Rapid growth only real option to fight inequality

A RECENT World Bank Report highlights the effectiveness of SA’s fiscal policies in reducing inequality and poverty. This has been achieved through the progressive nature of our taxes and the redistributive thrust of government spending. SA’s fiscal policy, the report concludes, achieves the largest reductions in poverty and inequality of the 12 middle-income countries that were studied. As a result, 3.6-million South Africans have been lifted out of poverty.

Redistribution occurs in part through tax collections. The rich contribute more in income tax than their share of income because tax rates rise as incomes increase and also because low earners are exempt from income tax. Government spending in SA is more than 30% of gross domestic product, which is high for middle-income countries. More than half of that spending is on grants, education and health, which is also unusually high. As a result, social spending in SA has secured large reductions in poverty and inequality.

Cash grants are the most effective way of achieving redistribution as only the poor receive these benefits. Spending on education and health is less redistributive because the rich also benefit.

The report finds that only the poorest 70% of South Africans receive more in cash transfers and social spending than they pay in taxes. The poorer half of income earners receive 70% of all government spending on direct transfers. When health and education services are included, the poorest 10% receive benefits equal to 32 times their income.

While these findings are encouraging, the report also makes for sober reflection. The decline in income inequality brought about by fiscal policy in SA is the highest of the 12 comparator countries. But even after taxes and social spending, SA is still much more unequal than the other countries. This is because SA starts with a much higher level of income inequality. The unusually high level of personal income taxes collected in SA is not just because of progressive tax rates and the efficient manner in which taxes are collected, but also because the rich earn an unusually high share of total income and are taxed accordingly. Second, the redistributive nature of government spending is measured in the report in terms of money spent and not the effectiveness of service delivery.

While education spending may reduce inequality, the quality of education spending received by the poor may be much less effective than for the rich. Finally, while fiscal policy has lifted 3.6-million people out of "poverty", this is based on a definition of only $2.50 a day, or about R750 a month. Most South Africans would regard such people as still being very poor. And, while inequality falls after taking taxes and social spending into account, the incomes of the richest 10% of the population are still a staggering 66 times higher than those of the poorest 10%.

What can be done to reduce inequality and poverty faster? The report warns that there is little scope for further redistribution through the budget. Only if the economy grows rapidly will more resources become available to combat poverty and inequality through the fiscus. The government can, however, focus on reducing inefficiencies and improving the quality of the social services the poor receive from existing spending.

We also need to address the reasons income inequality before taxes and social spending is so high. The first of these is our very high unemployment. Unless we can create large numbers of jobs, the unemployed will remain reliant on government transfers. Second, we need to address high income inequalities in the workplace. The distorted nature of our skills base gives rise to highly skewed incomes in the wage-earning population. Servaas van der Berg of Stellenbosch University has shown that if unemployment falls, poverty will fall. But income distribution will remain highly unequal unless the large wage differential between skilled and unskilled workers is narrowed.

This cannot be achieved by artificially boosting the wages of low-skilled workers. If low-skilled wages are pushed too high, employers will employ fewer workers and mechanise. Rather, Van der Berg argues, we need to improve the skills of low-paid workers and increase the pool of skilled ones. This will raise the productivity of lower-paid workers and also reduce the high premium paid to skilled workers because they are in short supply. Such outcomes require improvements in our education system. Faster growth, more efficient social spending and much better education are the keys to future reductions in poverty and inequality.

Article by: Gavin Keeton

Article source: Business Day Live

? Keeton is with the economics department at Rhodes University.