Raising taxes reduces income and higher debt service costs crowd out important economic and social expenditure
There have been several calls for a large fiscal stimulus to support SA’s post-Covid recovery. While this seems reasonable, before SA can embark on a fiscal stimulus we need to answer two questions: can we afford it? And will additional spending raise economic growth?
Unconventional methods include accessing the broader balance sheet of the government by drawing down unemployment insurance fund surpluses, accessing reserves held by the central bank or allowing workers to access their pension fund savings. Some argue that the central bank should reassure our lenders by buying more government bonds. For a short while central bank intervention may cause an increase in demand for our bonds, keeping bond prices up and yields down. However, as economic growth continues to disappoint lenders will soon determine that the government is unlikely to have the tax revenues to service debt, and they will stop wanting to hold our debt. Bond prices will fall and interest rates will rise.
To answer this question we need to turn to the literature on fiscal multipliers. A fiscal multiplier measures the impact of the government’s spending and tax decisions on GDP. In an excellent review of the literature published in 2019, Valerie Ramey finds that government spending multipliers lie in a narrow range of 0.6 to 1. This means a R1 increase in government spending increases GDP by somewhere between 60c and R1.
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