipal rates.
The reasons to implement a land tax include:
a) It is generally considered to be the least distortive of all taxes and least harmful to economic growth.
b) Ownership of land is generally easy to establish, making it possible to identify who is liable for the tax.
c) It is a ‘presumptive tax’ (in other words, the tax is levied irrespective of whether the owner of the land is in fact extracting the ‘economic rent’ from the land). This promotes and encourages efficient use of land and discourages unproductive use, such as simply leaving land vacant.
d) Taxing land reduces the likelihood of land price bubbles.
However, policy regarding any land tax would need to consider:
a) Liquidity and the ability to pay.
b) Singling out one asset class would disproportionately affect those who hold relatively more of their wealth in property. This would also likely affect middle-income families (who tend to hold a greater proportion of their wealth in immovable property) more than the very wealthy. The top 10 percent of the population of South Africa own more than 90 percent of the total wealth in the country. It therefore comes as no surprise that, when using wealth as a measure of living standards, the so-called ‘middle class’ is a very small group.
c) Valuation problems, because different municipalities use inconsistent approaches to determine property values. The administration of the current system needs to be improved first.
d) Transfer duty is a significant impediment to buying and selling property, which causes property owners to continue to hold property that no longer serves their needs, rather than sell and buy a different property.
e) The total tax on the gains from the transfer of high-end residential property can be as much as 31% if Transfer Duty and CGT are combined, which may cause stagnation in the residential property market. This reduces related capital and revenue income tax collections. Given the current state of South Africa’s tax collection, it is unrealistic to propose the unilateral or immediate withdrawal of Transfer Duty. It is equally unwise to propose a further tax of residential property through a wealth tax, at least until the adverse impact of the Transfer Duty rate can be reduced.
- Rates and taxes on land and improvements
There is technically an argument for a wealth tax to be imposed on land and buildings. This would have the advantage of collecting tax on a monthly or annual basis over the holding period of the property as opposed to delaying taxation through the transfer duty system until sale or transfer.
However, the following issues would need to be addressed:
• The Transfer Duty issue mentioned in section 4, above.
• The effect of double taxation at local government and national level.
• Possible inconsistency between local government rating policies and a wealth tax at national level.
• Complexity about business property, farming land and tribal land.
• The basis of valuation.
• The impact on recipients of a land redistribution programme.
- A recurrent tax on net wealth
A net wealth tax is a tax imposed on the difference between the sum of all wealth and the sum of all liabilities. Measuring net wealth is a complex process and requires a clear understanding of what constitutes assets and liabilities. Most submissions were not in favour of a net wealth tax. The following questions would need to be considered regarding a net wealth tax:
• Should all wealth be included? Should retirement savings be included?
• Which liabilities should be included?
• Is the individual the most appropriate tax unit or should the tax apply to households or couples?
• How should one treat residents versus non-residents?
The DTC recommendations
We need to address specific challenges before implementing any further wealth tax
The DTC suggested that while a recurrent net wealth tax may be an admirable and desirable form of wealth tax, we need to first address the challenges and unintended consequences of further wealth taxes before implementing them. This is essential to ensure that any such tax is well-designed and will yield more revenue than the cost of administration. The legislative and administrative processes required for both SARS and the taxpayer will be significant and must not be underestimated.
To create a wealth tax, we must consider the current tax base and have better data and admin
The process of creating a wealth tax needs to start with the consideration of a very simple form of annual net wealth tax. The decision however cannot be made without:
- Further consideration as to the appropriate tax base, in other words, which forms of wealth should be included – specifically, should retirement funds be included?
- Comprehensive data on patterns of wealth ownership.
- An evaluation as to whether revenue generated by the wealth tax would exceed the administrative and economic burden on taxpayers and revenue authorities.
- The quality of existing data on wealth must be significantly improved. The DTC suggested:
- All taxpayers and beneficial owners of wealth (which includes control of trusts and beneficiaries thereof) that are required to submit an income tax return must be required to include the market value of all readily ascertainable wealth in a revised tax return for the 2020 year of assessment. Taxpayers should also be required to disclose the existence of other forms of wealth where the market value is not readily available (such as membership of defined benefit retirement funds, shares in private companies, intellectual property, and personal assets above a basic threshold).
- The non-disclosure penalty provisions of the Tax Administration Act should be revised to make provision for implementation of substantial penalties where taxpayers fail to disclose the existence of their wealth.
The DTC recommends that the focus should initially be on increasing estate duty collections
Their view is that their previous reports and recommendations about Estate Duty have not been implemented fully, even though the administrative capacity already exists.
While we have existing wealth taxes, there are other tools to address inequality
South Africa has existing wealth taxes in the form of Transfer Duty, Estate Duty and Donations Tax. These currently raise very small amounts of tax revenue. A wealth tax is not, however, the only available instrument to address income and wealth inequalities. Other ways to address inequality include land reform, programmes on the expenditure side of the fiscal budget such as increased access to quality health and education, and the provision of infrastructure and effective government to improve growth and employment. A decrease in unauthorised and wasteful government expenditure and enhanced tax morality will also help.