FFC's Recommendation on Division of Revenue: hearings

Meeting report

FINANCE SELECT COMMITTEE
23 August 2000
FFC RECOMMENDATIONS ON DIVISION OF REVENUE: HEARINGS

Relevant submissions
COSATU on the Financial & Fiscal Commission recommendations
Professor Kuye
Foundation for Education, Science and Technology
AFReC

SUMMARY
COSATU believes that the FFC's costed norms approach will be favourable in various ways, including in terms of equity issues and the distribution of resources in favour of poorer provinces. However they noted that the approach will need further refinements as well as a gathering and analysis of all required data.

They recommended that the Medium Term Expenditure Framework budget figures (including the Medium Term Budget Policy Statement and other relevant documents) should be published as draft forms first rather than as final documents. This will facilitate greater participation by the public and Parliament. They also made various recommendations in respect of the MTEF figures.

Professor Kuye did not take a position on the FFC approach but encouraged the Committee to consider a biennial budgeting process which would be flexible in the face of changing needs.

The Foundation for Education, Science and Technology urged the Committee to increase spending on research and development and to develop a monitoring mechanism for such spending.

AFReC highlighted problems which would be encountered with the outright application of the FFC's recommendations. They recommended an approach outside the area of social security and proposed an additional budgeting tool known as the "ABX" method.

IDASA proposed a co-working method. This would involve per capita allocation per sector in conjunction with the proportion of the provincial budget.

Gauteng province said that the problem with the FFC formula was that there were no public performance indicators especially as the country is moving away from inputs, and moving towards outputs and outcomes. The Gauteng province generally welcomed the FFC approach as an instrument to assist the MTEF cycle and the FFC approach is not necessarily contradictory to the National Treasury's approach.

Eastern Cape believe that factoring the backlog component into the Basic Element was clouding the problem of the division of revenue. Differences in infrastructure between provinces make it very difficult for comparable purposes.

Northern Province commented that the FFC should note that provinces which are bordering on other countries are affected by the entry of illegal immigrants.

MINUTES
COSATU submission
Mr Neil Coleman (Deputy Secretary General of Cosatu) made the following comments:

Regarding the Budget process - the Medium Term Expenditure Framework (including the Medium Term Budget Policy Statement and other relevant documents) should first be published as draft documents rather than final documents. This will create greater room for public input and critique.

The FFC's costed norms approach will be generally favourable. It will however need some refinement. COSATU made a recommendation in terms of how the norms for service delivery should be costed.

In terms of the MTEF figures, COSATU proposed that there should be appropriate increases in the deficit and that there should be per capita increases in the overall expenditure (particularly in the social and economic services).

On the revenue side they proposed a shift on the overall composition of revenue so that more of the burden is shifted onto the corporate sector. Proposals include:
- the introduction of multiple VAT rating
- increasing the number of basic goods which are VAT zero-rated
- subjecting certain luxury goods to a higher rate of VAT
- increasing the rates of Company Tax and Secondary Tax on Companies (STC)
- implementation of a solidarity tax to finance development

Discussion
The Chairperson asked if an increase in the budget deficit would not increase the country's debt and debt servicing costs.

Mr Coleman replied that this is an important debate which needs to take place as the budget deficit is often misunderstood. The assumption that the budget deficit increases the debt is an incorrect assumption. In reality there is an irony which exists because the budget deficit in fact stimulates growth. An increase in the deficit releases resources available for strategic social and economic investment. This in turn allows debt to be brought down quicker. Debt reduction over the years has had the opposite of the desired effect. It has reduced what is available for expenditure. COSATU noted that they have done research on this and that they would be happy to present this before the committee.

Ms Fubbs (ANC, Gauteng) asked COSATU to expand on their comments on taxation. She said that a multiple VAT rating in Gauteng would increase the administrative burden and asked them to motivate their recommendation.
She also asked how goods which are VAT zero-rated would benefit the people concerned directly. On the MTEF projections she noted that the medium term budget only comes out in October and that COSATU's figures must then be based on the Budget Review. She asked for a comment.

