The tax incentive for employment in South Africa is not a success
South Africa has one of the highest unemployment rates in the world. This was true even before unemployment rose in the wake of the 2008 global financial crisis. And before COVID-19.
The country’s youth unemployment rate is still higher than average. The tax incentive for (youth) employment was supposed to help solve the problem. The incentive was passed by Parliament in 2013 and came into effect in 2014. The original incentive proposed to reduce the tax bill for companies that employed new workers aged 18 to 29 and earned less than R6,000. per month (400 USD). The idea was that reducing the effective cost of hiring young workers, by subsidizing up to 50% of their salary, would lead to more jobs being created for this group by companies.
The policy was renewed in 2016 for a further three years. And in 2018, shortly after Cyril Ramaphosa assumed the presidency, it was extended for 10 years. The upper age limit has been raised to 35 years. And it was made applicable to all new employees of companies operating in “special economic zones”, regardless of their age. There are currently 11 officially designated areas of this type.
The adoption and implementation of the policy was cited as a success in two respects. First, as a triumph of evidence in public policy formulation. Second, as an effective approach to reducing unemployment which should be expanded.
In a recently published article, I argue that the first claim is false and the second claim is not supported by existing evidence.
The analysis suggests that decisions to adopt, expand and expand the policy were based on misrepresentations of the evidence available at the time. This was accompanied by a concealment or minimization of the weaknesses and possible risks of the policy.
Moreover, the currently available evidence does not convincingly show a substantial effect on job creation. This means that the incentive is in fact a subsidy to corporate profits, so it increases societal inequalities rather than reducing them.
Where it started
The idea that cutting wages could increase employment seems pretty obvious. But it faces a number of serious challenges.
Much has to do with the structure of the economy. If most unemployment in the country is “structural” – which is the case in South Africa – then simply reducing the direct cost of labor may have little effect.
Structural factors include many legacies of apartheid and colonialism:
- distance from job opportunities in urban areas
- the sectoral structure of the economy and a lack of competition in certain sectors
- lack of skills or poor quality education, and,
- various other dimensions of poverty that prevent working-age adults from fully participating in the economy.
Historically, those who have favored wage subsidies tend to take one of two positions. Either they minimize these factors and instead focus on the role of unions in raising wages. Or they argue that a subsidy can offset the negative effects of structural factors on firms’ employment decisions.
While such debates have been unfolding for decades, the current tax incentive for jobs grew out of the work of a group of American economists appointed by then-President Thabo Mbeki to advise on economic growth. Their final report in 2008 endorsed the idea of a youth wage subsidy in the form of a voucher of a fixed value for all young people 18 and over that would subsidize their wages with any employer, provided that employers are allowed to fire these workers without having to provide reasons.
A panel member developed this idea and then partnered with a group of researchers at the University of the Witwatersrand to test a version of it with an experiment funded primarily by the International Initiative for Impact Assessment (known as name of “3ie”).
Some influential economists have claimed that experiments like this were the most credible form of evidence for policymaking, but this claim is vulnerable to a series of criticisms.
The basic purpose of the wage subsidy experiment was to estimate how well the job responded to a subsidy. The profitability of such a policy depends on the number of new jobs created with the money spent.
As early as 2008, then Finance Minister Trevor Manuel had already endorsed the idea of a youth wage subsidy based on the panel report. In 2011, the National Treasury produced a long policy document which also endorsed the basic idea. He predicted that 178,000 new jobs would be created over three years at a cost of 5 billion rand.
The problem with Treasury’s work, and subsequent academic modeling, was that in order to make such predictions, it had to assume the answer to the fundamental question: how employment reacts to a subsidy. Faced with opposition to union policy in particular, the government approved the idea of an experiment to test this hypothesis.
Prior to the decision on Parliament’s policy proposal in 2013, the lead researcher behind the experiment claimed in the press that it had shown the grant to be a success:
If a wage subsidy of a size similar to the one tested were introduced… approximately 88,000 new jobs would be created each year.
And the National Treasury referred to the positive results of the 2013 budget review.
What the evidence really says
A thorough analysis of the experience and its findings shows that the study did not provide any evidence to support the wage subsidy.
Besides many other limitations, the experimental intervention was very different from the incentive, and its main conclusions could just as well be the result of factors other than job creation. The nature of the relationship between researchers and the Treasury, reflected in the researchers’ “political influence plan”, suggested a shared desire to justify the policy proposal, rather than an objective effort to determine if it would work.
And the study was never published in any peer-reviewed media. All of this contradicts claims that the intervention demonstrates the value of randomized policy experiments in developing countries.
The policy review process in 2016 also had serious flaws. Again, studies that had been done in conjunction with the Treasury were cited as showing the policy to be successful. But, again, these were not released for consideration until Parliament made its decision.
What should happen
Since 1994, ANC governments have affirmed their ambition to position South Africa as a “developmental state”, including in the National Development Plan. A key characteristic of these states elsewhere is their ability to learn from their mistakes, which includes a willingness to discard failed or ineffective policies.
Such an approach should apply to the wage subsidy policy. Instead of reducing unemployment, the policy appears to serve as a costly subsidy to already profitable companies for employees they would have hired anyway. If the real priority is to tackle unemployment and the government is serious about being a successful developmental state, the policy should be stopped and resources directed elsewhere.
Seán Mfundza Muller, Principal Investigator, Johannesburg Institute for Advanced Study, University of Johannesburg
This article is republished from The Conversation under a Creative Commons license. Read the original article.