(IES) from 2010/11 (Statistics South Africa, 2012a) that contains data on household income, expenditures, cash transfers, and utilization of educational services collected from some 25,328 households covering over 95,000 individuals. Second, it assesses how each fiscal instrument examined in this paper contributes to redistribution and how effective it is in doing so given the resources used. Finally, because it applies the Commitment to Equity (CEQ) methodology (Lustig and Higgins, 2013), the results for South Africa can be compared with other middleincome countries for which the framework has also been applied.

The main results are twofold. First, the burden of taxes—namely, the Personal Income Tax (PIT), Value Added Tax (VAT), excises on alcohol and tobacco, and the fuel levy—falls on the richest in South Africa and social spending results in sizable increases in the incomes of the poor. In other words, for the components examined, the tax and social spending system is overall progressive. Second, for these elements, fiscal policy in South Africa achieves appreciable reductions in income inequality and poverty, and these reductions are in fact the largest achieved in the emerging market countries that have so far been included in the CEQ project.<sup>8</sup> Yet despite fiscal policy being both equalizing and poverty-reducing, the level of inequality and poverty rates that remain are still very high, as noted above, ranking as some of the highest in middle-income countries. Looking ahead, as South Africa grapples with slowing economic growth, a high fiscal deficit and rising debt burden, addressing the twin challenges of high inequality and poverty will require not only much improved quality of public services, but also higher and more inclusive economic growth.

Before delving into these issues more deeply, Sections II and III provide an overview of the key fiscal tools used by the South African government to redistribute income between the rich and the poor, followed by the basic framework, caveats and assumptions. Section IV then presents the progressivity of taxes and social spending by looking at each of the key fiscal instruments and then viewing the incidence of the key taxes and social spending as a whole. From theory one knows that a tax or expenditure instrument could be progressive but not have large impacts on equity if it is too small.<sup>9</sup> One also knows that a tax could be regressive but still equalizing if analyzed in conjunction with other taxes and, especially, transfers.<sup>10</sup> Furthermore, taxes and transfers could be equalizing and yet poverty increasing because inequality depends on relative incomes while poverty is affected by absolute income levels: that is, a tax system could be progressive and equalizing but hurt the poor if the level of taxes paid by them exceeds the transfers received by the poor. Finally, taxes and transfers could introduce horizontal inequity. One typical form of horizontal inequity occurs when the ranking of individuals (i.e., the ordering of individuals in the before taxes and transfers income distribution) gets changed (some individuals swap positions) by the fiscal system.<sup>11</sup> Recognizing these four elements, section V analyzes the impact of taxes and transfers combined on inequality, poverty and horizontal equity, and compares the results to those for other middle-income countries. Finally, the paper discusses the effectiveness of social spending, and whether the reduction in poverty is commensurate with the amount spent, compared to other middle-income countries.

**II. General Government’s Fiscal Instruments to Tackle Poverty and Inequality** Since the end of apartheid, the government has progressively expanded its fiscal programs to help address poverty and inequality while maintaining sound fiscal indicators. It broadened the tax base and built an efficient tax administration to generate the resources it needed to progressively expand the social safety net for the poor. However, in recent years fiscal space has become more limited. Reflecting the impact of the global financial crisis and the slowdown in economic growth in South Africa, the government pursued a countercyclical policy that preserved spending in the face of declining revenue collections.  As a result, the overall fiscal balance moved from a surplus of about 1.3 percent of GDP in 2008 to a deficit of 4.3 percent of GDP in 2012/13 before narrowing somewhat to a deficit of 4 percent of GDP in 2013/14.  The overall net debt burden rose from 22.9 percent of GDP in 2008/09 to 39.7 percent of GDP in 2013/14 and in an environment of slow economic growth it is

> 8 Led by Nora Lustig since 2008, the Commitment to Equity (CEQ) project is an initiative of the Center for Inter-American Policy and Research (CIPR) and the Department of Economics, Tulane University, the Center for Global Development and the Inter-American Dialogue. For more details, see <u>http://www.commitmentoequity.org.</u>

> 9 See Duclos and Tabi (1996).

> 10 As soon as there is more than one intervention, assessing the progressivity of fiscal interventions individually is not sufficient to determine whether they are equalizing or not (see, for example, Lambert (2002) pp. 277-278).

> 11 For details on these see the chapter by Lustig, Nora, Rodrigo Aranda and Ali Enami, in Lustig, forthcoming.

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