Mr Coleman replied that basic necessities would be raised at a lower rate than luxury goods. Many developing countries use this system. It is to the advantage of the poor. Specific items (for example, paraffin) could be zero rated. What the poor need to be zero-rated can be determined.

Mr Coleman agreed that they had relied on the Budget Review. ''That is precisely the point, we had to rely on last year's figures'' he said. The other figures will only be seen in November this year. This is why a draft document for Parliament to engage in development of the final document is necessary. The Department of Finance is reluctant to do this. The budget process in Parliament is not inclusive enough.

Mr Makhato (ANC, Eastern Cape), referring to COSATU's comments on rollovers, commented that national departments download the money very late (especially for conditional grants). This impacts on the cash flow of provincial departments and the money has to be rolled over. The provinces are held responsible for this but it is not their fault that the money comes late.

Mr Coleman replied that they were not trying to say that the provinces were responsible for roll-overs. He apologised if he had given that impression.

Ms Fubbs said that the problem is sometimes that IT systems do not interface properly. The result is that amounts are not readily apparent in the mainframe system.

Mr Makhato asked for a comment on the capital expenditure on the MTEF.
Mr Coleman replied that the increase in capital expenditure should be far greater than what it was. The area needs more attention in terms of investment. Further, expenditure on personnel should not be seen as purely consumptive expenditure. The problem is that there is a perception that capital expenditure is seen as an investment and human resources expenditure is seen as wasteful. However human resources is a critical issue. It should not be seen as consumptive. The two (capital expenditure and personnel expenditure) should not be pitted against each other. There are problems in the way the public service is organised. Layers of bureaucracy need to be reorganised.

The Chairperson commented that the Public Finance Management Act attempts to deal with the issue of unfunded mandates. She asked for their view on what could be added to this. She also asked for a comment on whether provincial power to collect revenue should be increased.

Mr Coleman said that the PFMA had welcome innovations in it. However some good mechanisms can be abused. The MTEF is a good planning tool but it has been abused. The Department of Finance sometimes acts as a ''government within a government''. One example of this is in respect of the skills levy. Cabinet decided to implement this but the Department of Finance intervened and it was delayed. Mr Coleman said that there were other examples. The budgeting process must be a programme related strategy. Participation by Parliament in the budgeting process is missing. The Department of Finance plays a vetoing role. There is a distortion of the budgeting process and spending priorities. Parliament cannot play a meaningful role.

Regarding the revenue powers of the provinces, Mr Coleman noted that South Africa is not a federal state - it is a unitary state. The problem is that political decisions are taken to reduce revenue. For example, company tax was reduced. This was a policy decision which was taken because of pressure from the business sector in the hope that businesses would invest more. The result was that they did not invest. These types of political decisions need to be scrutinised.

Mr Makhato referred to COSATU's contention in their submission that SARS and the Department of Finance understate the revenue. Even if it is understated, then there are reallocations during the year. He asked what the effect of overstating the revenue would be. If it is overstated and then reduced there would be an outcry from the provinces if they had already spent the money.

Mr Coleman replied that the revenue should not be understated or overstated. It should be accurately reflected.

Ms Fubbs commented that if the government is going to expand borrowing then that may crowd out private investors. She asked for a response.

Mr Coleman replied that the argument of deficits crowding out private investment was one school of thought. The fact was that what South Africa tried to achieve is not working. They must now look at other options. There is a lot of scope for international borrowing without crowding out domestic borrowing.

Professor J Kuye
Prof Kuye, Director of the School of Public Management and Administration at the University of Pretoria, discussed certain structural issues on the budgeting process. Specifically, he referred to the underspending by most departments (revealed in the July 2 document supplementary to the Budget Review 2000) and noted that his research showed that this underspending was the result of cyclical difficulties in the budget process. He encouraged Parliament to seriously consider switching to a biennial budgeting approach process instead of using the Medium-Term Expenditure Framework (MTEF) approach. He emphasised the need for budgeting to include a timely intervention capacity.

