2015/16 Division of Revenue: Financial and Fiscal Commission briefing

Standing Committee on Appropriations

19 August 2014
Chairperson: Submission for the Division of Revenue 2015/16
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Meeting Summary

The Financial and Fiscal Commission (FFC) briefed the Committee on the 2015/16 division of revenue submission. The submission consisted of four parts: macroeconomic perspectives and fiscal frameworks for inclusive growth, improving investments in education and health, investment in infrastructure and the impact of demarcations on municipal finance.

In the first part, macroeconomic perspectives and fiscal frameworks, the FFC said a counter-cyclical stance had led to increased budget deficits, which had resulted in an increase in the public debt/gross domestic product ratio from 23% in 2008, to over 40% in 2013.  Over the past 20 years much progress had been made in decreasing poverty and inequality and overall management of the macro-economy, but long-term investment challenges such as investment in more mid-level skills, the building of adequate infrastructure in the transport and energy sectors and the distribution of the fruits of growth, still remained.  Economic growth had been insufficient to generate convergence towards income levels envisaged by the National Development Plan.  The government should avoid setting targets for the size of the public debt.  It should not simply cut costs, but reform programmes and service delivery.  Spending should be aligned with government priorities to ensure adequate funding of high-priority initiatives and the elimination or reduction of programmes that were not priority.

Government should move towards a fully integrated benefits system that simplified client access, improved client outcomes and fiscal sustainability through greater programme effectiveness, reduced fraud and corruption and reduced administration costs.

In its submission on improving investments in education and health, the FFC’s key findings included disparities in the allocation of resources to schools and variations in performances of schools, a general perception of inadequate funding to fulfil curriculum requirements, and a dissociation between resources and outcomes, particularly in poor schools.  It recommended that the national Department of Basic Education should align learner subsidy allocations with national policy requirements and priorities.  The allocation framework for education infrastructure conditional grants for quintile 1 to 3 schools as well as the School Infrastructure Backlogs Grant should address the alignment between funding for non-physical and physical inputs, as well as curb the decaying of newly-constructed infrastructure.  The National Department of Education should integrate existing outcomes improvement programmes, such as the integrated national strategy to improve numeracy and literacy, and target poor performing districts so as to translate inputs into outcomes.

Despite an increased growth in health spending, the health sector had been beleaguered by challenges such as suboptimal quality of care, inefficiencies in the system, a heavy burden of disease, input cost pressures, a growing uninsured population, inequitable distribution of resources and the widely held perception that health care was under-funded.   The FFC recommended that provincial governments would have to increase its allocation levels of Primary Health Care (PHC) funding to be in line with the minimum norms and standards for PHC packages set by the National Department of Health.  Inefficiencies (wasteful/irregular expenditure) in the health sector should be minimised so as to be in line with international experience.

The FFC recommended that the Department of Agriculture, Fisheries and Forestry strengthen its ability to enforce the conditions in the grant framework, to ensure better oversight of provinces. This would ensure that the spending and performance of the conditional grants would be improved.  Special emphasis had been put on improving the operations of different food security programmes, especially agriculture, the Expanded Public Works Programme and the School Nutrition Programme, which would solve household food concerns without increasing programme expenditure.  

The current infrastructure grants were not sufficient to cover capital expenditure needs, given the current funding sources.  The FFC recommended that the monitoring and evaluation of municipal capital planning and spending be improved. Municipalities should explore interaction and partnerships with other organs of state and greater use of private/public partnerships, including fully or partly outsourcing municipal services.

Government should explore a new funding and infrastructure delivery model for poorly resourced and rural municipalities.

Household travel surveys had shown that large proportions of households had no access to any form of public transport or were dissatisfied with the quality of the available public transport.  The Commission recommended that all municipal integrated transport plans should clearly indicate how the municipalities intended to exercise control over the network. This should be one of the minimum requirements for preparing integrated transport plans.   The Department of Transport should formulate and implement a transport subsidy framework which incorporated social welfare, service productivity and environmental management.
A review of municipal integrated transport plans should be carried out with a view to identifying gaps that needed to be addressed. This should be carried out jointly by the Department of Transport and the South African Local Government Association.

