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Is a wealth tax the pragmatic solution to South Africa’s inequality?

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Luxury living: a wealth tax on Clifton houses such as this one could pay for larger social transfers

On Monday night, in a speech delivered at Stellenbosch University’s Department of Economics, Andrew Donaldson, Deputy Director General responsible for Public Finance in South Africa’s National Treasury, suggested the following: that to address the severe and persistent inequality of South African society, a much larger share of the government budget should be devoted to redistribution. Not only is this morally good, he argued, but recent research by the IMF suggests that it is also better for the economy (or, at the minimum, that it does not affect economic growth negatively). Whereas South Africa now redirects about 3% of GDP from the rich to the poor, this could increase substantially. Iran, for example, redistributes 11%.Yes, this is another post on inequality. I’ve written recently about the good and bad of inequality, and about its relationship with capitalism. But Donaldson’s paper, coming from the centre of policy-making in South Africa, suggests that it is a topic that we need to give our full attention. The study of inequality was, for a long time, the preserve of development economists, debating the many ways it could be measured, lamenting its slow change, while the rest of us focused on improving economic growth. Not any more. The rising popularity of more left-leaning policies, both outside and within the ANC, suggests that there is pressure within government to act on the perceived slow economic transformation since 1994; while poverty has declined significantly (thanks to growth and redistribution), inequality has remained stubbornly high.

Donaldson noted that there are several ways the state can help improve the income distribution. The most obvious – and for many economists, the only way – is to improve education. South Africa spends a considerable amount on education, yet education outcomes for a large segment of our population are appalling, to the extent that South Africa is ranked embarrassingly low on international rankings. But it is one thing to say that we ‘need to get the education system right’, and another to actually do it. It is clear our education is failing, and there is no indication that it will improve in the short run. In the meantime, these kids are exiting school and entering the labour market armed with very few skills. And so, because they are unable to partake in the fruits of the market economy, the dreams and aspirations of millions of young South Africans depend on what they can receive from government. Donaldson’s argument is that this growing gap between the educated and uneducated is unsustainable politically and economically. Something’s gotta give, and so one suggestion is to expand the social welfare system, to increase the amount these individuals receive directly from government, which will, hopefully, give them a better chance of participating in the formal economy.

The response from economists would naturally be that greater redistribution will have an adverse effect on economic growth; that increasing the marginal tax rates on the rich will disincentive them to work (or force them to move to other countries), reducing the productive and entrepreneurial capacity of the country, and cause economic stagnation, or decline. But this is not the case, Donaldson argues, citing a recent IMF report. The report, surveying a large number of countries over many years, finds little evidence for a trade-off between redistribution and growth. In fact, the IMF authors suggest redistribution has a benign effect on growth. That implies that governments can increase redistribution considerably without any adverse effects:

We nonetheless see an important positive conclusion from our look at the big picture. Extreme caution about redistribution—and thus inaction—is unlikely to be appropriate in many cases. On average, across countries and over time, the things that governments have typically done to redistribute do not seem to have led to bad growth outcomes, unless they were extreme. And the resulting narrowing of inequality helped support faster and more durable growth, apart from ethical, political, or broader social considerations.

Which is the reason for Donaldson’s question: Is there greater scope for fiscal redistribution? He proposes several ways that Treasury can redirect tax income to the poor: most notably he suggests that a labour subsidy, not only for young people, but across the economy for the lowest income earners, could incentivise businesses to increase employment of unskilled jobs. In reality, this is something like a negative income tax; individuals that earn below R5000 per month, would get an additional state subsidy of R1000, for example. Other tools to redistribute include the more blunt instruments of higher pensions and child support grants.

Of course, someone will have to pay. He suggests increasing marginal rates on income taxes. In a question I posed to him afterwards, I asked whether higher income taxes are not inherently unfair. The reason for South Africa’s skewed income distribution is its centuries of inequality, and of the repressive and discriminatory labour policies of the twentieth century. Surely, then, a wealth tax is more appropriate. Why should a twentysomething (black and white) of the coming decade pay for the mistakes of the past? A wealth tax, in theory, taxes past incomes. He was unimpressed: few wealth taxes have been successfully implemented, he suggested, and they are often administratively expensive. This is true, but I feel slightly justified in my question given that I share this with the author of a book (to be published in about a month) that will have a profound impact on the field of Economics.

At least, that is the claim of Paul Krugman, who recently reviewed Thomas Piketty’s Capital in the Twenty-First Century. South Africa is not the only country to struggle with solving rising inequality. In short, Piketty argues that globally “we haven’t just gone back to nineteenth-century levels of income inequality, we’re also on a path back to ‘patrimonial capitalism’, in which the commanding heights of the economy are controlled not by talented individuals but by family dynasties”. His suggestion to fix this? Wealth taxes! Here’s Krugman’s summary:

Piketty ends Capital in the Twenty-First Century with a call to arms—a call, in particular, for wealth taxes, global if possible, to restrain the growing power of inherited wealth. It’s easy to be cynical about the prospects for anything of the kind. But surely Piketty’s masterly diagnosis of where we are and where we’re heading makes such a thing considerably more likely. So Capital in the Twenty-First Century is an extremely important book on all fronts. Piketty has transformed our economic discourse; we’ll never talk about wealth and inequality the same way we used to.

Maybe Desmond Tutu, in his call for a white wealth tax in 2011 (in a speech at Stellenbosch University) was on to something, even though his emphasis on ‘white’ was perhaps misplaced. More realistically, while a wealth tax may have negative consequences, these may be less severe than the alternative policies. Consider the Promotion & Protection of Investment Bill (which allows the state to claim land and other property without compensation as a ‘custodian’), the Private Security Regulation Amendment Bill (which forces foreign-owned companies to sell 51% to South Africans), and the Employment Equity Amendment Act (which forces firms with more than 150 staff to use national demographics as ‘guide’ for racial targets in employment), to name a few recently proposed bills that aim to transform the South African economy (see more here). It is likely that these will have far greater, perverse and unintended consequences.

A wealth tax, especially if implemented at the global level, may allow government to strengthen the bottom of the income distribution through social transfers without jeopardizing the economy’s ability to produce.


Written by Johan Fourie

April 10, 2014 at 07:48

3 Responses

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  1. It will be helpful for the poor in the expense of the wealthy and potential entrepreneurs and will also discourage people to acquire wealth. So the impact it will have is what the government needs to consider before implementing the policy.

    Fortunate Mahlatse Mangaba

    October 10, 2014 at 08:13

  2. Education is only sustainable solution to inequality. Especially maths ed. Seems as if government is keen to sustain inequality. Have more positive alternative to wealth tax to deal with jobs if u want to email me

    Guy Harris

    April 12, 2014 at 22:42

  3. Thanks for another good post Johan. Krugman’s review of Piketty in the New York Review of Books is spot on and this brings the SA perspective. Only solution is to send Andrew a copy!

    Waldo Krugell

    April 10, 2014 at 20:17

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