Local Government Fiscal Framework, Equitable Share Formula: Financial & Fiscal Commission Reports

Meeting report

Chairperson’s opening remarks
The Chairperson welcomed Members, and noted that this briefing today emanated out of a meeting that he had had in the previous week with the Financial and Fiscal Commission (FFC or the Commission). When discussing the FFC’s review of the Local Government Fiscal Framework, he and the Chairperson of the Commission had concluded that it would be most helpful to brief the entire Committee, and an invitation had been extended to the provinces, as well as the Minister, and Members of the Select Committee on Cooperative Governance and Traditional Affairs, to engage with the FFC. The Minister was unfortunately unable to be present.

Financial and Fiscal Commission “Sustainable Local Government Finances- Final Report on the Financial and Fiscal Commission’s Public Hearings on the Review of the Local Government Fiscal Framework”
Mr Bongani Khumalo, Acting Chairperson, Financial and Fiscal Commission, outlined the context of the report, which was prepared in terms of section 3 of the Financial and Fiscal Commission Act 1997. He added that in the period of 2008-2010, the Commission held various discussions and debates about local government finances, in particular the local government equitable share and the adequacy of the revenue which went to municipalities through revenue sharing mechanisms. There were also various discussions on the different categories of municipalities. In response to some of these discussions, the Commission had made a number of recommendations related to local government, the equitable share formula, and other matters related to local government transfers. Recommendations were made during the annual Division of Revenue Bill process, and submissions were received from various stakeholders.

All recommendations were later consolidated, and the responses given to the Committee were also looked at. The Commission found that quite a number of the recommendations were received in a very positive light by government insofar as they related to implementation. The FFC then embarked upon a public hearings exercise, where all relevant stakeholders were invited to make submissions. The Chairperson for the Portfolio Committee on Cooperative Governance and Traditional Affairs led the process. The first hearings were held in Limpopo in 2008 and were driven by the MEC of Finance there, Mr David Masondo. The hearings were well attended. From these hearings, a problem statement was crafted, and it was then circulated to all stakeholders for them to confirm that all key issues were addressed.

Technical research was then conducted by the Commission on all the identified issues. During 2012 a second round of public hearings was held, to report back on the technical research. Proposed solutions were tabled to the stakeholders, and their feedback was captured. The report of the FFC was then finalised and was tabled to Parliament on 19 April 2013.

Mr Khumalo noted that the report was particularly important when considered with the broader review, which was led by the National Treasury and the Department of Cooperative Governance and Traditional Affairs (COGTA), looking at the local government fiscal framework. The Commission agreed to participate in that review but stated that it would maintain its independent view and would stick to its own mandate, outlined by the FFC Act. This report, however, did not address the assignment of functions to different categories of municipalities.

Mr Jugal Mahabir, Senior Researcher: Local Government Unit, FFC, said the aim of the process was to have a collaborative effort in identifying the key areas which needed to be analysed, in order to review the local government fiscal framework.

He noted that the key focus areas were:
- The principle of differentiation
- Attaining equity in vertical and horizontal Division of Revenue
- Data constraints
- Challenges with conditional grants

Mr Mahabir said that differentiation was one of the main areas of concern, and the Commission had needed to show sensitivity to the different situations of each municipality. He noted that there were various types of municipalities, ranging from Metropolitan municipalities, through secondary city municipalities, larger towns, smaller towns, and down to municipalities in rural areas. There were thus stark differences in population size, total number of households, the percentages of people employed and the percentage of households earning below, for example, R3 200 per month. The revenues from local taxes in these municipalities therefore also showed wide differentiation. For example, a metropolitan municipalities could have an operating expenditure of about R3 789 per capita, while a rural municipality could have an operating expenditure of only about R370 per capita, and these differences obviously impacted substantially on the distribution of resources and revenue.

Revenue in turn had a significant impact on the performance of a municipality. The Local Government Fiscal Framework (LGFF) therefore needed to be very sensitive to issues of context, be they social or economic, in the various types of municipalities. Finances thus needed to be built in line with the context. He noted that rural municipalities had a very poor economic base in comparison to other municipalities. The LGFF should therefore account for the differences in the minimum efficient expenditure needs, and government should explicitly adopt a methodology to differentiate municipalities in the LGFF based on performance and context.

