Issue: April/May 2006
Editorials

FIRST WORD

RFT is a Really Foolish Tax

To have reduced it is simply not good enough. And the reasons for it being retained are peculiar. Because Manuel doesn’t trust the financial-services sector to pass on the benefits, fund members will have to keep on paying.

In his latest Budget, Finance Minister Trevor Manuel halved the rate of retirement-fund tax (RFT) from 18 percent to nine percent “in order to contribute to the build up of retirement savings”. Journalism-speak turned this into “a move expected to significantly increase the level of savings in the country”. 
Manuel is right; the cut will contribute to the build up of retirement savings because the state will be helping itself to R2,4 billion less of them. The journalistic spin is wrong; as a move to encourage savings, which Manuel didn’t profess, the cut’s effect will be absolutely zero.
Ask the average Joe whether he has the foggiest notion of what RFT even is. Huh? Ask him whether the tax reduction will cause him to spend less and save more. Huh? Then ask him whether he’d prefer to invest in a vehicle where a lower proportion of his savings is gobbled in costs, say a unit trust instead of a pension fund. Ha!
RFT shouldn’t be there at all. Expecting people to be grateful for a cut in the rate is like expecting an innocent man to be happy when his 18-year prison term is reduced to nine.

First, the reason Manuel didn’t entirely scrap RFT is curious in itself. Logically, its abolition would have furthered his objective to help “the build-up of retirement savings”. No, his reason has nothing to do with him needing the money or trying to find other justification for the tax.
It has to do with his mistrust of the financial-services industry. Manuel is suspicious that the fellows who run it, unable to resist the temptation for money-grubbing, might find clever ways to pocket the benefits for themselves. At a briefing after the Budget, he was blunt. 
Further reductions or the scrapping of RFT, he said, would have to be accompanied by measures to ensure the two to three percent. Assuming benefits were passed on to the ultimate beneficiaries and not lost in higher charges. The retirement-fund industry needed to be reformed. With a revised National Treasury discussion paper pending, it remained to be seen whether the industry would “come to the party in terms of reforms”. If it did, he added, the tax could be scrapped and there might be no need to replace it with other measures.
There you have it. Average Joe, who behaves well by saving, is smacked because the Minister thinks (whatever could have given him the idea?) the industry doesn’t behave well in the charges it levies to service those savings. Clients, not the industry, pay the tax; if the industry behaves well, its clients will be rewarded. Talk of hostages to fortune. 

Second, RFT is paid by members of retirement funds. As such, it adds significantly to the cost of being a fund member. So RFT’s retention means National Treasury remains a perpetrator of the high costs level it’s determined to remedy.
Breaking down the series of retirement funds’ administration and compliance costs that eat into retirement benefits, RFT has comprised the biggest single slug. It makes retirement funds significantly uncompetitive savings vehicles against unit trusts, which don’t bear all similar costs (TT Feb-March 2006).
So the retention of RFT, although at a lower rate, perpetuates another ambiguity. It is less attractive to save for retirement via a compulsory scheme than a voluntary one. If you save through the former, you’re penalised; if you have the option to save through the latter, you might not take it. It’s a peculiar way to promote the build-up of retirement savings in order that the state’s burden to provide for the aged is lightened.

Third, finance ministers are notoriously loath to scrap taxes that serve them well. Since its introduction in 1996, the RFT rate (on net rental and gross income) has jumped all over the place. It started at 17 percent and has gone as high as 25 percent.
One consequence has been in causing lower-income learners, who don’t pay tax on their private savings, to pay tax when they save through retirement funds – and then at a rate higher than they pay during their working lives on their wages or salaries. This contradicts government policy both by creating a disincentive to save and by taking from those least able to afford it. And yet there’s no firm commitment....

Fourth, in introducing RFT, then finance minister Chris Liebenberg was at pains to emphasise that it was “not an ad hoc revenuegenerating measure” but a significant step towards a wider coverage of the tax system as a whole, thereby improving equity in the distribution of the tax burden”. 
This hasn’t happened. RFT was a recommendation picked piecemeal from the third report of the Katz commission, against its caution that the recommendations be applied holistically. Over 10 years since publication of the report, notes tax expert Lauren Immerman of Edward Nathan, few of its 29 recommendations have seen the light of day.

Fifth, if RFT really is destined for death in the imminence of retirement-fund reform, it would have made little practical difference for Manuel to have killed it now. The damage has been done. As Investec strategist Michael Streatfield points out, the impact on retirement benefits is only felt over the longer term by the difference (that would have been paid in tax) being reinvested (and so gaining the effects of compound interest). 

The point is driven home by Franco Busetti of Andisa Securities (see box). He concludes that:

  • Reduction in the RFT rate has only a “modest” effect, although it is beneficial and proportionately more advantageous to the lower-income taxpayer;
     
  • The effect on returns is “small” and would only become “material” with reinvestment of the taxed yield over long periods;
     
  • Over shorter periods, the boost to the returns of the fixed-interest asset classes relative to equities is “not large enough” materially to change their relative attractiveness.
RFT is not a tax for Manuel to kiss and cuddle. It’s for him to kill.
 

LOOK LONG TERM

The impact on returns will depend on the relative proportions of capital return and taxable-yield return, Franco Busetti of Andisa Securities explains.
As an asset’s yield rises, the proportional benefits of the RST reduction increases. The larger the yield as a proportion of the return (ie the smaller the capital portion), the larger the benefit. With zero capital gains, the maximum percentage improvement in returns (ie the percentage change in the percentage return) will be just under 11 percent.
Current taxable yields for cash and bonds are around seven and nine percent respectively, and for returns of around 20 percent the improvement in returns is only two to three percent.
Assuming that tax rates of 18 percent and nine percent had prevailed for the past 20 years, average taxed returns from bonds and property unit trusts would have increased by seven percent while the returns from cash would have increased by 11 percent. These changes in return are not large.
However, reinvestment is key in compounding returns over a long period. Taking the 46 years since 1960, for instance, total wealth creation would have risen (as a result of the lower tax rate) by 51 percent for bonds and 45 percent for cash.

IMPACT OF CHANGE IN TAX FOR DIFFERENT TAXABLE YIELDS
(CAPITAL GAIN OF 10%)
IMPACT OF CHANGE IN TAX FOR DIFFERENT TAXABLE YIELDS (CAPITAL GAIN OF 10%)