Key findings indicated that increases in electricity prices negatively affected municipal expenditure and revenue.   The FFC recommended that government should put in place a plan to manage the risks to municipalities associated with the increased price of bulk electricity purchases. Such a plan should be explicit in terms of the differential impact that increases in the price of bulk electricity purchases would have on different categories of municipalities.  

The Commission recommended that metros should be focused on planning for rental flats and the creation of new neighbourhoods in intermediate suburbs which have lower densities than in the inner city.  Government’s housing subsidy should prioritise the most vulnerable groups, such as poor female-headed households with children below the age of 20 years and households that contained adults who were permanently out of the labour market.   Municipalities should prioritise land ownership registration processes in informal settlements located in developable areas. Government should prioritise the provision of infrastructure in areas with the potential for self-build housing.

The Commission recommended that the financial and fiscal implications of boundary re-determinations should be prioritised and established before any demarcation decision was announced. A funding stream for the demarcation process should be identified before the process had taken effect.  In order to avoid the negative effects of demarcations on municipalities and their populations, economic considerations should be at the core of any demarcation decision, both in theory and in practice. The current criteria made it clear that economic considerations should be part of the criteria, but this did not appear to be the case in practice.
As the government bore the transitional costs for the restructuring of every vertically decided demarcation process, a transitional demarcation grant should be awarded to the amalgamated municipality. This grant should be temporary and should be awarded over at least three years. The grant would facilitate the restructuring process.

Members wanted to know why the Financial and Fiscal Commission recommended that government should avoid setting targets for public debt. Was it not because of this stance that South Africa was now facing a public debt/gross domestic product ratio of 40%?   Why did it want to avoid setting targets for public debt? What was the acceptable norm for borrowing?  Did South Africa have a plan to get out of debt?
 

Meeting report

Financial and Fiscal Commission Submission for the 2015/16 Division of Revenue
Mr Bongani Khumalo, Acting Chairperson of the Financial and Fiscal Commission (FFC), briefed the Commission on the 2015/16 division of revenue submission. “Balancing fiscal sustainability with socio-economic impact,” was the overarching theme that underpinned the submission.

The submission had been categorised into four parts: macroeconomic and fiscal frameworks for inclusive growth, improving investments in education and health, investment in infrastructure and the impact of demarcations on municipal finance.

Part 1 - Macroeconomic Perspectives and Fiscal Frameworks
Dr Ramos Mabugu, Research Head at the FFC, said the effects of the international crisis on the domestic economy was felt in 2009 when the growth rate was negative (-1.5%).  In 2010 and 2011, the South African economy recovered slightly, growing at just above 3%, but export demand from developed countries remained slow. Since then, as poor growth continued in developed economies and somewhat slower growth in large developing economies, the South African economy had struggled to achieve growth rates above 2%. The economy grew by 2.5% in 2012 but was expected to slow to 2.1% in 2013. South Africa was trapped in a cycle of modest growth, high inequality and record levels of unemployment.

A counter-cyclical stance had led to increased budget deficits, which resulted in an increase in the public debt/GDP (gross domestic product) ratio from 23% in 2008 to over 40% in 2013.  South Africa’s levels of inequality were among the highest in the world.  Despite priority being given to decrease poverty and inequality since 1994, most studies confirmed that income poverty continued to increase between 1993 and 2000 and had decreased only marginally since 2000.

Over the past 20 years, much progress had been made in decreasing poverty and inequality and overall management of the macro-economy. Despite this success, various long-term investment challenges such as investment in more mid-level skills, the building of adequate infrastructure in the transport and energy sectors and the distribution of the fruits of growth, still remained.

Public Debt Challenges and the Need for Fiscal Reforms
South Africa’s economic growth has been insufficient to generate convergence towards income levels envisaged by the National Development Plan. While South Africa’s fiscal policy continued to be prudent, public debt had increased during and in the aftermath of the recent global economic and financial crisis. The risk of decreased or subdued growth in output, in the absence of expenditure reform, constituted a threat to fiscal stability.