Mr Mahabir noted that the FFC had proposed the factors that should inform differentiation, as follows:

● Context (exogenous variables) - such as poverty, economic activity within a municipality, spatial factors such as topography and population density, powers and functions assigned, and population dynamics (migration).
● Performance (endogenous variables) - which comprised debt collection, expenditure efficiency, vacancy rates, ability to plan and execute budgets (using past budget surpluses/deficits as an example).

He then explained how vertical and horizontal equity would be viewed. Vertical division was adequate for operating expenditure. The Commission recommended a review of the funding for capital expenditure in local government, given the identified vertical fiscal gap in municipal capital budgets, which was driven by increasing infrastructure needs and constraints on municipal capital revenues, such as operating surpluses and borrowing powers. Noting that the data and allocations were not frequently updated, he said that it would be necessary to phase in all allocations. In relation to the Local Equitable Share (LES), he noted that some municipalities experienced dramatic increases, ranging from 73% to 83%, while others experienced significant decreases ranging from -41% to -49%. However, the funding was not following the expenditure needs and demands for services.

The FFC therefore recommended that there should be improvements made in the collection and frequency of data updates on local government. This would require a strengthening also of the Local Government Data Forum, to ensure that its mandate of rationalising data requests to local government was fulfilled. The Commission also recommended that Statistics South Africa (SSA) should conduct a census every five years, in line with the Statistics Act of 1999. It also recommended that the FFC should be consulted directly before any new conditional grant for local government was introduced, in line with section 214(2) of the Constitution.

Mr Mkhululi Ncube, Programme Manager: Local Government, FFC continued with the presentation, noting that other key areas considered by the FFC had included incentives, the review of “own revenue” sources, intergovernmental relations coordination and the social contract between Local Government and communities

In relation to revenue sources, the FFC had recommended that municipalities should explore new and innovative methods to generate revenue and collect outstanding debt, including taking advantage of new technologies. Municipalities needed to ensure that their tariffs were cost reflective and sensitive to the indigent profile of those living in the municipality, in order to minimise municipal consumer debt levels. This practice would ultimately result in poor households not getting billed for services they could not afford. The Commission also supported the devolution of additional taxation powers to metros and other urban areas, to support their greater economic growth mandate in the urban built environment. However, this should not compromise the greater macro-economic policies and the stability of the country.

The Commission, in relation to municipal performance, supported the recommendation that unspent grants be withheld, but it noted that such measures would ultimately be futile if capacity-building support was not given also to the poorly-performing municipalities. The Commission also recommended that laws and regulations be implemented to improve the social contract between local government and communities. These laws and regulations would require, and support, community consultation, which would be improved by sound political and administrative support from other spheres of government. Municipalities also needed to ensure that community consultation was not undertaken merely in order to comply, but that communities were actively involved in the budget process. Ward councillors also needed to strengthen their roles in the consultation process. Government also needed to review the mechanisms available to promote and strengthen social accountability.

Ms Tanya Ajam, Commissioner, FFC, concluded that the Report appeared very dense, because there were a lot of facts and figures contained in it, in line with the FFC’s attempt to produce evidence-based recommendations. This had been the first time that the Commission tried to conduct public hearings, but she maintained that it had been a very important departure because it had shown that on the ground there were some who did not understand the formula. However, she noted that National Treasury had published the formula, allocations and spreadsheets on its website. Individual municipalities could therefore access the information, to see how the allocations were made. She noted that although the FFC itself was systems-based, the public hearings process had also enabled the Commission to better understand the grievances and frustrations of each municipality.

She summarised that the key message from the FFC was that swift progress had been made and the Commission fully agreed with the need for a differentiated approach. The challenge now was to make sure that all municipalities received funds, and spent them properly. She acknowledged that there was still a lot of work needed to ensure that local government had a sustainable fiscal framework. The Local Government Equitable Share was therefore an important part of the fiscal framework. The vertical and fiscal gap in relation to capital expenditure and reintegration also needed to be looked at. Revenue was also a factor to which long term consideration must be given, in the Local Government Fiscal Framework. The increasing dependence on grants had to be minimised. In relation to transitional implementation arrangements, the Commission still needed to look at enforcing competency standards. Finally, she noted that many of the matters raised had been outlined on previous occasions.

