1 February 2001

The South African government has based the introduction of the capital gains tax (CGT) on
the following fundamental principles:
- To promote equity at both the vertical and horizontal levels. To prevent sophisticated
taxpayers converting otherwise taxable income into tax-free capital gains – thus eroding both
the corporate and individual income tax bases.
- To conform with international taxation practice (i.e. to bring South Africa’s "tax dispensation
in line with the systems of our major trading partners").

In the South African Revenue Service (SARS) guide , notable quotes from both the Carter
Commissions recommendations in 1966 and the United Kingdom experience in 1965 are
cited which point to the unfairness to wage earners as a result of taxpayers converting
taxable income to tax free capital gains. A number of Commissions in South Africa also
investigated the concept of CGT and its applicability to South Africa. The more recent Katz
Commission supported the concept of a CGT on the following grounds:
- To limit the tax arbitrage between capital gains and normal gains.
- On tax equity grounds. Here the maxim of horizontal equity dictates that people with equal
economic power should bear equal tax burdens, while vertical equity requires that wealthier
people should bear progressively higher tax burdens.

Based on the purported benefits of CGT - as espoused by the Katz Commission - the major
obstacle at that stage was believed to be the lack of capacity within the SARS to implement
and collect the CGT. Katz recommended that when the capacity problem at SARS was
solved that the CGT issue should be revisited.

The Parliamentary Joint Standing Committee on Finance (JSCOF) believed that the Katz
Commission report did not deal conclusively with the question of the CGT thus perpetuating
uncertainty. The JSCOF , "aware of the reluctance at a recent conference of the
Commonwealth Association of Tax Administrators to advocate a capital gains tax in
countries that had not already instituted them," recommended that:
- "The present weakness of Inland Revenue to administer this or any other tax should not
form the basis of an in-principle decision whether or not to impose such a tax…,
-The substantive arguments for or against imposing such a tax should be the determining

Guided by the recommendations of the JSCOF that the substantive arguments for and
against the tax should be the deciding basis for the introduction of such a tax, the Chamber
of Mines hereby submits that the principle of introducing a CGT should be tested against the
following questions:
-Should the fundamental premise of taxation policy be based on "taxation equity issues" or
on savings, investment, capital accumulation and, ultimately, economic growth?
- Does CGT actually promote equity and who really bears the costs of CGT?
- What are the global trends with respect to CGT?

Savings and capital formation are vital for economic growth
In answering this question it is rather important to place South Africa in the context of the
global emerging markets universe with respect to domestic saving, fixed investment and
economic growth. This is not to say that savings are the direct determinant of fixed
investment and economic growth. There are other important risk and sentiment issues that
affect investment hurdle rates and, thus, investment. However, the accumulation of capital
(human, physical and natural) is inextricably linked to economic growth and development . In
particular, the accumulation of physical capital is an absolutely vital component of economic
growth. According to a study by Dale Jorgenson of Harvard University , the increase in US
capital formation (gross fixed capital formation) was responsible for nearly half of the growth
of the US economy between 1948 and 1980.

According to John Page "accumulation of productive assets is the foundation of economic
growth". The emerging market economies that have experienced high economic growth
rates have accumulated both physical and human capital much more rapidly and
consistently than other economies – and that accumulation accounts for a large portion of
their superior performance. What is interesting is that the high-performance, emerging
market economies have all had high domestic savings rates to fund high levels of fixed
investment, which in turn led to high levels of physical capital accumulation. In fact, no
emerging market economy has been able to sustain economic growth rates higher than 5
percent per annum without having fixed investment rates (gross fixed capital formation to
GDP ratios) of at least 25 percent of GDP. In a closed economy a 25 percent investment
ratio would require a minimum savings level of 25 percent of GDP. In an open economy
foreign savings can top up savings shortfalls but this is normally limited to about 2 percent of
GDP. So in order to fund higher fixed investment levels countries have to have higher levels
of domestic savings.