Dr Magubu said interest rates have been low in recent years and South Africa had been able to borrow cheaply. The government’s interest payments have been trading at its lowest levels in the past 20 years, both in relation to GDP and South Africa’s total spending.  However, there was a danger that as interest rates increased to more normal levels, so would the cost of servicing growing debt, diverting rands away from public programmes.  Simulations had been run to assess the potential impact of the different public debt reduction scenarios on the South African economy. The impact of fiscal consolidation on investment and real GDP was found to be quite small, but showed that government would increase domestic borrowing, and this would hamper private investment, leading to a decrease in GDP in the long run. It was feasible to decrease public debt without slowing down GDP and therefore future growth.

Recommendations
Government should avoid setting targets for the size of the public debt.  Borrowing was a valid and appropriate option available to government to help finance ongoing infrastructure and developmental requirements.  Government should not simply cut costs, but reform programmes and service delivery. Simple cost cutting might have been effective in achieving deficit reduction targets, but did not encourage longer-run fiscal stability or allow for reforms that would generate more value for money spent.  Government should avoid across-the-board cuts or expenditure ceilings.  Spending should be aligned with government priorities to ensure adequate funding of high-priority initiatives and the elimination or reduction of programmes that were not priority.

Social Programmes and the Need for Fiscal Reforms
Government should move towards a fully integrated benefits system that simplified client access, improved client outcomes and fiscal sustainability through greater programme effectiveness, reduced fraud and corruption and reduced administration costs.  Government should implement a fully integrated benefits system that sought to centralise income testing and payment delivery; automate the processing of applications, eligibility and payments; automate income verification; consolidate programme delivery and standardise eligibility criteria. Government should collect the information necessary to deliver and evaluate a fully integrated benefit system.  In so doing, personal information and privacy would be respected and protected.

Part 2 – Improving Investments in Education and Health
Equitable Resourcing of Schools for Better Outcomes
Key findings included disparities in the allocation of resources to schools and variations in performances of schools, a general perception of inadequate funding to fulfil curriculum requirements and a dissociation between resources and outcomes, particularly in poor schools.

Recommendations
The National Department of Basic Education should align learner subsidy allocations with national policy requirements and priorities. The current baselines did not cater for the significant increase in funding to cover the curriculum requirements, i.e. Curriculum Assessment Policy Statement (CAPS), norms and standards for school infrastructure and municipal services to schools. The alignment should be carried out in conjunction with strengthening oversight of provincial education departments to ensure adherence to national policy priorities. The allocation framework to schools should take into account the full package of minimum education inputs when setting the minimum adequate benchmark funding per learner. This was in order to address the skewed distribution of resources between schools and districts. These inputs needed to be linked to both the process norms and output standards.

The allocation framework for education infrastructure conditional grants had set out clear expenditure targets for quintile 1 to 3 schools, and had also set out timelines for addressing priority infrastructure backlogs in each quintile. The general thrust of the School Infrastructure Backlogs Grant also made provision for transitional asset handover processes to school governing boards and Provincial Education Departments (PEDS) on newly built schools. This would address the alignment between funding for non-physical and physical inputs, as well as curb the decaying of newly-constructed infrastructure.

In order to avoid prolonged neglect of infrastructure upgrades and to ensure consistent budget allocation to maintain and monitor these upgrades, school funding norms and standards should indicate the responsibilities of schools and Parents’ Evaluation of Developmental Status groups to maintain and upgrade school infrastructure, so that the division of expenditure responsibilities was clear.

School expenditure and performance are monitored at national and provincial level and accompanied by inspectorate visits. The Department of Basic Education and National Treasury have been required to monitor provincial learner subsidy allocations and to intervene where national targets were not met or allocations not transferred to schools timeously. This should be done by means of a portal similar to the Education Management Information System, where individual no-fee schools were able to report payment delays and other problems.

