Economic Terms and Tax Concepts — Fiscal Drag causing higher tax rates

It often occurs that certain actions (or inactions) by government may have undesirable consequences for members of the public without the public even being aware.

One of the negative consequences for the average tax payer is that additional tax is paid without changes being made to the personal income tax rate if the tax bracket is not adjusted for inflation. This is termed fiscal drag.

The announcement that tax brackets would not be adjusted for inflation at all came as a surprise in the 2019 Budget Speech by Minister of Finance, Tito Mboweni. Treasury expects to raise R12.8 billion in tax revenue in this manner. Only marginal adjustments were made to rebates.

In 2018, of the 21 million individual taxpayers only 6.4 million (30%) were expected to submit tax returns. Only 4.9 million taxpayers (23%) submitted returns and were assessed. Of the assessed taxpayers 16.8% owed SARS some tax.

Definition of Fiscal Drag

Fiscal drag is a concept where inflation and earnings growth may push more taxpayers into higher tax brackets. Fiscal drag has the effect of raising government tax revenue without explicitly raising tax rates.

Fiscal drag could also work in the opposite direction. If there is deflation and falling wages, fewer workers would be in the higher tax bracket. However, deflation has not been common since pre-1939.

Fiscal Drag could be overcome by indexing tax bands to earnings or inflation. However, this is not frequently done.

Real Fiscal Drag is achieved when tax brackets are increased in line with inflation and earnings may grow faster. This means a higher percentage of earnings will be within higher tax brackets.

South Africa’s inflation rate is estimated to hover at 5.2% in 2019.
As the tax rate and brackets remain unchanged, an inflationary increase in your salary will increase your effective tax rate.

Basic calculations from the 2019/2020 tax contribution tables and salary assumptions (6% salary increase) suggest that income earners in the category:

Lower-income bracket will pay 10.83% more in income tax; an effective tax rate of 17.5%.
Middle-income bracket will pay 8.95% more in income tax; an effective tax rate of 26.6%.
Higher-income bracket will pay 7.35% more in income tax; an effective tax rate of 33.74%.

Do not be misled by comparing the increase percentages as 7.35% more tax on a higher income earner (>R1 000 000 per annum) is considerably more than 10.83% on a lower income earner (R250 0000 to R350 000 per annum typically).

Employees and Employers may use the option of non-taxable fringe benefits where possible.

An example: subscriptions due by the employee to a professional body, if membership is a condition of the employee’s employment.

Perhaps SARS should be required to annually adjust the tax brackets by CPI inflation rates as Personal Income Tax remains the largest source of tax revenue for the government.

This article is provided for information only, and does not constitute the provision of professional advice of any kind.

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