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

Meeting report

Introduction by Chairperson
The Chairperson welcomed members and said the agenda of the meeting was the presentation by the Financial and Fiscal Commission (FFC) on its proposal, recommendations and fiscal state of the country.  He congratulated the FFC for convening the Investors Conference in Cape Town, which had been broad and all-encompassing.  Everyone who attended was happy with the quality of the conference proceedings.

FFC Briefing: Submission for the 2015/16 Division of Revenue
Mr Bongani Xhaki, FFC Chairperson, said economic growth in South Africa (SA) began to slow down in 2008, but the full effects of the international crisis on the domestic economy were felt only in 2009, when the growth rate was negative (-1.5%).  In 2010 and 2011, the SA economy recovered slightly, growing at just above 3%, but export demand from developed countries remained slow.  Since then, as poor growth continues in developed economies and somewhat slower growth in large developing economies, SA’s economy has struggled to achieve growth rates much above 2%.  As it stands, SA is trapped in a cycle of modest growth, high inequality and record unemployment. This countercyclical stance has led to an increase in budget deficits, resulting in an increase in the public debt/GDP ratio, from 23% in 2008 to over 40% in 2013.
Over past 20 years, progress had been made in reducing poverty and inequality and overall management of the macro-economy.  Priority had been given to poverty reduction and inequality since 1994, but most studies confirm that income poverty continued to grow from 1993 to 2000, and has decreased only marginally since then.  Various long-term investment challenges remain in developing mid-level skills, building adequate infrastructure -- particularly in transport and energy -- and distributing the fruits of growth more widely.
SA’s economic growth has been insufficient to generate convergence towards income levels envisaged by the National Development Plan.  While SA’s fiscal policy continues to be prudent, public debt has increased during and in the aftermath of the recent global economic and financial crisis. The risk of subdued growth in output, in the absence of expenditure reform, constitutes a threat to fiscal stability. If debt explodes over time, policy makers have to respond to changing conditions in their tax base (economic growth) and in the cost of finance (interest rates).  Policy rules can help to ensure that at any given moment, specific fiscal policy stances taken by government are adjusted to changes in the environment, so that debt will not explode.
The global economic and financial crisis resulted in large deficits and public debt/GDP ratio increases from 23% in 2008 to over 40% in 2013.  Interest rates have been low in recent years and SA has been able to borrow cheaply. The government’s interest payments have been trading at around their lowest levels in the past 20 years, both in relation to the GDP and to SA’s total spending. The danger is that as interest rates increase to more normal levels, so will the cost of servicing growing debt, diverting rands away from public programmes.
The impact of fiscal consolidation on investment and real GDP was found to be quite small, but showed that government would increase its domestic borrowing, which would hamper private investment, leading to a reduction in GDP in the long run. The economic growth scenario was quite interesting, as debt would decrease in the long run and real GDP would decrease slightly. This suggested that it is feasible to decrease public debt without slowing down GDP -- and therefore future growth. The FFC therefore recommended the following
The government should avoid setting targets for the size of public debt. Borrowing is a valid and appropriate option available to government to help finance ongoing infrastructure and developmental requirements consistent with realising the aspirations of the National Development Plan. This presumes that debt management continues to have the objective of raising the required funding at the lowest possible cost within a given risk tolerance.
Government should not simply cut costs. The need to restrain spending should be an opportunity to reform programmes and service delivery. Simple cost-cutting may be effective in achieving deficit reduction targets, but does not encourage longer-run fiscal stability or allow for reforms that will generate more value for money spent.
Government should avoid across-the-board cuts or expenditure ceilings. Such tools treat valuable, efficiently-run programmes and outdated and poorly managed programmes in the same way. Spending should be aligned with government priorities to ensure adequate funding of high-priority initiatives and the elimination or substantial reduction of lower-priority programmes.
Social Programmes and the Need for Fiscal Reforms
The social security system plays a central role in alleviating and reducing poverty, vulnerability, social exclusion and inequality. The social protection system, as defined within the fiscal framework, has two separate but interrelated entities -- one that deals with social assistance, and the other with social insurance. Results show direct differences between beneficiaries and non-beneficiaries of the programme in terms of their observed outcomes. The main hypothesis that the findings confirm is that social grants have significant and important indirect effects through labour market participation and households’ total consumption patterns, consumption budget shares and saving-investment behaviour. The FFC had the following recommendations
Government should move aggressively towards a fully integrated benefits system that simplifies client access, improves client outcomes and improves fiscal sustainability through greater programme effectiveness, reduced fraud and corruption and reduced administrative costs.
Government should implement a fully integrated benefits system that seeks efficiencies by, at a minimum, centralising income testing and payment delivery, automating the processing of applications, eligibility and payments, automating income verification, consolidating programme delivery and standardising eligibility criteria.
Government should collect the information necessary to deliver and evaluate a fully integrated benefits system.  In so doing, personal information and privacy should continue to be respected and protected.
Improving Investments in Education and Health
The FFC noted variations and disparities in the allocation of resources to, and performance of, schools.  This general perception of inadequate funding had an effect on fulfilling curriculum requirements and a dissociation between resources and outcomes, particularly in poor schools. The FFC recommended the following:
                                                                                   
