Financial and Fiscal Commission Review of the Local Government Fiscal Framework

1. Financial and Fiscal Commission Review of the Local Government Fiscal Framework Presentation to the Select Committee of Appropriations 22 May 2013

2. Introduction • Section 3(1) of the FFC Act empowers the Commission to act as a consultative body for and make recommendations and give advise to organs of state in the national, provincial and local spheres of government on financial and fiscal matters • Section 3(2) emphasises that this function be performed to the extent that it is envisaged in the Constitution or required by national legislation and undertaken: • On the Commission’s own initiative; or • On request of an organ of state • The Commission resolved to review the LGFF in terms of this provision of the Act Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

3. The Review Process • FFC undertook the LGFF in terms of the Act • Two sets of public hearings were held • First public hearing outlined the problem statements within funding system • Second public hearing explored options to solve problems raised • The Commission prepared a problem statement which was then used as a basis for the first Public Hearings • A technical report was developed for discussion before the second Public Hearings • Stakeholder inputs were processed • Report was finalised and tabled in Parliament on 19 April 2013. Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

4. Key Areas • The principle of differentiation • Attaining equity in vertical and horizontal DOR • Data constraints • Challenges with conditional grants • Incentives • Review of own revenue sources • IGR coordination • Social contract between LG and communities Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

5. Differentiation Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

6. Context of Differentiation Presentation to CoGTA Technical MinMec on FFC Review of the Local Government Fiscal Framework

7. Recommendations for Differentiation • The LGFF should account for the differences in the minimum efficient expenditure needs and fiscal capacities of municipalities in the country. • It is recommended that government should explicitly adopt a methodology to differentiate municipalities in the LGFF • Based on performance and context. • Inform funding and capacity support • The Commission proposes the following factors that should inform such a differentiation: • Context (exogenous variables): poverty; economic activity within a municipality, spatial factors such as topography and population density; powers and functions assigned; population dynamics (migration). • Performance (endogenous variables): debt collection, expenditure efficiency, vacancy rates; ability to plan and execute budgets (using past budget surpluses/deficits as an example). Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

8. Vertical and Horizontal Equity Structural gap Actual gap actual costs gap inefficiency costs incurred in providing services at a reasonable level of expenditure for a properly managed service gap actual costs gap REVENUE REVENUE EXPENDITURE EXPENDITURE maximum own revenue fiscal capacity actual own revenue fiscal effort 8 Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

9. Vertical and Horizontal Equity • Vertical division adequate for operating expenditure • Estimated to be R21 Billion in 2009/10 without grants • Total LES package was R23.7 billion • LES formula was R20.2 billion • Replacement grant and Councillor support was R3.5 billion • The quantum of resources allocated to local government for operating expenditure is sufficient but there are inequities in its distribution across municipalities • Commission notes that new LES formula addresses horizontal concerns • Commission estimates shortfall in vertical division on capital expenditure • Estimated at R42 billion without grants • Total shortfall of R25 billion with infrastructure grants at R16.8 bn Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

10. Vertical and Horizontal DOR (OPEX) (1) Fiscal gap largest in rural municipalities – Need for greater distribution of LES to these municipalities Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

11. The New Formula and Horizontal DoR (Opex 2) Distribution of funds better reflect demographics and expenditure need Share of funds follow share of hh and poor

12. The New Formula and Horizontal DoR (Opex (3) Funds better reflect revenue ability

13. Vertical and Horizontal DOR for Capex Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

14. Recommendations for Vertical and Horizontal DOR • The Commission recommends a review of the funding for capital expenditure in local government given the identified vertical fiscal gap on municipal capital budgets, which is driven by increasing infrastructure needs and constraints on municipal capital revenues (operating surpluses and borrowing powers). Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

15. Data and Impact of Infrequent Updates on Allocations • Phasing-in of allocations required due to infrequent updating of grant formulae. In terms of LES: • Some municipalities experience dramatic increases ranging from 73% to 83% • Others experience significant decreases ranging from -41% to -49% • Funds have NOT been following expenditure need and demand for services! Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

16. Recommendations on Data Constraints • Reiterates previous data recommendations for improvement in collection and frequency of LG data • Role of the Local Government Data Forum is strengthened to ensure that its mandate of rationalising data requests to local government is fulfilled. • Recommend extension of LGDF mandate: • Collating and updating local government data collected by departments • Exploring methods to fill the between-census data gaps. • The Commission also recommends that StatsSA conduct a census every five years, in accordance with the Statistics Act of 1999 Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

17. Conditional Grants - Proliferation Consolidation of CG in 2004/05 – 2003 FFC Recommendation Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

18. Conditional Grants - Targeting Are CG allocations reflective of need? Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

19. Recommendations on Conditional Grants (1) • Rationalise LG CG system • Consolidate grants where possible to minimise administrative burdens • Government should generally refrain from introducing or fragmenting new and existing grants unless they have clear objectives and value-add to the LGFF. • Attempt to use existing grant mechanism to distribute the funds if possible. • Where the introduction of a new grant is necessary it should have explicit objectives, performance targets, monitoring mechanisms, required capacity building (to ensure expenditure absorption) and criteria for its phasing out and exit strategy. • The Commission further recommends that the Commission be consulted directly before a new conditional grant is introduced to local government as per Section 214(2) of the Constitution Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

20. Recommendations on Conditional Grants (2) • Implement existing legislation to withhold CG funds for perennial under spenders • Use such instances as an indicator for capacity building • Should not shift grant administration as an attempt to solve problem • The transferring officers need to ensure that a comprehensive analysis of the outcomes of retrospective and current grant allocations is undertaken • In accordance with the DORA. • Accounting and tracking outcomes of conditional grants need to be improved • appropriate risk mitigation measures put in place to account for potential over or under-spending Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

