Submission for the Division of Revenue 2011/12

Submission for the Division of Revenue 2011/12 Financial and Fiscal Commission Version of 02 June 2010 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Introduction • Financial and Fiscal Commission established in terms of Section 220 of the Constitution and the Financial and Fiscal Commission Act (2003) as amended • This submission is made in compliance with Chapter 13 of the Constitution, the Financial and Fiscal Commission Act (2003) as amended, the Intergovernmental Fiscal Relations Act (1997) and related legislation • Recommendations submitted 10 months prior to tabling of the next Division of Revenue Bill and the budget 22 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Outline of 2010 AnnualSubmission (4 Chapters) • The Global Economic Crisis, Fiscal Frameworks and Coping with Vulnerabilities • Options for Social Assistance Reform During a Period of Fiscal Stress • Towards an Effective, Efficient and Transparent Intergovernmental Fiscal System • The Performance of Conditional Fiscal Transfers in the South African Fiscal Relations System • Local Government Revenue Enhancement Programs and Fiscal Stress • The Review of the Local Government Equitable Share Formula • Regionalising Municipal Services: The Case of EDI • Intergovernmental Fiscal Issues in Urban Public Transport 33 2011/12 Submission On The Division of Revenue

1. Global Economic Crisis, Fiscal Frameworks and Coping with Vulnerabilities 2011/12 Submission On The Division of Revenue 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Channels of crisis: • World Economy • International prices • International demand • Foreign Direct Investment • Tourism • Remittances • Channels to households • Consumer and producer prices • Employment • Channels to children • Consumption • Access to child support grant, school etc

2011/12 Submission On The Division of Revenue Impact on government Income/GDP and Savings /GDP for government 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Impact on real GDP 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Poverty headcount ratio (P0) under three scenarios 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Conclusions • Global crisis interrupted decline of child poverty and hunger – the impact was strong on child poverty, mostly at extremely low income levels, i.e. amongst the very poorest children • GDP and Employment effects worse, due to large wage rigidities and demand • Short- to medium-term fiscal imperatives: • Fiscal consolidation unavoidable • Little room for introduction of costly new programmes • Longer-term fiscal imperatives: • Deficit/debt projections suggest that fiscal reforms required • Longer-run revenue growth likely to constrain future growth in spending 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Recommendations • In the short term, government should continue to strive for fiscal consolidation through limiting the growth in entitlement spending to those programmes that have demonstrably worked while refocusing expenditure to ensure better coordination and to deepen access by focusing on improved service quality. In particular the Commission recommends, • Continued expansion of child support grant and old age pension grant • Maintain the high access level to education and health services that have been achieved even during the period of fiscal consolidation • Reprioritise expenditure towards repair and maintenance by emphasising existing projects and initiating new ones. • In the medium to long term, government should: • Introduce a block grant for education, health and social development that funds clearly defined and costed outcomes in these areas • Carry out independent cost effectiveness and quality review (both public and private) in education, health and social wage 2011/12 Submission On The Division of Revenue

2. Social Assistance Reform During a Period of Fiscal Stress 2011/12 Submission On The Division of Revenue 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Introduction • The South African social assistance system is large for a middle-income country • 9th highest social assistance spending-to-GDP ratio among 74 developing economies • Three reasons for reflecting on the state and future of the system: • Deterioration of the public finances • Trends in living standards since 1994 • Reservations regarding design and impacts of the social grants 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Fiscal sustainability of the grants system • Post-1994 expansion of the grants system has not threatened fiscal sustainability • Successful fiscal consolidation (1994-2000): • Overhaul of tax collection and administration • Role of economic growth • Extensive fiscal space (2000-2007): • Rapid revenue growth, falling interest burden • Expansion of most spending categories (percentages of GDP) 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Social grants and anti-poverty policy in South Africa • Social spending and poverty: • Marked spending growth since 1994 (per capita spending increased by 21% from 1995 to 2000 and a further 42% from 2000 to 2006) • Poverty impact of social spending enhanced further by improved targeting • Social spending had a large and growing redistributive impact from 1995 to 2006 • Poverty impact of free basic services: severe data problems 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Developmental effects of social grants • No evidence of large-scale squandering of grant money • Grants receipts usually boost the food spending of recipient households • Increases in food spending associated with child support grants and social pensions improve the nutrition and health of children • Evidence: ex post height-for-age rations • Impact of gender of grant recipients? • Receipt of child support grants and old-age pensions also encourages school attendance • Absolute effects are small, because school attendance is high already 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue The future role of the social grants system • Very strong case for maintaining existing social grants • Poverty reduction in an environment wherein informal social security is under pressure • Could developmental impact be strengthened by conditions? • What about the unemployed? • Universal income grant should be avoided (cost considerations, likely perverse incentive effects, possible dependency effects) 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Recommendations • Protect overall social-assistance expenditure during fiscal consolidation, in particular targeted social spending programmes and the main cash-transfer component of poverty-focused public spending (complements anti-poverty interventions) • Do not compromise the relative simplicity of the social assistance system especially when contemplating reform options. • Pilot conditional cash transfer and workfare programmes on a smaller scale, evaluate them in order to expand successful pilots. • Strengthen non-cash complementary social developmental services through emphasising quality improvements within a defined resource envelope. • Avoid universal income grants, as these are currently unaffordable and would need to be accompanied by a broader restructuring of the entitlement system 2011/12 Submission On The Division of Revenue