Provincial Education Departments (PEDs) must reprioritise their budgets for public ordinary schools away from personnel, ensure the correct mix of teaching and non-teaching staff, make adequate provision for learners’ subsidies within the public ordinary school programme, and redirect resources toward districts that experience multiple performance obstacles.
The allocation framework to schools should take into account the full package of minimum education inputs when deriving the minimum adequate benchmark funding per learner in order to address the skewed distribution of resources between schools and districts. These inputs must be linked to both the process norms and output standards.
The allocation framework for education infrastructure conditional grants sets out clear expenditure targets for quintile 1 to 3 schools and timelines for addressing priority infrastructure backlogs in each quintile, and the general thrust of the School Infrastructure Backlogs Grant makes provision for a transitional asset handover process to School Governing Boards and Provincial Education Departments (PEDS) on newly built schools. This would address the alignment between funding for non-physical inputs and physical inputs, as well as curb the decay of newly constructed infrastructure.
            School funding norms and standards must explicitly indicate the responsibilities of schools and PEDs for maintaining and upgrading school infrastructure, so that the division of expenditure responsibilities is clear, in order to avoid prolonged neglect of infrastructure upgrades and to ensure consistent budget allocation to maintenance, and the monitoring thereof.

            Provincial education departments must, with the assistance of the national department,                standardise the monitoring of school level expenditure and performance and where necessary, provide shared services for the preparation and auditing of financial services.

            The national Department of Education must integrate existing outcomes improvement programmes, such as the integrated national strategy to improve numeracy and literacy, and target them to poor performing districts, to improve translation of inputs into outcomes. Schools should be placed under the programme for a set period, during which necessary infrastructure upgrades are carried out, skilled teachers are attracted and existing teachers trained, learner-specific interventions are carried out and, more importantly, School Governing Bodies (SGBs) are trained. This would ensure interventions were holistic and targeted at the schools that experience multiple performance constraints and, more importantly, reduce inter-provincial variation in performance.
 
