Financial & Fiscal Commission: Annual Submission for Revenue

1. ANNUAL SUBMISSION FOR THE DIVISION OF REVENUE 2005/06 PRESENTATION TO THE JOINT BUDGET COMMITTEE, SELECT COMMITTEE ON FINANCE, & PORTFOLIO COMMITTEE ON FINANCE 17 August 2004

2. Outline of Presentation • Introduction to the FFC • Annual Submission for the Division of Revenue 2005/06 • Review of Provincial Equitable Sharing System • Review of Local Government Equitable Sharing System • Review of Intergovernmental Fiscal Relations System • Poverty targeting, budgeting systems, evaluation of data sources

3. Introduction to theFinancial & Fiscal Commission

4. Introduction to the FFC • Background: Interim Constitution • Rational for FFC: independent advice on division of revenue • Role of the FFC • Contribute to development of intergovernmental fiscal relations system • Make recommendations on equitable division of national revenue • Vertical division (between three spheres) • Horizontal division (among provinces, munis) • Advice on wide range of issues, e.g. criteria for allocations, provincial and municipal taxes and borrowing, function shifts

5. Introduction to the FFC cont’d • Legislative requirements • Constitution: advice on division of revenue • Intergovernmental Fiscal Relations Act outlines structures and processes • FFC Act: Advice / recommendations to organs of state • Provincial Tax Regulation Process Act: FFC assessment of proposed tax(es) • Municipal Systems Act & FFC Amendment Act: comments on function shifts between spheres of government • Municipal Finance Management Act: FFC to consider of all amendments to Act

6. Introduction to the FFC cont’d • Structure of the Commission • Nine Commissioners, appointed for five-year terms: • Chairperson, Deputy Chairperson, and two other Commissioners: direct appointment by President, Chairperson is also CAO • Three Commissioners appointed from list of nominations from provinces; • Two Commissioners appointed from list of nominations from organised local government • Required to be independent and impartial • Expertise in economics, public administration, public finance, taxation, accountancy, management, and/or local government finance

7. Introduction to the FFC cont’d • Commission staff • Secretariat of 22 people • Based in Midrand and Parliamentary Office in Cape Town • Research managers, researchers, database specialists, administration staff • FFC reports to Parliament, budget funded from fiscus • Reporting and accountability processes to be discussed with Parliament

8. Introduction to the FFC cont’d • Work of the Commission • Development of principles for intergovernmental fiscal relations • Analysis of local, provincial, and national government budgets • Identification and measurement of factors influencing provincial and local expenditures • Assessment of fiscal policy instruments (e.g. conditional grants, taxes)

9. Introduction to the FFC cont’d • Work Cycle • April: Submission of Annual Recommendations • May-September: Consultation on Recommendations with stakeholders • November: Commission Review Session to consider the next year’s recommendations • December / January: • Consultation with Finance Minister on Division of Revenue Bill • Commission finalisation of next year’s proposals • February: Minister presents Annual Budget • Division of Revenue Bill includes Government response to FFC Recommendations • March: FFC Submission on the Division of Revenue Bill

10. Introduction to the FFC cont’d • Stakeholders • FFC reports to Parliament, provincial Legislatures, and organised local government • Parliamentary Office established to strengthen relationship with Parliament • Regular interaction with National Treasury, national departments, Statistics South Africa • Attendance at and presentations to various forums, e.g. Budget Council, Budget Forum, MinMECs

11. Introduction to the FFC cont’d • Key recommendations • Framework Document: Principles for intergovernmental fiscal relations in SA (1995) • Recommendations on structure and content of provincial equitable share formula (1996) and local equitable share formula (1997) • Development of costed norms approach (2000) • Development of provincial capital grants model (2000 onward) • Comprehensive review of intergovernmental fiscal relations system (2003) • Review of provincial and local equitable sharing system (2004)

13. ANNUAL SUBMISSION FOR THE DIVISION OF REVENUE 2005/06

14. Review of the Provincial Equitable Sharing System

15. Background • Proposals on the PES formula • Follow up work on past decisions of the Commission and further investigation of issues relevant to the social sector • Follow up on research work mandated by government and other stakeholders over the past four years • Take into account the provisions of 214 a-j of the Constitution in the equitable sharing of revenue

16. Overview • Review of the PES Formula • Evolution of formula since inception • FFC recommendations and government responses • Evaluation of the formula components • Follow up work on welfare services, learner support materials, decentralisation of healthcare • Intergovernmental revenue sharing system • Provincial own revenue • Revenue sources • Review of conditional grant system • Follows up on Recs made for 2004-05 • Review of Capex model • Proposal for the use of formula based conditional grant for financing backlogs and on-ongoing capital needs