South Africa’s domestic savings and fixed investment rates are the lowest out of 29
emerging market countries surveyed. Selected emerging market and developed country
examples are included in the following graph: [Ed. Note: Graph not included]
Source: Chamber of Mines and IMF World Economic Outlook tables

It is interesting to note that countries with high investment rates are also the best performers
in terms of economic growth as shown in the following graph: [Ed. Note: Graph not included]
Source: Chamber of Mines and IMF World Economic Outlook tables

Unfortunately, South Africa’s low investment rates have confined the country to the lowest
growth quartile within the emerging markets universe. The trends in domestic savings,
investment and economic growth for South Africa are shown below: [Ed. Note: Graph not included]
Source: Chamber of Mines and SARB

There is no doubt that the pursuance of sound macroeconomic policies in the new
democratic era has placed the economy on a sounder, higher growth footing. However, the
low levels of domestic savings and investment simply cannot provide for physical capital
accumulation levels which would result in a growth rate beyond 4 percent per annum. The
government is increasingly placing priority on promoting economic growth to raise living
standards. President Mbeki , at launch of the Millennium Labour Council, stated the
"A critical question, which needs to be addressed, is the matter of massively expanding
productive investment by South Africans in our economy. Despite accelerated economic
growth after 1994; the growth in Gross Domestic Fixed Investment has been slow. As South
African we must find ways of saving more and investing more so as to generate more wealth
and create more jobs."

Economic growth, sustainable employment creation and rising living standards are
absolutely crucial for South Africa’s social and political future. Government policies that
undermine this objective need to be seriously reconsidered.

Tax equity – positive concept, but insignificant compared to the economic growth
Tax equity is driven by concepts such as "fairness," "progressivity of the tax burden," and so
on. As mentioned in section one, the Katz Commission’s view on equity issues the
concepts are certainly meritorious. There is certainly little benefit in objecting to the issues of
tax equity. However, it has become clear (section three of this report will deal with where the
burden of CGT falls) that CGT is not the correct policy instrument to use to achieve tax
equity. Evidence from research on the issue suggests that the real burden of CGT fall on
those who aspire to wealth, not on those who have it.

The government has suggested that the arbitrage between tax-free capital and taxable
income undermines the tax base. It is perhaps worthwhile to question the extent of this
problem? It appears as if the government has not considered the negative impact of CGT
on economic growth and thus normal tax receipts. Studies indicate that CGT actually
undermines growth and thus the tax base.

Research points to CGT undermining savings, capital formation, growth and
There is a growing body of research that concludes that CGT undermines savings, capital
formation, economic growth, employment opportunities, productivity and the potential output
of any economy. In the United States several studies have shown that reducing CGT would
cause greater levels of economic activity. A 1995 study by Allen Sinai concluded that the
proposed US CGT cut would boost national savings, increase capital spending, raise real
GDP growth, increase employment, reduce the cost of capital and improve household net
worth. Dr Sinai again validated this position with further research in 1997 .

Table 1: Estimates of the Effects of a Capital Gains Tax reduction* on the USA, average per
year, 1997-2002 [Ed. Note:Table not included]

What the above table illustrates is that a lower CGT in the USA would lower the cost of
capital, thus increasing business capital spending by $17.6 billion per year. Higher levels of
capital formation and fixed investment would add an additional $51 billion to GDP annually
and the result of higher levels of economic activity would generate close to half a million new
jobs per year.

The McGraw-Hill/DRI study found similar benefits from lower CGTs in the US. In 1999 a
study by David Wyss
"Found that the improvement in the economy over time (based on the 1997 CGT reduction)
is significant. Our model suggests that after 12 years, GDP would be 0.4% higher than in the
baseline, adding $116 billion to incomes." He went further "the model probably understates
the impact of capital gains."

Even a paper by Steven Fazzari who was sceptical about the benefits of CGT reductions
indicates that the output benefit of a CGT reduction would be of the order of 0.3 percent per
annum. If this rate is compounded over 5-years the benefits become significant.

Many respected economists maintain that having no CGT at all would be optimal for
economic growth. They argue that completely eliminating the tax – i.e. a CGT of zero
percent –would be fair and most efficient for the economy because the CGT imposes a
multiple (at least double) tax on savings and investment. By punishing such productive
activity CGT stifles capital formation, an essential force behind economic expansion. For
example Kenneth Judd, of Stanford University, has maintained that the optimal tax rate on
capital gains is no greater than zero.