Adequacy and Efficiency in Primary Health Care Financing
Despite an increased growth in health spending in SA, the health sector was beleaguered by challenges such as sub-optimal quality of care, inefficiencies in the system, a heavy burden of disease, input cost pressures, a growing number of an uninsured population, inequitable distribution of resources and the widely held perception that health care is under-funded.  If left unchecked, these challenges will continue to undermine performance and delivery of the health care system and negatively impact on progress towards the implementation of the National Health Insurance (NHI) programme and its roll out. The FFC recommended the following
Provincial Governments must increase their allocation levels of PHC (Primary Health Care) funding, to be in line with the minimum norms and standards for the PHC package set by the National Department of Health, in particular on clinic services such as the 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 international experience. Wasteful expenditure needs to be identified, categorised and addressed:
Clinical waste, through measures such as clinical performance measures that promote efficient use of resources (cost effectiveness, research and information dissemination);
 Operational waste, through measures such as the standardisation of system processes and procedures;
Behavioural waste, through measures such as preventative services advocacy, so as to avoid unnecessary complications or illnesses.
Impact of Fiscal Expenditure on Food Security
The economic crisis in 2007 had led to a possible reduction in household purchasing power due to the sudden increase in the prices of electricity and fuel, and food inflation rising faster than overall inflation. Coordination problems exist, partly contributing towards the under-performance of the agriculture conditional grants. The FFC had the following recommendations.
DAFF (Department of Agriculture Forestry and Fisheries) should strengthen its ability to enforce the conditions in the grant framework, to ensure better oversight of provinces, so that spending and performance of the agricultural conditional grants can be improved. The Commission suggested that norms and standards should be developed to assess the performance of provinces, and that five-year evaluations of conditional grants be institutionalised.
Special focus needs to be put on improving the operations of different food security programmes, especially agriculture, the Expanded Public Works Programme (EPWP) and the School Nutrition Programme (NSNP), which accelerates a reduction in household food security without necessarily increasing programme expenditure.  Areas that can 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 assistance of the Chief Procurement Office. The ability to use available resources optimally for the food security programmes had declined over time.
Government must 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 will be funded. Currently, food security is not seen as a competence of municipalities and therefore cannot 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 unlocking 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 (DRDLR) should be invited to be part of the committee, and ways to streamline the funding overlap between the Illima /Letsema grant and the recapitalisation and development programme should be examined.
Improving the Financing of Municipal Capital Investments
The Commission’s hearings on the Local Government Fiscal Framework (LGFF) had confirmed a vertical (and likely horizontal) capital funding gap. The current infrastructure grants were not sufficient to cover capital expenditure needs, given current funding sources. The monitoring and evaluation of municipal capital planning and spending needs 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; by placing a greater emphasis on refurbishing and renewing existing infrastructure stock, as determined by the municipality’s asset register; and by Ensuring that tariffs were appropriately designed so that the depreciation costs of existing infrastructure and the funding of new infrastructure were recovered from the tariff. The design of such tariffs should explicitly consider the customer affordability and protection of the poor

Municipalities should find alternative and innovative methods to fund and deliver infrastructure if the capacity to plan and spend remains a concern. These municipalities should explore:

-  Increasing their interaction and partnerships with other organs of state (Eskom and Water Boards);
-  Greater use of private-public partnerships (PPPs) including fully or partially outsourcing municipal services;
-  The PPP Unit within the National Treasury must improve its monitoring and evaluation of municipal PPPs. This should include:
-  Maintaining a database of existing municipal PPPs;
-  Evaluating the success/failures of existing PPPs;
-  Quantifying the uptake of PPP agreements and assessing the current bottlenecks that discourage the use of PPPs.

The government should explore a new funding and infrastructure delivery model for poorly resourced and rural municipalities. There was potential for a greater role for state-owned companies and other state agents to deliver infrastructure on behalf of these municipalities.

Improving Public Transport for Better Mobility
Household travel surveys consistently showed that a large proportion of households had no access to any form of public transport or were dissatisfied with the quality of the available public transport. Public transport was managed as isolated modes of transport, and was becoming more fragmented as new modes of transport were added to the network. Experience elsewhere showed that addressing such backlogs required focused interventions and appropriate consolidation of functions.
All municipal integrated transport plans must clearly indicate how the municipalities intend to exercise control over networks, 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 (the custodians of national transport policy) must formulate and implement a transport subsidy framework, which explicitly incorporates social welfare, service productivity and environmental management -- the three aspects endorsed by national transport policy.
Given the ever increasing complexity of modern transport networks, municipalities should be guided on the minimum skill set required to be able to manage modern transport systems. This was one of the critical interventions to unlock service delivery constraints. This should be carried out jointly by the Department of Transport and the South African Local Government Association.
A comprehensive review of municipal integrated transport plans should be carried out, with a view to identifying gaps that need to be addressed. This should be carried out jointly by the Department of Transport and the South African Local Government Association
Impact of Electricity Prices Increases on Municipalities
Studies on the impact of electricity price increases tend to focus on poor households or the economy as a whole, but not on municipalities – despite the pivotal role that municipalities play in facilitating social and economic development.  Key findings indicate that an increase in electricity prices negatively affects municipal expenditure and revenue. Therefore, government needs to put in place a plan to manage the risks to municipalities associated with increases in the price of bulk electricity purchases. Such a plan should consider the implications of increases in the price of bulk electricity purchases on municipal expenditure (to the extent that increases may crowd out expenditure on other items) and revenue (to the extent that revenue to fund maintenance, asset renewal or cross-subsidisation may be eroded). Such a plan should be explicit in terms of the differential impact that increases in the price of bulk electricity purchases will have on different categories of municipalities. The crafting of this plan is particularly important given developments aimed at prioritising environmental sustainability, such as for example, the pending implementation of the Carbon Tax and the implications that this will have on the cost of bulk electricity purchases.
 