3. Towards Effective, Efficient and Transparent Intergovernmental Fiscal System 2011/12 Submission On The Division of Revenue 2011/12 Submission On The Division of Revenue

3.1 The Performance of Conditional Fiscal Transfers in the South African Intergovernmental Fiscal Relations System 2011/12 Submission On The Division of Revenue 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Challenges emerging from the implementation of conditional grants in South Africa • Introduction and termination of conditional grants • There seem to be no policy guideline for the introduction and termination of Conditional Grants. • Allocation criteria for conditional grants • Rules for allocating and targeting of grants are not always based on verifiable indicators • E.g. allocation formulas for Municipal Infrastructure Grant and Infrastructure Grant for Provinces do not pay serious attention to differentiated cost factors for delivering infrastructure • Classification and budget allocations by recipient government • Budget allocations at sub-national level do not always follow grant frameworks – examples include CASP, Phase II of EPWP, and System Improvements Grant • Reporting on the performance of conditional grants • Non-financial data on the performance of Conditional Grants is either scanty or non-existent. 2222 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Recommendations I • When introducing and terminating conditional, national departments must: • Introduce a mandatory, systematic process for designing and planning individual conditional grants that covers incentive effects, administrative accountability arrangements and stipulates regular review periods and exit strategies of the grant • Ensure that there is an independent evaluation of the grant performance at entry, midterm and end of the grant • Government should make the criteria for dividing grant allocations transparent. At the moment, they are only explicitly reflected for the whole programme and not for each individual grant. 2323 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Recommendations II • Government must continue to emphasise the importance of non-financial data reporting. In this regard it should link outer year allocations to independently evaluated performance information and gazette expected deliverables. • To ensure results-based accountability through incentive grants, national departments must make accounting for delivery a prerequisite for most conditional grants. They should encourage designing grants that consider explicitly promoting innovation in sub-national governments and strengthen incentives for optimal service delivery. • The budget allocation process must follow the grant frameworks specifically. This should be monitored periodically through s32 of the PFMA and s72 of MFMA. 24 2011/12 Submission On The Division of Revenue

3.2 Local Government revenue enhancement programs and fiscal stress 2011/12 Submission On The Division of Revenue 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Introduction • Most local governments are generally perceived to be hard pressed for revenue or fiscally stressed • Municipal capacity to collect own revenue and the share of own revenue to total revenue is declining • What role for local government revenue enhancement in addressing municipal revenue challenges? 2626 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Main findings • Many municipalities demonstrating chronic fiscal stress • Own revenue being eroded by national transfers, inability and unwillingness to collect revenues by municipalities or to pay by residents. • Revenue challenges a result of: • intergovernmental system design • poor services delivery • politics and administration interface • local economic, social and demographic circumstances etc • Low revenue invariably due to low fiscal effort • Revenue enhancement programs are not producing desired results 2727 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Recommendations I • Government should adopt standard early warning systems to detect fiscal stress in municipalities and reach consensus on them: • These should be pre-conditions for instigating mandatory provincial intervention in terms of S139 of the MFMA and MFRP in terms of S140 of the MFMA. • Amend Section 71 of the MFMA to require that accounting officers report on actual revenue per source and on the percentage of collected revenue to the total value of billed revenue. • Government legislates, through S43 of the LGMS Act of 2000, revenue collection as one of the key performance areas against which to assess overall municipal performance. Indicators used to include at least: • The collection ratio, which is the extent to which services are billed, collected and enforced. • The coverage ratio, which is the extent to which all service users are captured on the tax or rates roll. 28 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Recommendations II • Excessive levels of municipal debt from residential customers, businesses and government must be reduced through taxpayer education and incentives to improve the provision of good quality services generally. • Government must enable local government through the MSA of 2000 to issue garnishee orders on defaulting customers. • Judicial system should have dedicated courts to deal with outstanding municipal accounts until the debt is reduced to acceptable levels. • The Revenue Raising Component of the Local Government Equitable Share should be reformed so that it rewards good performance in revenue collection as opposed to the current ‘Robin Hood system’, or stepped tax bands, which allocates more funds based on low revenue collection. 29 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Recommendations III • Municipalities should have broad revenue improvement programmes focusing on revenue-side interventions, expenditure-side interventions and efficiency-based interventions. • Interventions must be specific to local economic circumstances so that small rural municipalities, which mainly face structural fiscal stress, develop efficiency-based and expenditure-side revenue improvement interventions. Urban municipalities, which encounter cyclical fiscal stress, can pursue revenue-side interventions. • Small rural municipalities must develop institutional arrangements or reforms that emphasise revenue assignment that is geared especially to sharing powers and functions between category B and C municipalities. • Effective revenue management processes, good financial management and the provision of good quality services should underpin revenue improvement programmes. Municipalities should only conduct them when they have maximised the collection of locally available and outstanding revenue sources. 30 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Recommendations IV • Government should support efforts to estimate the fiscal capacity and fiscal effort of municipalities to dispel the perception that certain municipalities will never be financially viable. • Where feasible, bigger municipalities, which already have financial systems, should be encouraged to share their systems and expertise with smaller ones. • The performance of revenue improvement programmes should be subjected to empirical tests that cover changes in the effective tax rates, tax burdens for all service users, the total revenue yield, economic efficiency and overall fairness. 31 2011/12 Submission On The Division of Revenue