The US Federal Reserve Board Chairperson, Alan Greenspan, has consistently supported
abolishing the CGT. In his 1997 testimony before the Senate Banking Committee,
Greenspan elaborated on his previous testimony before the Senate Budget Committee:
"The point I made at the Budget Committee…was that if capital gains tax were eliminated,
that we would presumably, over time, see increased economic growth which would raise
revenues for the personal and corporate taxes as well as other taxes we have…. The crucial
issue about capital gains tax is not its revenue-raising capacity. I think it is a very poor tax for
that purpose. Indeed its major impact…is to impede entrepreneurial activity and capital
formation… While all taxes impede economic growth to one extent or another, the capital
gains tax is at the far end of the scale. I argued that the appropriate capital gains tax was

Other economists have supported Greenspan’s view and many concluded that the greatest
contribution to long-term economic growth in the US would arise from eliminating the CGT.
"By removing the destructive bias against savings and investment, totally abolishing the
capital gains tax would unleash the economy’s powerful, natural forces ."

One overarching conclusion of the effects of CGT reductions in the USA, Canada, Australia
and the UK is that the benefits flow to all workers and the economy as a whole. Workers
benefit from greater appreciation in their pensions, unemployment is reduced and the
average worker will see wage gains associated with the greater investment in higher
productivity activities.

The support by many distinguished economists for a zero capital gains tax in many
developed economies, and the empirical evidence of the negative effect of CGT on savings,
investment, economic growth and job opportunities, provides food for thought regarding CGT
applicability to South Africa.

CGT has a deleterious effect on venture capital and small business
Small businesses (SMMEs) and entrepreneurship are the driving forces behind any market
economy. SMMEs are affected by the strength of incentives that motivates business people
to undertake innovative projects and their ability to raise enough capital for such projects.
Venture capital is an important source of funding for SMMEs, but the impact of CGT lowers
the potential return from backing financiers (many of whom are private individuals) thus
reducing the quantum of venture capital available.

For entrepreneurs wanting to start SMMEs one of the key motivations is the potential capital
gain that will arise if the project is successful. Many entrepreneurs will spend a lifetime
sacrificing current income and leisure to ensure that their SMME survives and can be sold.
For any SMME owner wanting to sell his/her business (under 55 years of age) the capital
gain will be taxable and pushes the owner into a higher (once-off) tax bracket without
inflation indexation. If potential returns are taxed, the entrepreneur’s motivation is reduced!

As far back as 1963 the late President John F. Kennedy said:
"The present tax treatment of capital gains and losses is both inequitable and a barrier to
economic growth….The tax on capital gains directly affects investment decisions, the
mobility and flow of risk capital from static to more dynamic situations, the ease or difficulty
experienced by new ventures in obtaining capital, and thereby the strength and potential
growth of the economy."

The impact of CGT on economic efficiency (and the lock-in effect)
Mr. Grote Chief Director of Tax Policy in the National Treasury argues that the lack of CGT
results in individuals investing their savings in assets that provide capital returns (such as
property) rather than investing in productive assets (plant and machinery). The argument is
that the lack of a CGT undermines investment efficiency. Unfortunately this argument relies
on the model of a closed economy where domestic savings fund domestic fixed investment.
In a more globalised open economy like South Africa’s investment decisions are made on
the basis of risk-return trade-offs in a global sense. The lack of investment in productive
capacity in the economy – is not because the absence of CGT is encouraging investment in
property – it is due to the cost and risk profile of South Africa being too high and the
domestic supply of savings being too low. The introduction of CGT will not automatically shift
investment from property into productive assets.

The economic efficiency rationale for introducing CGT is further undermined when one
considers the private compliance costs borne by the taxpayer and the economy. A study by
Bracewell-Milnes on the US economy concluded that CGT imposed an "excess burden" on
small business to the tune of nine times its tax revenue yield. This means that small
businesses have to spend $9000 to comply with the law (to hire valuators, accountants,
upgrade computer systems, etc.,) for the government to realise $1000 in CGT revenue. The
opportunity cost of the lost working hours complying with CGT, especially if this time had
been spent productively on wealth generating activities is significant. CGT therefore does not
promote economic efficiency.

The compliance costs for government to administer CGT also undermine the economic
efficiency argument. Due to the high cost-low yield of CGT it appears that such government
effort could be better spent capturing taxes where the yields are more significant (e.g. debts
owed by VAT vendors) and where the costs lower. From a government investment and
economic efficiency perspective (regarding the use of public funds) it would be more
appropriate to concentrate on the latter and not CGT.