The Chairperson thanked the Commission for the presentation, and agreed that the report covered most matters which had previously been discussed.

Discussion
Mr D Joseph (DA; Western Cape) said the budget increased every year and asked why the Commission suggested that there would be no funds available for municipalities. He pointed out that South Africa had money available to lend to other countries such as Zimbabwe, but questioned why these funds were not being directed instead to the upliftment of South African communities. He also pointed out to the fact that most people were moving away from rural areas and into the cities, and that the 2011 census was already outdated. He raised a concern about whether cities would be able to budget properly to accommodate all those moving in. Finally, he asked whether the bursaries for public servants would also apply to government employees.  

Ms T Memela (ANC; KwaZulu Natal) wondered if there was any way to measure the incentives. She noted the comment that there was limited revenue-raising ability in the poorer municipalities but wondered how the Commission would recommend that they be encouraged to improve their performance. She noted that departments drove municipalities and therefore questioned what mechanisms were in place to monitor clean audits.

Mr A Lees (DA; KwaZulu Natal) (Alt) thanked the Commission for a professional and well presented presentation. However, he felt that some of the recommendations did not take the broader perspective into account. He also raised a concern that urbanisation was vastly increasing, and wondered if the FFC had factored in the large unit costs and lower efficiency of providing services to rural areas, and how it could balance increasing urbanisation with development of rural municipalities. He noted, in relation to the fuel levy, that there was no longer ring-fencing of funding, and wondered if the FFC was suggesting that the levies should be ring-fenced and allocated back to specific areas. He agreed with the FFC and earlier comments that “own revenue” collection was a major problem and asked whether the FFC had considered the possibility of recommending that the whole question of rating government departments be eliminated, and the funds be transferred through the Equitable Share. Finally, he asked what the Commission had in place to encourage good performance within all municipalities.

Another Member agreed that there were some rural areas which were so poor that effectively no taxes could be collected from the communities, as people living there were solely dependent on grants. She suggested that another strategy was needed, and asked also whether traditional leaders were involved in the collection of revenue.

Ms N Dube, MEC, KwaZulu Natal, asked what mechanisms the FFC was recommending to ensure that rural areas were developed, so that it was not necessary for those with skills to migrate to urban areas. She said that in KwaZulu Natal (KZN), about 28 out of the 61 municipalities were 80% dependent on grants. She agreed with the Commission that grants should be re-evaluated, but also made the point that there were various problems with the integration of grants. When the municipalities were established in 2000, there were different phases, but some municipalities had never moved from one phase to the next. One explanation for this was that no life was ever injected into those that now remained stagnant. Another area that needed to be looked into was the extent of national and provincial support to municipalities. The audit outcomes suggested that not enough support had been given to municipalities by departments of local government. She therefore wanted to know what mechanisms were in place to make sure that the relevant support was channelled where it was most needed.

Ms Dube agreed with other Members that it would be necessary to look into the revenue sources of municipalities, and that a differentiated approach was needed, particularly to try to capacitate district municipalities. Some local municipalities were stronger than the district ones. In some areas, the lack of grants was the reason for some municipal protests. She wondered how it would be possible to deal with the grants without affecting the livelihoods of poor communities. Rural economic development was one mechanism to ensure the development and sustainability of poorer municipalities. She wondered why the Commission had not raised the matter of the tourism levy. Finally, she asked how the Capex and Apex were structured to assist municipalities that had no revenue base.

Mr S Skhosana, MEC for Local Government, Mpumalanga, did not understand why the Commission was referring to “incentivising” people or rewarding them, as if their performance was something outside of their job description. He also said it was also a concern that funds were being taken back from municipalities because they did not perform adequately, as it amounted to punishing everyone in the municipality whether or not they individually deserved it, and reminded the Committee that it was the communities who were affected. Mr Skhosana asked what source the Commission was using to collect data. He also raised a concern that the South African Local Government Association (SALGA) was not present in the meeting, as it was supposed to deal with municipalities, and added that the Chairperson of the SALGA in Mpumalanga should have been present.

The Chairperson responded that SALGA was invited to the meeting, but the Executive Director of SALGA had indicated that he would be unable to attend.