17. Proposals and Recommendations: PES and Transfer System • Greater revenue raising powers to provinces • Fiscal autonomy, efficiency and accountability • Revise formula to account for fiscal disabilities • Specific beneficiary groups • Population density • Input cost variations • Scale economies • Remove Social security grants from the PES formula • Social security grants are a cash transfer – provinces play an agency role • Crowding out • Revision of weights • New government priorities • New components (ECD and social security grants)

18. Proposals and Recommendations cont…. • Education: • incorporate ECD into PES and augment PES by at least the current conditional grant • useful to consider the entire school education component together for determining the pool for basic education • Health care services: • revise formula to account for population with differential medical needs • Use of public health facilities depends on age composition of population • There is no evidence that medical aid population makes use of private facilities

19. Proposals and Recommendations cont…. • Social Development: remove component from the PES • During transition to the national agency, social security grants may be funded via conditional grants, or any other appropriate mechanism • National department must ensure measures are in place to monitor administration and payments of grants • Financing status quo should remain until the agency is complete to ensure minimum disruptions • Social welfare services: define basket of goods

20. Proposals and Recommendations: cont…. • Define the economic activity component to provide for expenditure on infrastructure and maintenance thereof • Inappropriate to use economic activity component as a compensation for provincially collected taxes • Component should provide for social infrastructure maintenance • Remove the backlogs component from PES and design separate CG (infrastructure model) • No evidence that it has actually been used to address backlogs where they existed • Since it’s part of the PES there is no way of ensuring that it is spent on backlogs

21. Proposals and Recommendations:Conditional Grants • Ways of relaxing conditions should be considered to allow for decision space, innovation and creativity in spending • Consider provinces’ individual circumstances when deciding on conditions • Introduce varying degrees of matching ratios • Accommodates provinces’ varying revenue raising capabilities • Permit mobilisation of resources within CG system by allowing shifting of funds • Introduce formal agreements/contracts between national and provincial spheres into CG mechanism • Ensures accountability and adherence to agreed standards

22. Rationale for the Capital Grants Model • Provincial capital spending insufficient to address infrastructure backlogs • Declining trend in capital budgets: 5.3% in 1996/97 to 4.2% in 1998/99 • Limited or no provincial access to capital markets. • Very small or non-existent own revenue sources • Insufficient & widely differing levels of provincial public infrastructure to enable delivery of CMBS • No proof that backlogs component of PES used to address backlogs

23. The Model Structure • Model allocates from a pool of funds: • a per capita grant to all Provinces to compensate for the overall deficiency of capital; and • an additional grant to those Provinces estimated to have ‘domestic backlogs’. • Model operates over three periods. • MTEF cycle

24. Proposals and Recommendations:Capital expenditure • Fold the backlogs component into the basic component of the PES • Creation of separate CG to deal with infrastructure financing backlogs • FFC Capex model be used to allocate infrastructure grants

25. Review of the Local Government Equitable Sharing System

26. Local Government: Proposed Framework • FFC’s proposed formula for the Local Government Equitable Share: LES = S + B + I + T LES = equitable share allocation S = basic municipal services B = other constitutional functions I = institutional costs T = tax (revenue-raising) capacity equalisation

27. LES: S Component • S (basic services) component intended to provide basic services • List of basic services needs to be specified by Government • Should reflect provisions in Bill of Rights • Key principle: everyone entitled to basic level of service, but different types of service delivery according to circumstances

28. S Component Cont’d • The following principles should inform the measurement of municipal service costs: • Should measure cost factors beyond the influence of municipalities (e.g. population density) • Methodology should not be too data-intensive • Calculations should be built up separately for each basic service (e.g. electricy, refuse removal) • Formula should be as simple as possible

29. LES: I Component • I component is for capacity maintenance, not capacity-building • FFC approach to I component: • define “core capacity” according to legislative requirements (e.g. collection of fees and rates)

30. LES: Revenue-raising Capacity • Current I component has a revenue-raising capacity element • Such a component should be applied to the formula as a whole • Revenue-raising capacity measure should relate to specific local government revenue sources • Property rates, income (tariff-funded services), regional levies (if relevant), electricity surpluses (if relevant)

31. LES: Link with Infrastructure Transfers • New Municipal Infrastructure Grant (MIG) combines infrastructure allocations of various departments (e.g. DWAF, DoT) • Current no link between MIG and LES • Should municipalities receive LES funds according to number of poor households, or number of poor households with access to basic services? • Key considerations: current service provision, equity, data availability

32. Infrastructure Transfers cont’d • Three options for linking LES and MIG • FFC Recommendation: if MIG and LES are linked, should take account of: • Need to provide appropriate incentives to munis to extend infrastructure efficiently • Need to achieve equity • Need to take account of differing capacities • Need to ensure LES allocations keep pace with installation of new infrastructure

