1. Overview
South Africa faces significant fiscal challenges due to the ongoing COVID-19 pandemic. During the 1990s and early 2000s, South Africa saw significant improvements in economic development, per capita income and overall well-being. In the aftermath of the global financial crisis, however, the country has been faced with sustained low growth, rising debt levels and socio-economic challenges such as high poverty, inequality and unemployment rates, which have resulted in limited fiscal space. While the situation was already difficult before, the COVID-19 pandemic has exacerbated these issues with the country’s gross domestic product (GDP) contracting by 6.4% in 2020. To alleviate its impact, the government’s implementation of fiscal measures has been rapid and comprehensive, deploying emergency liquidity provisions and financial support of more than 10% of 2020 GDP. While these measures have helped to cushion the detrimental effects on the economy and public health, making public finances more resilient and returning to a more sustainable fiscal path in the future will require sizeable additional financial efforts. Moreover, achieving the sustainable development goals (SDGs) by 2030 further demands the continued mobilisation of domestic resources to finance public goods and services.
Curtailing illicit financial flows (IFFs) and combatting tax evasion are therefore important elements in supporting South Africa’s fiscal position and increasing the potential for revenue growth. Several recent studies have documented substantial IFF outflows during the last decade, from South Africa and the continent overall, reflecting South Africa’s challenge in successfully combatting IFFs. The amounts of IFFs leaving the country during the last decade, for instance, are estimated to range from about USD 14 billion to USD 20 billion annually as reported by AU/ECA (2015[1]) and GFI (2021[2]) respectively. However, some have called into question these estimates, as they are often based on aggregated data, which may conflate measurement error in cross-border statistics with illicit activity. At the same time, better policies require more analysis to disentangle and analyse the different contributing IFF categories and assess existing policy measures that are being taken to tackle them.
In an effort to assess IFFs more precisely and to support domestic revenue mobilisation, the OECD and South Africa’s National Treasury have embarked on a joint project to assess the IFFs landscape in South Africa. The project focuses on assessing the impact of recent tax compliance initiatives, understanding where continuing gaps remain, and estimating historical non-compliant foreign wealth and resulting illicit outflows. By analysing anonymised individual tax data on foreign income declarations, applications to Voluntary Disclosure Programmes (VDPs) and exchanged accounts under the Common Reporting Standard (CRS), the project not only attempts to provide an order of magnitude of IFFs from South Africa in recent years but also evaluates the behaviour of taxpayers facing increasing global and domestic tax transparency. The project uses tax data to measure all IFFs.
The analysis shows that tax evasion has a long history in South Africa and has been concentrated among the very wealthy and top income earners. It is estimated that in 2018, non-compliant assets worth between USD 40 billion and USD 54 billion were held in international financial centres (IFCs) based on cross-border financial account data from the CRS. Based on these figures and a number of assumptions, the analysis estimates that these deposits would suggest that annual IFFs of between USD 3.5 billion and USD 5 billion have left the country per year over the last decade. The analysis and the estimation process will be provided in more detail below. While this analysis is based on well-founded assumptions, it relies on new data of foreign financial accounts that has never before been used in the analysis of IFFs and allows for a more accurate understanding of IFFs than previous studies.
The analysis suggests that some progress has been made in supporting taxpayer compliance in recent years. Examining taxpayer data, revenue source data and data from VDPs shows evidence of increasing taxpayer compliance and additional revenues collected as a response to multilateral tax transparency initiatives that increase the global risk of detection, such as the CRS. Taxpayer responsiveness to domestic policy initiatives such as VDPs has also been triggered by the commencement of the automatic exchange of information (AEOI), successfully encouraging evaders to declare non-compliant foreign accounts. Taxpayer compliance, particularly among high-income earners, may be expected to further increase amid the rising risk of future detection.
Exchanged CRS information can provide new insights beyond other available data sources related to individual cross-border finance and can become an essential tool in the fight against tax evasion and IFFs, but additional work is required to get the most from the initiative. Successfully linking the foreign CRS accounts of South Africans with existing income tax returns is key to credibly increasing the risk of detection and the potential for revenue collection. The analysis suggests that matching CRS records to domestic tax records continues to be a challenge for South Africa. Accounts from IFCs did however have a higher match rate than non-IFCs. The number of matched taxpayers not having declared their foreign income is also found to be large, suggesting that exchanged CRS data provides an important new data source for tax authorities. Effective use of CRS data also depends on the capacity of tax administrations to exploit the information transmitted. Increasing the use of existing EOI treaties for requesting information held abroad on specific taxpayers, particularly with well-known IFCs, should be a key priority. Better domestic enforcement not only demands an enhancement of inter-agency collaboration across the different relevant authorities but also a strengthening of data processing capacity to enable a comprehensive analysis of taxpayer information. These improvements will not only result in much needed additional revenue gains but will also help to increase overall progressivity in the tax system.
The report is structured in six different chapters. Chapter 2 provides an overview of macroeconomic and fiscal developments in South Africa since the global financial crisis. A particular emphasis has been put on the recent economic scarring inflicted by the COVID-19 pandemic, with a particular focus on its impact on South Africa’s near-term fiscal space. Chapter 3 discusses the concepts of IFFs, how they relate to the South African context and provides an overview of South Africa’s participation in multilateral initiatives to combat tax evasion. Chapter 4 presents an overview of the structure and recent development in the South African tax system, stressing in particular the need for a well-functioning income tax system due to an increasing reliance on direct taxes. Commencing with the data-driven analysis, chapter 5 provides a quantitative analysis by assessing tax compliance over time amid a variety of tax transparency initiatives implemented in South Africa. It also evaluates the effectiveness of VDPs and looks into the income and wealth characteristics of applicants. Chapter 6 estimates the amount of previously ‘hidden’ or non-compliant foreign wealth and the size of IFFs in South Africa by relying on several different descriptive and quantitative approaches. Chapter 7 concludes the report.
References
[1] AU/ECA (2015), Track it! Stop it! Get it! Report of the High Level Panel of Illicit Financial Flows from Africa, https://repository.uneca.org/bitstream/handle/10855/22695/b11524868.pdf?sequence=3&isAllowed=y.
[2] Global Financial Integrity (2021), Trade-Related Illicit Financial Flows in 134 Developing Countries: 2009-2018, https://secureservercdn.net/50.62.198.97/34n.8bd.myftpupload.com/wp-content/uploads/2021/12/IFFs-Report-2021.pdf?time=1643653304.