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 adopted by Parliament in 2013 and came into effect in 2014. The original incentive proposed to lower the tax bill for companies that employed new workers aged 18-29 and earned less than R6,000 per month ($ 400). 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 have officially designated such areas.

The adoption and implementation of the policy was cited as a success in two respects. First, as triumph of evidence in the formulation of public policies. Second, like an effective approach to reduce unemployment which should be broadened.

In a recent published paper I submit that the first claim is false and that 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 be allowed to dismiss these workers without having to provide reasons.

A panel member developed this idea, 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 “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.

Read more: Randomized Trials in Economics: What Critics Have to Say

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 approved the idea of ​​a wage subsidy for young people based on the panel report. In 2011, the National Treasury produced a long policy document who also approved 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 the work of the Treasury and the academic modeling, was that in order to make such predictions one had to assume the answer to the basic 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.

In view of the decision on the political proposal of the Parliament in 2013, the principal researcher behind the experiment claims in the press that she had shown that the grant would 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 in-depth analysis of the experience and its results shows that the study did not provide 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 this contradicts complaints 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.

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