21. Municipal Revenues –Grant Dependency Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

22. 50,000,000 45,000,000 40,000,000 35,000,000 30,000,000 25,000,000 20,000,000 15,000,000 10,000,000 5,000,000 0 2004 2005 2006 2007 2008 2009 Municipal Debt (R'000) Municipal Revenues – Consumer Debt Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

23. Recommendations on Own Revenues(1) • The Commission recommends that municipalities should explore new and innovative methods to generate revenue and collect outstanding debt, including taking advantage of new technologies • Municipalities need to ensure that their tariffs are cost reflective and sensitive to the indigent profile of municipalities in order to minimise municipal consumer debt levels • This practice will ultimately result in poor households not getting billed for services they cannot afford • The Commission supports the devolution of additional taxation powers to metros and other urban areas to support their greater economic growth mandate in the urban built environment • Should not compromise the greater macroeconomic policies and stability of the country Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

24. Municipal Revenues - Fuel levy Own revenue or transfer? No control over generation or allocation If transfer, then use of fuel sales as a proxy is unclear What incentives does it create, if any? 24

25. Recommendations on Own Revenues(2) • Review the sharing of the General Fuel Levy with metros • Government needs to find a permanent replacement for the RSC levies for district municipalities • Municipalities are constitutionally assigned the electricity distribution function and are also legislatively entitled to apply a surcharge on the electricity tariff charged. In instances where Eskom is the service provider on behalf of the municipality, the municipality should be allowed to impose a surcharge on Eskom’s tariff. Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

26. Municipal Performance – Efficient and Effective Use of Resources Poor performance in LG manifests in poor service delivery, under spending, poor audit outcomes, violent protests etc Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

27. Municipal Performance Issues - FBS Portion of identified indigents NOT receiving FBS Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

28. Recommendations on Municipal Performance Issues • Formula-based grant mechanisms should implicitly or explicitly reward good municipal performance and not reward poor performance • Commission undertaking research on this issue • Commission supports measures to incentivise good performance and penalise poor performance • When determining current year allocations, all conditional grant allocations should explicitly account for past spending (and outcomes) performance • The Commission supports the withholding of unspent grants but notes that such measures are ultimately futile if capacity-building support is not given to the poorly performing municipality Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

29. Context of Capacity Support and Incentives in the LGFF Well performing municipality Performance based transfers Capacity building transfers Poorly performing municipality Amount of transfer per household Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework 29

30. Context for Improving Municipal Performance • LG performance needs to improve to ensure objectives of LGFF are achieved • Internal controls • Act on AG’s concerns • Greater support for LG from other spheres • As per Section 154 of the Constitution • Improved monitoring and evaluation • Improved capacity support • Direct and structured intervention • Appropriate implementation of Sections 139 and 216(2) of the Constitution Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

31. Context for Oversight and Support Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

32. Recommendations on Improving IGR • Review of the capacity and performance of national, provincial departments and provincial treasuries in supporting municipalities as required by the Constitution. • Commission recommends stricter implementation of regulations to establish intergovernmental forums, at both political and administrative level, that ensure support, communication and policy implementation by all parties within a province/district, including improved interactions with national government departments and public entities such as Eskom and water boards. • Greater efforts should be made to promote the sharing of information and learning-by-doing across the local government sphere. • As per Section 105 of MSA, national and provincial government ensures that a financial impact analysis is undertaken when new laws and regulations are enacted to quantify the impact of such legislation in the function of municipalities. Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

33. Recommendations on Improving Social Contract • The implementation of laws and regulations that support and impose the need for community consultation can only be improved by sound political and administrative support from other spheres of government • Municipalities need to ensure community consultation is not undertaken as a matter of legal compliance but that communities are actively involved in the budget process • Ward councillors need to strengthen their roles in the consultation processes • Council needs to improve its oversight role within municipal governance structures • Government needs to review the mechanisms available to promote and strengthen social accountability • This can include improved and formal channels for public grievances such as community grievance forums Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

34. Conclusion (1) • In framing a long term fiscal framework, a differentiated approach responsive to both context and performance is required • Recognise huge variation in the distribution of economic activity and socio political profiles of municipalities • Rewards good performance and sanctions underperformance • Vertical DOR for operational expenditure is adequate but needed to be targeted better. • The Commission supports the LES formula review and is confident that it will address the previous problems. In particular rural municipalities will receive allocations more commensurate with their fiscal needs • There is a vertical fiscal gap in relation to capital expenditure and rehabilitation which must be addressed Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

35. Conclusion (2) • Commission is concerned about the revenue situation in municipalities • increased dependence on grants even in metros • lack of own revenue instruments • Commission reiterates its previous concerns about conditional grants • Inadequate planning • Poor monitoring, and evaluation • Proliferation • Poor targeting • Transitional and implementation arrangements • Effectively and efficiently spending of funds – particularly rural municipalities • Improve capacity buildings initiatives and monitoring and evaluation procedures • Ensure MFMA and MSA provisions for competent municipal officials are enforced Presentation to the Select Committee on Appropriations Outcomes of the FFC Review of the Local Government Fiscal Framework

36. Thank You. Financial and Fiscal Commission Montrose Place (2nd Floor), Bekker Street, Waterfall Park, Vorna Valley, Midrand, Private Bag X69, Halfway House 1685 www.ffc.co.za Tel: +27 11 207 2300 Fax: +27 86 589 1038