Discussion
Mr Makgatho (ANC, Eastern Cape) indicated that he was trying to follow the arguments on underspending, the budget cycle, and the biennial proposal. He asked for further information on how the presenter's proposals for devolution of spending authority to mid-level managers would interact with policy-driven limits on spending (such as an 80/20 split between social services and other programs).

Prof Kuye stated that in most places in the world an estimates process is completed before the budget is presented. Although he acknowledged that a first world approach alone would not work, he stated that a biennial process would allow for midstream changes and greater flexibility. He acknowledged that it would come with disadvantages but that South Africa should experiment with it as several of its provinces already had. He also suggested that it would be appropriate to look at the idea of trading allocations within already established clusters.

Mr Makgatho (ANC, Eastern Cape) stated that an 80/20 or 80/15 split did not allow for flexibility. He also asked how the government could deal with obligations in the biennial approach and how fair it was to compare the South African budgetary process to that in countries like Canada (where Professor Kuye had done his research).

Prof Kuye stated that it was not fair to make comparisons to countries like Canada. However, he stated that a biennial process would allow for increased flexibility and trade-offs in a process that was not currently functional and that the Parliament should at least consider it. On the 80/20 and 80/15 splits, he noted that African states faced major problems and stated that departments needed to look for synergies of cooperation and to reduce duplication and oversights. He stated that establishing pockets within the budget might improve capacity-sharing.

The Chair stated that members were not here to talk about overall government structures but about the budget. She asked how else the budget could be approached other than through futuristic budgeting as under the MTEF. She also asked about the presenter's view on the role of civil society in the process, noting that the fact that the presenter was at the hearing already said something about this. She also asked for the presenter's comments on how the choice of how much to spend on what is cast against a specific background.

Prof Kuye stated that indicators from first world countries could provide guidance in the development of home-grown processes. He stated that South Africa has good infrastructures but faces insurmountable third world issues. He stated that South Africa has a unitary structure but all the characteristics of a federal imperative. But he noted that only two or three provinces might have the capability to raise revenue.

Prof Kuye concluded that he was proposing that a biennial approach be reconsidered so there could be intervention when something went wrong. He stated that this would allow for adjustments in the delivery of government programs. He stated that South Africa need not and cannot copy Britain or Canada but that it can customise their approaches to suit South African needs.

Foundation for Education, Science, and Technology
Dr Pouris (CEO) discussed the issue of funding for research and development (R & D). He began by discussing a number of foreign countries' major commitments to R & D spending and to tax incentives to support R & D. He moved on to reasons in the economic literature for government funding of R & D (public good, externality, increasing returns to scale, informational asymmetries, and levelling the playing field) and to economic literature on the importance of R & D to economic growth. He indicated that there was low, and declining, government spending on R & D in South Africa and that the government was not even monitoring this in its budget documents. As a result, he stated that South Africa was losing competitiveness. He recommended to the Committee that it use international best practice and set a budgetary R & D target in the order of an immediate doubling and that it request a monitoring mechanism to keep track of the R & D situation.

Discussion
The Chair asked why there were only one or two developing countries in the list provided of those spending heavily on R & D and asked if South Africa should try to invest in R & D when it was a country with many other priorities.

Dr Pouris stated that the country can keep trying to solve effects of problems but that it will not solve its problems until it deals with such causes as a lack of economic growth. He stated that Malaysia and India were recognising the importance of this and that Ireland was a success story because it had recognised this. He re-emphasised research stating that seven-eighths of economic growth comes from innovation.

The Chair asked how other developing countries spend on R & D when they are facing other very pressing questions and stated that South Africa was not very similar to OECD countries.

Ms Fubbs (ANC, Gauteng) asked about the presenter's references to India and about its gross expenditures on R & D. She noted that other countries to which the presenter had referred had a highly educated population and asked whether education or R & D came first. She noted that countries in Eastern Europe with highly educated populations without much technology seemed better poised for growth than South Africa.