The National Department of Education should integrate existing outcomes improvement programmes, such as the integrated national strategy to improve numeracy and literacy, and target poor performing districts so as to translate inputs into outcomes.  Schools should be placed under the programme for a set period during which necessary infrastructure upgrades were carried out, skilled teachers were attracted and existing teachers trained. This would ensure that the interventions were holistic and targeted at the schools which experienced multiple performance constraints. It would also reduce inter-provincial variation in performance.

Adequacy and Efficiency in Primary Health Care Financing
Despite an increased growth in health spending, the sector has been beleaguered by challenges such as suboptimal quality of care, inefficiencies in the system, a heavy burden of disease, input cost pressures, a growing uninsured population, inequitable distribution of resources and the widely held perception that health care was under-funded.  If left unchecked, these challenges would continue to undermine performance and delivery of the health care system and would negatively impact progress toward the implementation of national health insurance and its roll out.

Recommendations
Provincial governments would have to increase their allocation levels of primary health care funding to be in line with the minimum norms and standards for primary health care packages set by the National Departments of Health, in particular on clinic services such as integrated management of childhood diseases, reproductive health and HIV/Aids.

Inefficiencies (wasteful/irregular expenditure) in the health sector should be minimised so as to be in line with the international experience. Wasteful expenditure needed to be identified, categorised and addressed. These included clinical waste, operational waste and behavioural waste.

Impact of Fiscal Expenditure on Food Security
Coordination problems partly contributed to the underperformance of the agricultural conditional grants.

Recommendations
The Department of Agriculture, Fisheries and Forestry (DAFF) would have to strengthen its ability to enforce the conditions in the grant framework to ensure better oversight of provinces. This would ensure that the spending and performance of the conditional grants would be improved. The Commission suggested that norms and standards be developed to assess the performance of provinces and that five-year evaluations of conditional grants be institutionalised.

Special emphasis has been put on improving the operations of different food security programmes, especially agriculture, the Expanded Public Works Programme (EPWP) and the National School Nutrition Programme (NSNP), which would solve household food concerns without increasing programme expenditure. Areas that could yield improved results include better joint planning (such as creating a value chain between smallholders receiving grant support and the NSNP) and streamlining procurement processes with the help of the chief procurement office. The ability to use available resources optimally for the food security programmes had declined over time.

Government should clarify the legislative mandate and responsibility of municipalities in relation to food security. In this regard, DAFF should develop a policy on urban food security with concrete proposals on how such a mandate would be funded. Currently, food security was not seen as a competence of municipalities and therefore could not be funded.

The terms of reference for the Committee to review the agricultural conditional grants should be finalised without unnecessary delays. The review should be comprehensive in scope and should include assessing the value chain of conditional grants and the unlocking of operational constraints, especially in relation to planning, procurement, comprehensive smallholder support, cash flow and monitoring and evaluation. Stakeholders such as the Department of Rural Development and Land Reform should be invited to be part of the Committee, and ways of streamlining the funding overlap between the Ilima/Letsema grant and the recapitalisation and development programme should be examined.

Part 3 – Investment in Infrastructure
Mr Ghalieb Dawood, Programme Manager at the FFC, said the Commission’s hearings on the local government fiscal framework (LGFF) confirmed a vertical and horizontal capital funding gap. The current infrastructure grants were not sufficient to cover capital expenditure needs, given the current funding sources.

Recommendations
He recommended that the monitoring and evaluation of municipal capital planning and spending needed to be improved. National and provincial treasuries should improve this assessment during municipal benchmarking exercises by:

-  Ensuring that capital budgets were realistic and financed based on capacity to deliver and revenue assumptions;

-  Placing a greater emphasis on refurbishing and renewing existing infrastructure stock as determined by the municipality’s asset register; and

-  Ensuring that tariffs were appropriately designed so that the depreciation costs of existing infrastructure could be recovered from the tariff. The design of such tariffs should consider the customer’s affordability, and protection of the poor.