CGT interferes with the dynamic, efficient reallocation of capital in an economy by forcing
people, especially those with small returns on their assets, to defer realising a capital gain,
which locks capital in assets (some of which may be unproductive). While the government
has provided certain rollover provisions in the draft legislation, it must be borne in mind that
the CGT then has a significant bearing on how investors make decisions. It is probably
better for an investment to be made on the basis of good underlying economic
fundamentals, rather than on the basis of tax reasons (i.e. to prevent lock-in, or realising a

The overriding premise for tax policy should be economic growth
The principles of tax equity are meritorious. The issue is whether tax equity is more
important than encouraging higher levels of savings, investment, capital formation, economic
growth and ultimately raising living standards for all our people. The Chamber of Mines
believes that the economic growth issue is paramount to South Africa’s future success. The
introduction of CGT will undermine this objective. The government, in introducing CGT, is
doing so on the basis of a flawed premise.

The Majority of People who pay CGT are middle-to low-income earners
Research emanating from the United States and Canada has refuted the long held belief
that capital gains taxes are an important instrument for taxing the wealthy and promoting tax
equity. In both the USA and Canada roughly 50 percent of the burden of capital gains tax
falls squarely on middle-and low-income families. In the US 54.5 percent of the CGT burden
is paid by people earning less than $100 000 per annum. People with annual incomes of
less than $50 000 per annum accounted for 40 percent of CGT paid.
Source: Heritage Foundation calculations

In Canada it is estimated that over half of all capital gains were paid by families with incomes
of less than $50 000 per annum. One of the significant reasons for this is that the majority of
middle and lower income earners realise a once-off capital gain which pushes them into a
higher tax bracket for that year (the bunching effect).

Vertical equity and CGT
The vertical taxation equity principle holds that on the basis of rising incomes, those earning
higher incomes can afford to pay a progressively higher tax burden. The fact that the
majority of the burden of CGT falls on middle- to low-income households as described in
section 3.1 has significant ramifications for the vertical equity issue.

The following quotes are appropriate in this regard:
"The simple fact is that anyone sitting on a big pot of money probably isn’t paying capital
gains taxes…. And the Government can adopt rule after rule – but the people who get stuck
paying capital gains taxes will be ordinary investors.." (David Bradford , economist at
Princeton University).

"How fair is a tax that the wealthy can apparently avoid but the middle class gets stuck with?
I don’t see any fairness in that." (William Gale of the Brookings Institution).

"Capital is mobile and difficult to tax – it flows away from places with strict constraints and
high taxes to locations where it can freely circulate and grow. This is why CGT revenues are
low: the tax burden effectively falls on the most immobile factors. Thus the popular claim that
CGT is a tax on the rich is misleading. The tax is effectively paid by those who cannot move
their capital or themselves. Is this fair? (Reuven Brenner )

Horizontal equity and CGT
The horizontal taxation equity principle holds that people earning the same income, whether
by capital gain or by wages, should be taxed at the same rate in a given year. Because of
the "bunching effect" whereby capital gains are realised in a bunched up fashion, and do not
occur on a regular basis, individual taxpayers are pushed into a once-off higher tax bracket –
so the income from capital gains is not strictly the same as that of income gains.

While it may be true that income from a capital gain accrues the same purchasing power as
an equivalent sum of wage income, it is worthwhile considering the equity concept over a
period longer than one year. Capital gains are normally earned by owners of small
businesses who sacrifice leisure and current income to make their business successful and
thus be rewarded with a once-off capital gain. If the capital gain had been taxed at a rate of
accrual in the years it was building up – it is likely that the total tax paid by the small
business would be lower than a once off capital gain. The material difference between
capital and wage income does violate the horizontal equity principle.

The taxation of inflation gains hurts low capital growth earners the most
Perhaps the most inequitable characteristic of the proposed CGT for South Africa is that the
proposal forces people to pay taxes on inflation. Taxing inflation dramatically increases real
effective tax rates especially for people with low rates of return on their investments. The
following table illustrates that a company with a small nominal rate of capital gain over five
years pays a much higher capital gains tax on real returns than companies with higher

Table 2: Effective Capital Gains Tax rates for various nominal rates of return, given 5%
annual inflation [Ed. Note:Table not included]

The lack of indexation for inflation imposes a severe penalty on companies with small capital
returns. According to Federal Reserve Chairperson Greenspan :
"’s really wrong to tax a part of a gain in assets which are attributable to the decline in the
purchasing power of a currency, which is attributable to poor government economic policy."