Better Human Settlements through Improved Planning and Funding
The FFC had identified key constraints and levers for self-build housing, and considered what well-located land in spatial terms entailed in relation to empirical demands of population movement and settlement in the subsidy income band.  It recommended that municipalities, especially metros, should invest in forward-looking processes and systems that will enable such municipalities to accurately understand and disaggregate housing demand.  Metros focus on planning for rental flats and creating new (or transform existing) neighbourhoods in intermediate suburbs, which have lower densities than in the inner city. The government’s housing subsidy prioritises the most vulnerable groups, which include poor female-headed households with children below the age of 20 years, and households containing adults who are permanently out of the labour market.  Municipalities should prioritise land ownership registration processes, where informal settlements were located in the developable areas. Government should prioritise the provision of infrastructure in areas with the potential for self-build housing.

Impact of Demarcating Municipal Boundaries on Their Financial Viability
The Municipal Demarcation Board (MDB) is mandated to determine municipal boundaries and to delimit wards. The process of demarcation has seen 1 262 local government structures reduced to 843, then 284, 283 and now 278.  Proposals with the MDB indicate that municipalities will decrease further by 2016.

As municipal boundaries were being changed, the questions that arise include:   What is the impact of these demarcations on municipal financial performance? What is the impact of the demarcations on tax bases, revenues, expenditures, asset bases, liabilities and other fiscal variables of municipalities? Have these demarcations promoted fiscally sustainable municipalities?

Therefore the financial and fiscal implications of boundary re-determinations need to be prioritised and established before any demarcation decision is pronounced. A funding stream for the demarcation process should be identified before the process takes effect.  In order to avoid 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 were clear -- that economic considerations should be part of the criteria -- but this did not appear to be the case in practice.

For every vertically decided demarcation process, government must bear the transitional costs of the restructuring. A transitional demarcation grant should be awarded to the amalgamated municipality. This grant should be temporary and be awarded over at least three years (at least a year before, the year of, and the year after, demarcation takes place). The purpose of the grant will be to facilitate the restructuring process. This would include planning and preparing an amalgamated municipality’s delivery model, e.g. combining the delivery models of individual municipalities, rationalisation and harmonisation policy regimes, integrated development plans and bylaws of different municipalities, rationalisation of tariffs, rationalisation of employment policies and other human resources systems (grading of workers and job evaluation processes), rationalisation and harmonising evaluation rolls and asset registers, building capacity to deal with change management, and facilitating communication about demarcation.