33. LES: Ceding of LES Allocations • Munis beginning to “pledge” LES allocations to obtain loan finance • FFC concern about delivery of CMBS • Conclusions of FFC research: • Munis can pledge LES allocations, but inadequate legal safeguards in MFMA • FFC recommendation: amend MFMA to insert safeguards, or issue Government guidelines

34. LES: Current Funding Windows • Introduction of “funding windows” into LES formula since 2002/03 • Nodal allocations, Free Basic Electricity / Free Basic Services, guaranteed amounts • FFC concerns: No information on how amounts determined, or how windows relate to each other (some duplication) • Recommendation: Government should avoide the use of funding windows

35. Review of the Intergovernmental Fiscal Relations System

36. Context: Previous Recommendations • The Costed Norms Approach - 2001 • Introduced in Submission for 2001 MTEF. • Analytical tool – long-term implementation process • Process of identifying CMBS, measuring, valuing and costing outputs and outcomes to enable setting of [minimum, affordable] national norms and standards. • Application beyond the horizontal division of revenue. Particular relevance to performance monitoring and the relationship between budgetary & strategic planning. • Government noted data limitations, perverse incentives and moral hazards of approach.

37. Context: Previous Recommendations • Progressive Realization of C.M.B.S. - 2002 • Identifying C.M.B.S. from the Bill of Rights – basis for defining spending programs • Defining progressive realization in terms of access to C.M.B.S. • This involves defining target populations to enable measurement of take-up rates. • DoRB 2003 submission measured take up rates for education, health, social assistance and housing. • Data Requirements - 2003 • Process of identifying data gaps • Introduced the matrix approach

38. Context: Previous Recommendations • Performance Monitoring - 2004 • Spending programs – financial inputs – real growth rates and relative contributions as indicators • Operational and capital components • Service delivery programs – delivery outputs – quantity and quality components – measuring affordable norms from average and cross-national comparative costing • Access of target populations to CMBS reiterated as performance indicator • Policy outcomes – poverty, literacy, life expectancy, morbidity • Measurement of efficiency and effectiveness

39. Context: Previous Recommendations • Budgetary & Strategic Planning - 2004 • Links between financial inputs (Budgets), delivery outputs and policy outcomes also relevant • Basis for coordinating municipal I.D.P.s with Provincial G.D.S. • Poverty Targeting - 2004 • Costs and benefits of poverty targeting in respect of both service delivery and revenue collection noted. • Impact of government programs on poverty reduction important to measure. • Distinction drawn between income, capability and asset poverty. • Relationship between C.M.B.S. provision and poverty reduction quantified in submission on DoRB 2004.

40. Poverty Targeting • Performance Measures • Progressive improvements in policy output measures i.e. take up of or access to each C.M.B.S. in Bill of Rights • Progressive improvements in policy outcome measures i.e. impact of government spending and delivery programs on income, capability and asset poverty. • Independent assessment required (Stats SA with government departments). Consistent measures required. • Time lag between funding, implementation and impact noted.

41. Poverty Targeting • Poverty and Employment • Poverty strongly related to un- and under-employment. • Relative reliance of poor on wages, grants and subsistence useful in defining levels of poverty. • Self-selection on Public Works program most effective targeting method. • Supplementary categorical targeting for vulnerable groups.

42. Budgeting Systems • Costs and Benefits of Budgeting Reforms • Net additional operational costs (HR and IT) against: • Improvements in efficiency and effectiveness against service delivery and policy outputs and policy outcomes and • Improvements in accountability information flows • Performance Incentives • Need for each sphere to identify inputs, outputs and outcomes to identify available data and data gaps that should be shared. • Need to identify misaligned incentives (especially between sub-national and national government policies) e.g. incentives to exaggerate demand, conceal resources, year-end spend-ups.

43. Stakeholder Comments • Performance Measurement initiative supported • Poverty outcomes should be supplemented with economic growth and income distribution measures. • Service delivery outputs should be varied against different levels or quality of service. • Supplementary process measures of institutional capacity, quality of governance and political voice required.

44. An Evaluation of Data Sources for the IGFR System • Evaluation of data sources • Local government surveys • Municipal data problems • Population data / household / census • Poverty – Challenges / Labour and Income & Expenditure Surveys • Data requirements for allocation formulae • Health, housing, social development, education • Policy outcome indicators

45. Proposals for the Review of Data and Information Systems • Government should pool municipal household surveys • Warehousing and evaluation of municipal accounts information should be co-ordinated • Government should provide a definitional norm for household income poverty • Common definitions of populations targeted for CMBS delivery should be developed

46. Conclusions • Annual Submission for 2005/06 builds on previous FFC recommendations • Process: • Further interaction between FFC and stakeholders (e.g. provincial Legislatures, organised local government) • Government responds to FFC recommendations in Division of Revenue Bill (February) • FFC response to budget in FFC Division of Revenue Bill Submission (March)