Municipalities should introduce alternative and innovative methods to fund and deliver infrastructure if capacity to plan and spend remained a concern. These municipalities should explore interaction and partnerships with other organs of state and greater use of private/public partnerships (PPPs), including fully or partly outsourcing municipal services.

The PPP unit within the National Treasury should improve its monitoring and evaluation of municipal PPPs. This should include maintaining the database of existing municipal PPPs, evaluating the success/failure of existing PPPs, quantifying the uptake of PPP agreements and assessing the current bottlenecks that discourage the use of PPPs.

Government should explore a new funding and infrastructure delivery model for poorly resourced and rural municipalities.

Improving Public Transport for Better Mobility
Household travel surveys had showed that large proportions of households have no access to any form of public transport, or were dissatisfied with the quality of the available public transport.  Public transport had been managed as isolated modes of transport, and had become more fragmented as new modes of transport had been added to the network.

Recommendations
All municipal integrated transport plans should clearly indicate how the municipalities intended to exercise control over the network, including the required resources. This should be one of the minimum requirements for preparing integrated transport plans and should be gazetted accordingly.

The Department of Transport should formulate and implement a transport subsidy framework which incorporated social welfare, service productivity and environmental management. These were the three aspects endorsed by the national transport policy.

Municipalities should formulate a minimum skill set that would be required to manage modern transport systems. This intervention would unlock service delivery constraints. It should be carried out jointly by the Department of Transport and the South African Local Government Association (SALGA).

A comprehensive review of municipal integrated transport plans should be carried out with a view to identifying gaps that needed to be addressed. This should be carried out jointly by the Department of Transport and SALGA.

Impact of Electricity Price Increases on Municipalities
Key findings indicated that increases in electricity prices negatively affected municipal expenditure and revenue.

Recommendations
Government should put in place a plan to manage the risks to municipalities associated with the increased prices of bulk electricity purchases. This plan should consider the implications of increased prices of bulk electricity purchases on municipal expenditure (to the extent that increases might crowd out expenditure on other items) and revenue (to the extent that revenue to fund maintenance, asset renewal or cross subsidies might be eroded).  Such a plan should be explicit in terms of the differential impact that increases in the price of bulk electricity purchases would have on different categories of municipalities. The crafting of this plan was important, given developments such as the pending implementation of the Carbon Tax and the implications this would have on the cost of bulk electricity purchases.

Better Human Settlements through Improved Planning and Funding

Recommendations

Municipalities, especially metros, should invest in forward-looking processes and systems that would enable such municipalities to understand and disaggregate housing demand.  Metros should be focused on planning for rental flats and the creation of new neighbourhoods in intermediate suburbs which have lower densities than in the inner city.

Government’s housing subsidy should prioritise the most vulnerable groups, such as poor female-headed households with children below the age of 20 years and households that contained adults who were permanently out of the labour market.

Municipalities should prioritise land ownership registration processes in informal settlements located in developable areas. Government should prioritise the provision of infrastructure in areas with the potential for self-build housing.

Part 4 – Demarcations and Beyond
Mr Khumalo said that as municipal boundaries changed, certain questions came to the fore. These included: What impact has these demarcations had on municipal financial performance?  What had been the impact of demarcations on tax bases, revenues, expenditures, asset bases, liabilities and other fiscal variables of municipalities? Had these demarcations promoted fiscally sustainable municipalities?

Recommendations
The financial and fiscal implications of boundary re-determinations should be prioritised and established before any demarcation decision had been announced. A funding stream for the demarcation process should be identified before the process had taken effect.

In order to avoid the negative effects of demarcations on municipalities and their populations, economic considerations should be at the core of any demarcation decision, both in theory and in practice. The current criteria made it clear that economic considerations should be part of the criteria, but this did not appear to be the case in practice.

The government bore the transitional costs for the restructuring of every vertically decided demarcation process. A transitional demarcation grant should be awarded to the amalgamated municipality. This grant should be temporary and should be awarded over at least three years. The grant would facilitate the restructuring process. This included planning and preparing an amalgamated municipality’s delivery model, rationalising and harmonising policy regimes, rationalising tariffs, rationalising employment policies and other human resources systems, building capacity to deal with change management and facilitating communication regarding demarcations.