3.3 The Review of the Local Government Equitable Share (LES) Formula 2011/12 Submission On The Division of Revenue 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Background • Tight economic environment calls for institutional and operational efficiencies of fiscal and revenue instruments of Local Government • Performance and efficiencies of intergovernmental transfers and own revenue sources crucial for cushioning the effects of recession and providing a solid platform for buoyant and equitable growth • Section deals with how to reform the Local Government Equitable Share formula to improve its effectiveness and efficiency • Highlight urgent issues to contribute to and form part of greater review undertaken by Treasury • Based on static (one year) and dynamic (multi-year) analysis of allocations as well as simulations 3333 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue The Current LES 34 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Key Findings and Conclusions • Technical shortcomings of current formula • Lack of accurate costing framework to determine subsidies • Inefficient calculation, application and possible unconstitutional aspects of the RRC component • Lack of transparency of the correction/stabilisation component and is currently inefficiently applied • Formula not robust enough to factor in changes and target funding • Use of outdated data and lack of frequent data updates • Poverty indicator “outdated” and income not a good measure of poverty 3535 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Key Findings and Conclusions (2) • Dynamic analysis suggests previous government reforms of formulae have largely been ineffective • Static analysis indicates certain degree of redistribution and high dependency on LES funds for rural municipalities • Review of LES to consider following issues: • Differentiated approach to funding LG • Links to broader objectives of the LG fiscal framework (eg MIG) • Funding maintenance of social infrastructure • Flexibility to incorporate any changes to current FBS policies and expenditure and tariff shocks • Factor in other services provided by LG • The cross subsidisation ability of urban municipalities 3636 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Recommendations • Government should use the institutional component of LES to assist poor municipalities. • Government should remove the step structure of the differentiated tax mechanism of the RRC and develop a flat gradient structure so that municipalities on the outer ends of bands are not treated unfairly • Government should develop alternative methods of revenue prediction for the RRC component. 3737 2011/12 Submission On The Division of Revenue