Mr Makgatho (ANC, Eastern Cape) asked how South Africa should move to turn around its situation when it faced problems in education, illiteracy, welfare dependency and other areas.

On these questions, Dr Pouris stated that countries such as Malaysia and Mexico had recognised the importance of R & D spending. He stated that India had committed to a target of two percent of GDP for government spending alone. In terms of education or R & D, he stated that the choice should not be one or the other but both. He stated that a highly educated population without adequate resources so as to have job opportunities would lead to brain drain and that R & D spending without adequate scientists would be frustrated by bottlenecks. He stated that South Africa was already spending an enormous amount on education but only a minimal amount on R & D (R 1,3 to 1,4 billion).

Ms Fubbs (ANC, Gauteng) also asked how long it took for R & D spending to make an impact in Ireland.

On the time lag question, Dr Pouris stated that the lag was dependent on how R & D money was spent. He stated that spending on basic research would pay off in the long term but that industrial or natural resource council spending would provide an immediate benefit. He stated that the life cycle of products was now less than four years, less than the length of a government.

Dr Conroy (NNP, Gauteng) asked whether the presenter was talking only about the Department of Arts, Science, Culture, and Technology.

Dr Pouris stated that the issue was broader and went beyond the boundaries of this Department, although there were problems insofar as that department did not have a competitiveness approach.

Dr Conroy (NNP, Gauteng) commented that South Africa should conduct research on problems unique to the country. These problems included diseases like malaria and bilharzia. He also referred to specific agricultural research which is important in a developing country because solutions which are developed in the United States might not be applicable here.

Ms Sithole (ANC, Northern Province) stated that in the Northern Province, where 95% of the population was black, those 95% had known no development in the 1990s so that even if some said that development had dropped, the fact was that there had previously been no development.

Dr Pouris stated that the World Competitiveness Handbook provided an objective measure showing that South African growth had fallen.

He concluded by stating that forty years ago, science and technology was winning wars and that it was now producing economic growth. He stated that South Africa needed to pursue high innovation through appropriate policies.

AFReC
Conrad Barberton and Donald Maphiri of AFReC discussed a number of issues. These included the "ABX" budgeting tool and problems which may be encountered in trying to implement the FFC's costed norms approach. Mr Maphiri introduced the ABX budgeting tool as a means of boosting transparency by distinguishing the costs of existing programs and new programs. The A budget represents the baseline of existing programs, the B budget represents new and expanded expenditures, and the X factor represents reductions and savings.

Mr Barberton expanded on this by saying that it reflected a step toward performance budgeting that would relate inputs and outputs. He discussed at some length the need to have an MTEF "scorekeeper" by keeping a database on MTEF numbers and making sure that provinces followed MTEF rules.

He explained that a costed norms approach might be quite appropriate in an ideal world where there was no research costs. However there were serious problems with it today. It might be appropriate in the area of social security which had clearly defined national standards but in other areas of government spending the approach required information which was not available. Thus, it was not yet appropriate to use in these other areas. He emphasised that the average costs to be used in a costed norms approach must not be based on past expenditures or the approach would amount to nothing other than a renamed incremental budgeting process.

He stated the importance of clearly defining provincial tax powers for the long term.

Discussion
Ms Fubbs (ANC, Gauteng) asked for expansion and clarification on the idea that there would be any difference between the FFC costed norms approach and the current treasury approach in the absence of sufficient data on costs. Mr Makgatho (ANC, Eastern Cape) approached this issue through a question about the combination of the FFC approach and the traditional finance approach and about getting a clear indication of where these would collide and where they would collude.

Mr Barberton stated that in an ideal world the costed norms approach would offer a very different approach and was an approach to move towards. However, with imperfect information and a large number of assumptions there was not a significant difference. One exception to this was in the area of social security where an enormous amount of information along with clearly defined national norms and standards made costed norms the best method.