Discussion
Mr M Figg (DA) questioned why the Commission requested that government should avoid setting targets for the public debt. It was that sort of approach which had resulted in the country facing a public debt/GDP ratio of 40% at present.

Mr Khumalo replied that what he meant was that the government should not cut the costs of certain programmes which actually helped to generate growth. He was concerned that debt levels were growing too fast, but said the focus should be on what was growing debt, and to arrest that growth. Were we borrowing to address the infrastructure problem in South Africa, or were we borrowing to pay salaries?  If it was the latter, then we had a big problem.   

The Chairperson asked the Commission if South Africa’s debt level was out of control.

Mr Khumalo replied that it was not out of control, but that that it was a concern.  South Africa’s public debt/GDP ratio of 40% was still below the international norm of 60%. The USA’s public debt/GDP ratio were hovering at around 80%.

The Chairperson asked if the counter-cyclical instrument was a good one to use.

Mr Mabugu replied that there was nothing wrong with using the countercyclical tool, as long as it was understood that there were consequences. The tool was easy to rely on in a crisis, but not so when the economy was doing well. Why? Because in a crisis you simply grew your expenditure, but in good times you had to decide whether your crisis would be transitory or long term, and whether to enforce a counter-cyclical or full-scale stance.

The Chairperson asked if the country’s fiscal framework was designed to propel growth. How were we going to fund growth?

Mr Khumalo replied that the country needed to “shift its thinking” on where the money should come from to increase growth.

Mr A Mclaughlin (DA) said the country needed to have a plan to get out of debt. You cannot borrow yourself out of debt.

Mr Khumalo replied that he too was concerned that debt levels were growing too fast. But the focus should be on what was growing debt and to arrest that growth. Were we borrowing to address the infrastructure problem in South Africa or were we borrowing to pay salaries? If the latter, then we have a big problem.

Mr Mclaughlin said that negotiating with Eskom was almost impossible and asked for support in that regard.

Mr Khumalo replied that Eskom was a genuine concern and that parliament should play a role in ensuring that the parastatal cooperate more.

Mr McLoughlin said PPPs were overregulated and that was why they failed. He said they needed to be simplified.

Mr Dawood replied that there was not enough data available to say whether PPPs were succeeding or failing. He said they needed to assess and identify why the uptake of PPPs was so poor.

Mr McLoughlin said the transportation of goods via the railway system was under-utilised. Was that option being considered?

Mr Dawood said municipalities should play a stronger role to foster the change from road to rail, as “they were better positioned” to do so.

Mr N Gcwabaza (ANC) wanted to know if there was a better system than the quintile system that could be implemented. He felt it was not an accurate system.

Mr Khumalo agreed that the quintile system had its challenges, and that the Commission had raised its concerns with the Department of Education.

Ms C Madlopha (ANC) asked the Commission why it wanted to avoid setting targets for public debt.

Mr Khumalo replied that what he meant with “avoiding setting targets for public debt” was that the government should not cut the costs of certain programmes which actually helped to generate growth.

Ms Madlopha asked what the acceptable norm was for borrowing.

Mr Khumalo replied that South Africa’s public debt/GDP ratio of 40% were still below the international norm of 60%. The USA’s public debt/GDP ratio was hovering at around 80%.

Ms Madlopha asked if the Commission had reduced the use, and costs, of consultants. Were consultants really adding value -- were they transferring skills to employees so that they could function without them?

Mr Khumalo replied that it was the duty of every accounting officer to formulate a plan to reduce the reliance on consultants in government departments. They were mandated to do so.

Ms M Manana (ANC) referred to page 11 and the Commission’s recommendation to curb wasteful expenditure. How could this Committee help to nip wasteful expenditure in the bud?

Mr Mabugu replied that the Committee could help curb wasteful expenditure by giving the Commission an update on the “worst areas” when it embarked on its oversight visits.

The meeting was adjourned.
 

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