Mr Kopung Ralikontshane, Head of Department of Local Government, Free State thanked the Commission for a very comprehensive presentation. He argued that the problem of local government was in fact larger than indicated in the Commission’s presentation. He asked to what extent municipalities used the differentiated model for their own processes. Municipalities executed specific responsibilities, based upon unfunded mandates. He argued that there were instances of reckless spending across various municipalities, such as municipalities sponsoring festivals and concerts outside of their mandate, but this was indicating of the municipal managers failing to exercise proper financial management. He thought that government needed to refine the monitoring and evaluation processes, and give MECs a better hand to deal with municipalities at local level.

Mr Ralikontshane wondered to what extent the Commission had addressed the decay of infrastructure in municipalities. He asked whether the issue of revenue decline was linked to declining financial figures. He added that the Department and Rural Development and Land Reform had attempted to develop standards of service delivery, and he wondered whether the proposed fiscal framework was sufficient for infrastructure provision.

The Chairperson asked if the FFC could prioritise the responses to Ms Memela and Ms Dube as they would be attending other meetings shortly.

Mr Khumalo thanked all the Members for the questions and comments raised and noted that part of the FFC’s objective had already been achieved, in that such stimulating discussion had followed the presentation of the report. He firstly wanted to deal with incentives, and acknowledged that it needed adequate attention. He noted, however, that the mention of “incentives” in the context of transfers was not implying monetary rewards, but rather referred to institutional arrangements which impacted on behaviour of municipalities or individuals within a municipality. Legislation and implementation were possible incentives. Municipal performance could be compared against set standards and requirements. Incentives were intended to influence the proper implementation of legislation, and could influence behaviour by the way the transfer system was designed. On the other hand, grants could not be used to solve individual problems. Mr Khumalo noted that the report would be tabled on 24 May 2013. The annual submission of the FFC on the Division of Revenue had addressed most of the problems highlighted here in relation to infrastructure and local government. The report would be recommending refurbishing existing infrastructure according to norms and standards, within the funding constraints.

Mr Khumalo moved on to the questions and comments around the rural economy and revenue, and agreed that there were some municipalities which would never really be able to raise any revenue, where intervention was needed. The rural economy therefore had its own challenges. He noted the comments on the high rise in urbanisation, but responded that the existing share formula did not discriminate against urban areas for having a higher population than rural areas. Instead, it recognised that urban municipalities generally had the fiscal capacity to fund their own services, although they were still given adequate allocations of funds. He noted also that there had been a steady increase in the pool of funding to rural areas, compared to the funding to urban areas, over the years. The Commission was trying, through the formula, to increase allocations in order to improve the condition of basic infrastructure. However the roll-out of infrastructure was not moving as fast as the Commission had hoped.

Mr Khumalo responded to the question around the tourism levy, by noting that the Commission had made a suggestion on this, when it was dealing with the Municipal Fiscal and Powers Act, that it be listed as a possibility for securing revenue for municipalities. Some provinces had been utilising these levies as revenue sources. Local business taxes were also supported by the Commission.

Mr Khumalo commented on the issue of balancing rural and urban migration, by noting that the Commission had been dealing with a variety of questions about municipal fiscal viability. However, it was ultimately in the hands of the Municipal Demarcation Board, with whom the FFC had already signed a Memorandum of Understanding. The Commission was working closely with the Board when dealing with the fiscal viability of some municipalities, and more detailed information would be provided at a later stage. Some matters were outside the scope of the Commission. The current Equitable Share Formula made a 10% allowance for different components of basic services, such as maintenance, even though the National Treasury made an 8% allowance for the same matters. He agreed that national and provincial departments needed to capacitate municipalities, with a strong focus on rural municipalities.

Mr Khumalo said that he could not answer the question as to the people for whom the learnership programme were intended.

Ms Ajam noted that it was the municipal managers who had to take on the role of monitoring and ensuring proper financial management, and suggested that Members also needed to make use of their oversight visits, in order to assist the Auditor-General at the end of the financial year.

Mr Mahabir responded to the questions on the fuel levy and said only 23% of the general levy accrued to metros. When the fuel levy dropped, the transfer levy was also reduced.

The meeting was adjourned.