3.4 Regionalising Municipal Services: The Case of the Electricity Distribution Industry in South Africa 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Background • Improving service delivery performance and ensuring value for taxpayers’ money an ongoing government concern • A number of approaches to tackle these challenges: • Legislative promulgations e.g., MSA (No. 117 of 1998), as amended and MSA (No. 32 of 2000) • Rationalisation and corporatisation of municipal services e.g., Johannesburg’s iGoli 2002 programme • Capacity support to local governments, e.g., Project Consolidate later linked to Siyenza Manje. • In dealing with a specific municipal function challenges like electricity distribution, government has attempted to create six Regional Electricity Distributors (REDs) since early 1990s 39 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Background • Notwithstanding all these intervention efforts, government tabled the Constitution Seventeenth Amendment Bill in 2009. • Seeks to empower national government to regulate the executive authority of municipalities further with regard to matters listed in part B of schedule 4 and part B of schedule 5 of the Constitution • FFC submitted its submission on Constitution 17th Amendment Bill to Department of Justice in March 2010 • Hoped this will achieve regional efficiencies and economies of scale with regard to a specific municipal function • Restructuring of the electricity distribution industry (EDI) by creating REDs used as an example in the memorandum to the bill. • However, challenges facing service delivery at local government level are complex, dynamic and require a proper diagnosis 40 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Research findings • Adopt holistic and integrated reform approach • Base reform decisions on solid research findings • A proper diagnostic of the challenges should be carried out on a case-by-case basis • A differentiated approach to reform recognising cases of good performance is preferable • Base participation in reform processes on appropriate incentives and knowledge of benefits of the change • Ensure compatibility of individual operational systems of municipalities and harmonise employment levels • Social objectives of universal service access should not be lost in the process of restructuring 41 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Recommendations I - General • In the absence of an assessment of the specific performance challenges that municipalities face in implementing the functions listed in part B of schedules 4 and 5, a blanket regionalisation approach, as proposed in the 17th amendment to the Constitution, is not supported. Current legislative provisions allow for alternative and creative service delivery arrangements that do not call for a dilution of executive authority at the local level. • Not all electricity distributors suffer from the challenges that the restructuring intends to overcome. As a result, the EDI restructuring process should consider a differentiated approach that allows for differences in performance. 42 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Recommendations II – Assuming EDI restructuring proceeds • Government should revisit the Blue Print assumptions initially made to restructure the EDI. The EDI component was informed by restructuring the electricity industry as a whole, including the electricity supply industry. Government needs to clarify the policy issue of whether it is necessary to change ownership and structure in order to ensure efficiency, economies of scale, robust regulations and to deal with management challenges in the sector • Government should conduct an up-to-date re-evaluation and analysis of the benefits of restructuring the EDI. In addition to the political, economic and social changes that have happened in the last eight years which raise questions about the current assumptions underpinning the restructuring process, delaying the implementation of the REDs has generated new costs that require a total re-evaluation against the benefits that were perceived at the conception of the idea. 43 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Recommendations III – Assuming EDI restructuring proceeds • Government should finalise the EDI Restructuring Bill and the practical guidelines (the Asset Transfer Guide) related to the shifting of municipal/Eskom distribution assets first, before moving towards more advanced stages of restructuring. • Government should ensure the compatibility of operating systems that will underpin the activities of the REDs before establishing them as this can negatively affect service delivery and reduce any savings from the restructuring • It is important that the social objective of making access to electricity universal is not lost in the process of restructuring the EDI. The government must make it clear which sphere of government will be responsible for planning, budgeting for and implementing the electrification programme. 44 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue 4. Intergovernmental Fiscal Issues in Urban Public Transport 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Background • Subsidy regime has developed around assisting workers to get to and from work in this high cost context • Distribution of economic activities results in a tidal flow of commuters in and out of cities in morning and evening (twin peaks) • Data – National Transport Household Survey last conducted in 2003 • Public transport serves largely urban poor • Considerable amounts invested in infrastructure for private motorists hence difficult to undo • Coordination between different transport modes needs to be improved • There has been under-investment in the rail sector and the National Rail Plan was developed to guide re-investing purposes. • Investment on rail infrastructure currently does not follow corridors prioritised on the National Rail Plan. 46 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Background • Serious public transport challenges especially in major urban centres • Significant increase in public transport spending in recent years with the inter-governmental fiscal system being instrumental in much of this expenditure • Key items include the ongoing bus subsidies, the Gautrain, and the new bus rapid transit projects • Apparent confusion about accountability in the three spheres of government has been amongst the biggest obstacles to investment in the improvement of public transport. • Urban form of South African cities results in long trip distances hence higher costs 47 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Institutional arrangements/legislative issues • The nDoT plays a pivotal role in the roads and transport sector by providing strategic policy direction and regulatory oversight which are implemented through provincial departments, local government and public entities • SANRAL on behalf of the nDoT is responsible for the planning, design, construction, operation, management, control, maintenance and rehabilitation of national roads • Provinces are responsible for the management of the provincial road network • Bus subsidies have traditionally been transferred from the nDoT to provincial departments, based on a variety of agreements. • Municipalities are responsible for the construction and maintenance of municipal roads and streets within their areas of jurisdictions 48 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Institutional arrangements/legislative issues • National Land Transport Transition Act is key to the reviewing of the way in which bus subsidies are awarded • Key is shift from lifelong permits to tendered bus contracts • National Land Transport Act is also one of the key pieces of legislation and provides for metropolitan governments to become responsible for managing the bus contracts previously managed by the provinces the potential financial risk to them could be overwhelming. • Especially since the general tax revenues, which cities control, are property taxes and a share of the fuel levy which do not offer the scope or depth to manage this level of risk. 49 2011/12 Submission On The Division of Revenue

2011/12 Submission On The Division of Revenue Overarching financial strategic issues • Over-riding financial question is how public resources should be spent to optimise mobility and access in cities. • The key question becomes how revenue raising powers and subsidy flows between the different spheres of government should be configured to lead to optimal solutions. • Existing subsidies for public transport are quite substantial. • However, these are mostly available for weekly or monthly tickets. Those not travelling on most working days can therefore not use the subsidised fares. • Subsidies are being used to maintain an inefficient status quo, rather than to improve efficiencies. • Incentives are required to encourage relocation, taking account that this is likely to be highly contentious and could have negative distributional effects. 50 2011/12 Submission On The Division of Revenue

Submission for the Division of Revenue 2011/12