Discussion
The Chairperson said the Deputy Minister of Finance had made the remarks at a conference that the FFC recommendations needed to be taken seriously, as they enhanced government debates on what needed to be done in various sectors. The government needed strong institutions on governance that contributed to the development of the country.
Mr C de Beer (ANC, Northern Cape) said the decision on the amalgamation of municipalities was crucial if one takes into consideration the financial impact that follows demarcation. Grants for agriculture were first rolled out in 2004, but when one moved into the communities, one does not see any progress in agricultural activities, which was a concern to him.  Given that it is now 2014, extreme mechanisms to monitor need to be enforced, as it was not a shortage of money that was the problem, but implementation. The document also needed recommendations from other portfolio and select committee Members, not just Appropriations.
Mr V Mtileni (EFF, Limpopo) wanted clarity on local government demarcation, as the FFC was proposing radical changes to transfer the economy to benefit the disadvantaged. He asked if the change would create jobs.  While he agreed with conditional grants to avoid fiscal dumping, the proposed changes were too sensitive for municipalities.
Mr T Motlashuping (ANC, North West) said the presentation carried a lot of weight, and was well done. He asked if the FFC was involved with other Committees.  SA was borrowing too much.  He wanted clarity on why the country was borrowing while at the same time giving aid to other countries, or whether there was logic in doing so. In terms of demarcation, there were some municipalities who did not deserve municipal status, but because of an individual who had power, it remained a municipality. He asked if the FFC had meetings with the Demarcation Board and informed them about what might be right or wrong, because some people seemed adamant as far as the demarcation of municipalities was concerned.
The Chairperson said the presentation was very useful on the public policy side. It included infrastructure, the economy and fiscal allocation. The Committee needed to deal with wasteful expenditure seriously, as this had an impact on how fiscal resources were directed.  He wanted clarity on the principle of the co-subsidisation of electricity, and whether it meant differential pricing.
The FFC replied that how oversight was exercised needed to be done differently, because issues such as health and education expenditure were understood only if one was proactive on the ground. When the Commission tabled its report to Parliament, different Committees were able to follow up and ask on issues of particular interest to them.  The FFC had a direct relationship with the Finance Committees and Appropriations Committees in both Houses. It responded to the budget and the fiscal framework and divisions of revenue to the Finance Committees.  The relationship on other Committees was dependent on invitations to the FFC to share its inputs with them. An office for institutional support had been established in the Deputy Speaker’s Office to arrange meetings with Parliamentary Committees.
On borrowing and lending to other countries, the FFC said that it was catered for in the budget. The FFC borrowing was in reference to the division of revenue internally, since it was a division from a pool that is collected by the fiscus.  If the debt was growing, the focus should be on where the money was actually going. It should be spent on productive investments, and this was the question that must be put to the executive -- how much borrowing over a certain financial year was spent on productive investments?  SA had not yet reached a point where it could cut public expenditure, but public expenditure had been growing at a high rate.  The FFC was looking at slowing down public expenditure.
The FFC had relations with the Demarcation Board that had started in 2012. It had useful engagements with the Municipal Demarcation Board (MDB) over the past two years, looking at the economic issues involved in the demarcation of municipal boundaries. There was a difference between the economic viability and fiscal viability of a municipality, with the former meaning the economy must grow over a period of time. The municipality had to provide services to people, regardless of the economic outlook.
Ms Sasha Peters, Manager: Budget Analysis Unit, FFC, said each municipality determined tariffs on approval from the electricity regulator. The Municipal Systems Act provides guidelines on how tariffs should be structured. The revenue tariffs that come from the sale of electricity must be reinvested in the repair, maintenance and operations.  Municipalities may also charge a surcharge on top of the tariffs, which makes them higher. The revenue generated from the surcharge is then used for cross-subsidising the delivery of other services to households.  It was not clear where the revenue tariff begins, and where the surcharge tariff begins, with electricity prices.
There were potential drawbacks for utilising public private partnerships (PPPs).  Internationally, there were benefits that tailored the use of PPPs, depending on the economic context. The government takes the recommendations from the FFC and submits them to the relevant government departments and budget councils for consideration and inputs.
Dr Ramos Mabugu, Research and Recommendations Head: FFC, said that there were problems with the agricultural conditional grant, mainly on procurement emanating from a service provider failing to complete a project. The Department of Agriculture Forestry and Fisheries was not monitoring agricultural conditional grants the way it was supposed to be doing.  It was not following up on reports submitted to ensure that whatever was reported was actually taking place.
The Chairperson said economic considerations were an important factor in demarcation, but were often not taken into consideration when demarcations were made. He asked why it was lost in the process.
Mr Xhali replied that the rationale behind amalgamating municipalities with others was that it was thought that some municipalities could be made viable of there were joined with other municipalities. The cost that arose from transferring staff from municipalities was often overlooked. There was a need to understand the economic difference that came from a merger of municipalities. There were costly requirements for the operation of PPPs, starting with impact assessments.
The Chairperson said there was a need to engage continuously with the FFC, especially when the Committee made provincial visits to assess the use of conditional grants. The presentation had been useful, and comments on who could invite the FFC to Parliament had been noted. There was a need to create an open way of talking, whether round a table or through dialogue. The Committee would not hesitate to invite the FFC, should the need arise.  The hallmark of a successful country was long-term planning and the implementation of policies to ensure the desired results.
The Committee Secretary said the Committees on Appropriation and Finance would convene a session on 2 and 3 September 2014. This would be followed by a Medium Term Budget Policy Statements (MTBS) workshop where the National Treasury will be invited to explain the kind of documents the Committees must have when the Finance Ministry presents the Medium Term Expenditure Framework (MTEF), and how they must navigate the documents.  The FFC, as advisor, would explain which issues Members needed to look at.
The meeting was adjourned.