Ms Fubbs (ANC, Gauteng) asked if the ABX system was an alternative budgeting method. She stated that all she saw was a variety show. Mr Makgatho (ANC, Eastern Cape) asked a question about the ABX system, stating that its relationship to potential budgetary cuts was not very clear.

Mr Barberton stated that the ABX system was not meant as an alternative but as a tool to use in the context of MTEF to explore different policy options. Where A was the cost of a current policy in future years, B was what was being changed, and X was what savings would help to pay for B, the ABX was about a range of options rather than a variety show. The idea behind the X factor was to discuss savings as opposed to cuts and to deliver services more efficiently and show year-by-year improvements.

Mr Makgatho (ANC, Eastern Cape) asked for clarification on the respective roles of the treasury and the committees in the proposed scorekeeping.

Mr Barberton stated that the treasurer and committees would be involved at two different stages of the process. He stated that an objective under the MTEF was to monitor deliverables and to move toward specifying not just spending but also outputs. Parliament's role would be to pass budgets that the MTEF scorekeeper had approved and to oversee whether departments were meeting their targets.

Mr Makgatho (ANC, Eastern Cape) asked whether policy costing should be just about costs or about inputs as well.

Mr Barberton stated that we need to understand that we are dealing with two different kinds of costs. He stated that when passing a policy, Parliament should have both kinds of costs in front of it. He noted that social benefits are usually fairly intangible and that Parliament must make a judgement as to whether these outweighed the costs of a policy.

Mr Makgatho (ANC, Eastern Cape) asked about social security projections, stating that these were an area for problems. In particular, he suggested that there were often problems in the area of child support grants because of inadequate information on intakes. He suggested that the lack of data under the present system was yet another reason to overhaul social security.

Mr Barberton responded that budgeting for social security took place at the provincial level and that there was confidence in the information at a national level. He stated that there was something of a budget game going on at the provincial level in which provinces considered allocating insufficient resources to social security as a means of getting bailouts from the national government. In 1996-97 the national government had resisted the temptation by extending loans with later repayment for those provinces that had done this. Mr Barberton stated that there was significant pressure on social services and other areas of expenditure at the provincial level.

Ms Fubbs stated that exit costs had not yet been determined in the ABX.

Mr Barberton explained that programs that were phased out would become part of the X budget. He did not deal specifically with Ms Fubbs comment that A in the ABX was based on a current level of efficiency but that the presenter had just been talking about problems with this level of efficiency.

Ms Fubbs (ANC, Gauteng) stated that A and B were both based on data and wondered if this did not face the same problems as the FFC approach faced.

Mr Barberton accepted that this was an excellent point as there needed to be activity costing and performance budgeting.

An FFC representative interjected that he wished to respond. He stated that an ideal world was not something to be afraid of. The Constitution itself was a great leap of faith and on some matters a great leap of faith is needed. The first MTEF approach as well as the first formulae on intergovernmental transfers had been a leap of faith. He also attacked the AFReC allegations that there were no standards to which the FFC approach could apply. He stated that apartheid-era data were being transformed and that there were contradictions in how the AFReC approach had been presented.

Mr Barberton responded to these points by saying that while we must not be afraid of an ideal world, we must also remember to jump with both eyes open. Certain principles of the costed norms approach can be integrated now. He contended that there was no contradiction in the AFReC presentation in saying that some areas have accepted norms and standards and some areas do not. The country could move away from apartheid-era data by reprioritising expenditures such as child support grants. Incremental budgeting methods always risked carrying this data over into future years and that there needed to be new costings not based on existing expenditures.

Mr Barberton concluded by stating that the government needed to make a judgement call on which leap of faith to make and which leap of faith was the better one. He stated that the question was whether to adopt an FFC formula for the division of revenue or to look toward an approach based on the delivery of services. The ABX was not a formula but a system of presenting budget information. He concluded that there would continue to be problems with saying that there was sufficient funding in a given area until there was some system that accepted the delivery factors driving costs.