Application of CGT varies widely
One of government’s tenets for the introduction of the CGT is that South Africa will then be in
line with international practice. The purpose of this section is to highlight that the application
of CGT varies widely between countries and that it is not a universal practice. The
application of the practices of exemptions and exclusions, indexation for inflation and
minimum holding periods, varies considerably from country to country. For example, in the
case of individual capital gains the first $8315 is exempt in France while in Germany all
capital gains are excluded from CGT if the asset is held for more than six months.

The following table attempts to capture, for one class of potential capital gain (equities) what
the practice is regarding CGT in various countries.

Table 3: International Comparisons of CGT Rates for individuals
Source: study by Arthur Anderson LLP for the American Council for Capital Formation
Centre for Policy Research
. [Ed. Note:Table not included]

In the table above eight countries do not levy CGT on personal equity capital gains. Several
countries – Argentina, Belgium, Hong Kong, Malaysia, the Netherlands, New Zealand and
Singapore, for example do not tax personal capital gains at all.

At the corporate level a similar picture emerges with a significant number of countries
exempting corporate equity capital gains from CGT.

Table 4: International Comparisons of CGT Rates for Corporates
Source: study by Arthur Anderson LLP for the American Council for Capital Formation
Centre for Policy Research
. [Ed. Note:Table not included]

There have been significant reductions in CGT in a number of countries
In a number of jurisdictions there have been significant reductions in the rate of CGT (USA,
Australia, Canada and UK) and in a number of countries there have been calls for a total
elimination of CGT because of its distortionary effect on savings, investment and economic
growth. According to Allen Sinai , "the trend is towards a lower, and in some cases a zero,
CGT in most countries around the world." The following table highlights countries that have
reduced and modified CGT:

Table 5: Examples of countries that have reformed CGT policy
Australia: In 1999, the Federal Government Business Tax Review (the Ralph
Commission) proposed that the maximum CGT rate on individuals be dropped to 30% with a
$1000 tax-free exemption. CGT on long held assets should be reduced to zero to encourage
investment. The "New Tax System" came into force on 21 September 1999. CGT only
applies to 50% of gains made by an individual and trust, while small business can get up to
100% exemption in a number of cases. Indexation and averaging were abolished to reduce
the complexity and compliance costs of CGT. The rate of CGT applicable to corporates will
be reduced with the decline in the company tax rate to 30%. Funds from venture capital
investors from a number of developed countries were exempted from CGT.
Canada: In 2000 the Standing Senate Committee on Banking, Trade and Commerce in
a report on CGT recommended that CGT rates be significantly reduced to promote
international competitiveness.
Germany: The German Bundestag adopted the Tax Reform 2000 on 6 July 2000 with
substantial corporate and income tax relief granted (max corporate rate reduced to 25%).
Capital gains from the sale of shareholdings between corporations will be exempt from CGT
with a 1-year holding period requirement.
UK: In 1999 the UK reduced CGT rates for investments lasting more than 3-years to 22%
from 40%. For 5-year investments the CGT rate was reduced to 10%. To boost employee
share ownership, shares held by employees for more than 5-years will be exempt from CGT
and income tax.
USA: In 1997 US CGT was lowered to 20% from 28% for holding periods of greater than
one year. In 1999 the US House of Representatives approved US$792 billion in tax cuts
including reducing the top CGT rate on investment profits for individuals to 15% from 20%.
CGT rate for low-income earners reduced to 7.5% from 10%. Certain motions have been
made for a total abolition of CGT.This table does not capture all recent CGT changes world-
wide, but attempts to show that international practice is moving towards lower CGT rates
and ultimately to an abolishment of the tax in a number of countries.

Many countries have not introduced CGT
The governments of New Zealand, Malaysia and Holland decided not to introduce CGT
because the compliance costs (not only for government but also for businesses) were too
high and revenues too low. In Argentina, Belgium, Hong Kong and Singapore personal
capital tax gains are not taxed at all.

Even if the government’s fundamental premise of taxation policy was that of tax equity, the
introduction of CGT will not achieve this end. If the government’s central objective of taxation
policy is to facilitate economic growth and development (which the Chamber of Mines thinks
it should be) then the introduction of CGT is detrimental to this objective. The introduction of
a CGT will undermine savings, investment, capital formation, economic growth and,
ultimately, undermine employment levels and living standards. South Africa’s major global
trading partners and competitors have either not introduced the CGT at all, or where they
have, the CGT rate has been lowered or is currently under review.