A new tax on businesses to be paid to municipalities?

IOL today reported that the SA Local Government Association (SALGA) is backing a new tax on businesses to be paid to municipalities. Aparently, "with municipal debt nationwide totalling well over R60 billion, the National Treasury said that at least one metropolitan government had mooted the new tax" and it has also been discussed at a MinMec meeting. The article goes on to report that Mr Jan Hattingh, the Treasury’s chief director of local government and budget analysis explained that the proposal has been discussed at a Budget Forum, but there is a process to follow: Salga would have to propose the tax to the Treasury, followed by consultation with the Financial and Fiscal Commission and the Department of Co-operative Governance and Traditional Affairs.

At this point one should note that there are few details available about the above proposal. Will the tax be levied at local level? Or will SARS collect and Treasury redistribute? Before we get to the obvious objections to taxing businesses during an economic downswing and the #epicfail of  local government in South Africa, it is worth to briefly mention the theory of taxes and spending at sub-national level. What sort of tax would be sensible or fair?

According to the ability-to-pay principle, the burden of a tax should be shared according to taxpayers' ability to pay - firms with bigger payrolls or profits, pay more. This is best when typical public goods are supplied that are non-rival and non-excludable in consumption and equity is an important consideration. The alternative is the benefit principle - the tax burden is shared out among taxpayers in accordance with the benefits they receive. This is best when the tax is a user charge and the link between tax income and spending is more direct.

Proponents of fiscal decentralisation argue that provincial or local governments may be more efficient at allocating resources since they are closer to the people and better able to determine their demand for public goods and services. In an economist's perfect world, the decentralisation of spending responsibilities is also followed by revenue-raising capabilities. Since the people are closer to government they should also be able to better monitor taxes and spending and if they do not like it, vote with their feet and move somewhere else.

The implication is that the proposed tax may be neither sensible nor fair. It is not clear that the businesses will be paying a user charge for a local good or service supplied according to their preferences. If the aim is only to repay some of the debt of ill-managed municipalities, allowing them to set rates will precipitate a tax competition race to the bottom with the more solvent municipalities setting lower rates and drawing in businesses. If government wants prevent this and administer a uniform tax centrally, there is no sense in setting up another tax to do it. A simple structure is always more efficient.

My final point has already been made in the responses to this tax proposal on Twitter: Pouring more money into municipalities is not the solution to improved service delivery.

This relates to earlier work by myself and some co-authors (See Krugell, Otto & van der Merwe, 2010 in the SAJE no less) where we examined indicators of the ability of municipalities to supply services. We constructed a service delivery index and had a close look at the places that were able to improve delivery.

Our results showed that:

Different municipalities face different challenges reflecting socio-economic conditions and municipal competence. The analysis showed that urban municipalities with higher population densities and greater GDP per capita are able to provide better access to services, while improved service delivery attracts people. Improvers have, on average, fewer vacancies, more spending on goods and services in proportion to the total budget, and they relied much less on grants income relative to rates income.

Re-reading this I realise it is a long story to make a simple point - a new tax on business at municipal level is a bad idea.