The impact of tax incentives in South Africa's manufacturing sector-subsectoral analysis

It is an undisputed fact that the South African economy is highly capital intensive (see Levy (1992), particularly the manufacturing sector (see Black, 2012). Even though the stated objective of government support has been to boost labour intensive activities and small business development, the reality has been continued support of capital-intensive firms (Black, 2009). Tax allowances constitute one particular intervention government use to attract investment to specific sectors in the economy. An example is the Strategic Industrial Project programme that provided more than R7 billion tax relief for large capital-intensive projects in the early 2000s (Black, 2012). Currently, differentiated accelerated depreciation allowances provide benefits to firms by reducing their tax burden.

This paper aims to analyse the extent to which government support in the form of tax allowances impacts the marginal effective tax rates in various subsectors of the manufacturing sector. The marginal effective tax rate is a summary measure of the impact of the tax system on the investment decision at the margin. Using the King Fullerton model, we estimate marginal effective tax rates for various manufacturing subsectors in the South African economy, with the specific goal of determining the extent to which policy objectives may be conflicting, i.e. do tax allowances counter government's objective of placing the economy on a more labour-intensive growth path, that would contribute to higher levels of employment?

We investigate subsectors including the manufacturing of basic metals and textiles, and estimate the implications of depreciation and other allowances that effectively reduce tax rates. Data sources include the Annual Financial Statistics of South Africa and relevant tax information from SA National Treasury. The findings will give marginal effective tax rates by asset and overall for various subsectors, and provide an indication of the potential benefits of tax allowances. These findings are especially relevant given the recent focus internationally on base erosion. In this case, our focus will be on internal base erosion, and its implications. Even though tax allowances are not the only driving factor influencing investment in a particular sector, it may accentuate capital deepening in an economy where labour intensive industrial development is one of the focal areas of macroeconomic policy.