IDASA presentation
Mr Albert van Zyl said that in analysing the MTEF cycle, IDASA had made an effort to engage with what the Budget Review says. The overriding sense, is one that the division of revenue problem, is a complex one. IDASA proposed three ways of approaching the problem:
- The FFC costed norms approach be used
- Per capita equitable shares be considered
- Per capital sectoral budgets be considered

The problem with using the FFC formula was the issue of insufficient data and the absence of official norms and standards. The problem with using per capita equitable shares, was the different resource and structural needs of provinces. The problem with using per capita sectoral budgets, was that provinces would be faced with the task of allocating budgets themselves, thereby creating the incidence of their inflating their costs.

Mr van Zyl said that IDASA was proposing a co-working method. This would involve per capita allocation per sector in conjunction with the proportion of the provincial budget.

He outlined that Eastern Cape has a low per capita allocation, yet high allocations are made to social services. He said that this means that the current formula is underfunding that province.

He said that in terms of the Education component, the current formula does not take into account rural and disabled people. In the Health sector, women and children have a greater demand for services, and the current formula was not taking this into account. The current formula was inadequate in its analysis in the Welfare component.

Discussion
Mr Makgatho (ANC) commented that as long as the FFC formula did not account for differences in provinces, the FFC had overlooked the fundamental issues.

Ms Fubbs (ANC) said that variable urban costs had not been factored into the FFC formula. What alternative has IDASA considered in approaching the division of revenue?

Mr van Zyl answered that the alternative is to build in the Health, Education and Welfare components of the FFC formula into the existing formula

Dr Fast of the FFC said that there was a clear way forward in terms of approaching the division of revenue. She said that the present formula used by the Department of Finance was quite simple. The FFC formula was more complicated, producing an improved result based on existing data. She said that the problems facing the FFC were not insurmountable.

Mr Barberton (Afrec) stated that when the finance formula was first introduced, there was to be a phase-in period of five years. He asked if that was still the case

Mr van Zyl responded that there were two phasing in periods: a phasing in for equity purposes and a phasing in for progressive purposes. He however expected more changes to take place before the overall phase-in period is through

Gauteng Province comment
Ms Joan Fubbs said that she was glad that the FFC had collaborated with Statistics SA in preparing the formula. She said that the problem with the FFC formula was that there were no public performance indicators. She stressed that as a country we are moving away from inputs, and moving towards outputs and outcomes. She said that the FFC approach puts an unnecessary reliance on input standards. She agreed with the FFC that norms and standards are poorly defined, but this is not a situation peculiar to South Africa. She said that in the Health sector, it had to be considered that some individuals cost more to service than others, because of their economic backgrounds. She said that problems in densely populated areas and transport costs involved in accessing health services had not been factored into the costed norms approach. She said that the Gauteng province generally welcomed the FFC approach as an instrument to assist the MTEF cycle, and she stated the FFC approach is not necessarily contradictory to the National Treasury's approach.

Eastern Cape Province comment
Mr Makgatho thanked the FFC for provoking debate around equity. He however felt that factoring the backlog component into the Basic Element was clouding the problem of the division of revenue. He pointed out that differences in infrastructure between provinces make it very difficult for comparable purposes.

Northern Province comment
Ms Sheila Sithole thanked the FFC for sending representatives to the Northern Province to explain the costed norms approach to them. She commended the costed norms approach since it addressed the equitable sharing of revenue. She said that the FFC should note that provinces which are bordering on other countries are affected by the entry of illegal immigrants. She also thanked the National Treasury for releasing R98 million for flood relief in the Northern Province.

Conclusion
The Chairperson, Ms D Mahlangu, said that in discussing issues of such importance, it was a major setback that not all provinces were represented at the hearings. She highlighted that infrastructural shortcomings have been highlighted throughout the proceedings. She stressed that the shortcoming of the FFC Recommendations is the link between the vertical and horizontal split. She however praised the FFC for its hard work in preparing the costed norms approach.