2017 MTBPS: Financial and Fiscal Commission submission

Standing Committee on Appropriations

07 November 2017
Chairperson: Ms Y Phosa (ANC) and Mr C De Beer (ANC; Northern Cape)
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Meeting Summary

The Financial and Fiscal Commission briefed the Committee on the 2017 Medium Term Budget Policy Statement. The main problem, currently, was that the 2017 Medium Term Budget Policy Statement was formulated against a backdrop of an economy mired in low growth, which acted as a dead weight on the country’s ability to raise tax revenues. The low growth also meant that South Africa was missing out on the benefits of the global economic upswing, as the economy had become de-coupled from the world economy and this was a matter of concern. While the Medium-Term Budget Policy Statement recognised that the low confidence in the economy was almost a ‘structural constraint’, it did not reflect any detailed plan of action to address the negative situation and confidence-building aspects. The Commission noted that Fiscal and Monetary Policy, as instruments for promoting growth, had reached its limits and that medium-term growth forecasts were consistently being revised downwards. This meant government had to look elsewhere for growth, notably to look for growth at the subnational sphere as most of what was driving growth was lying in the provinces and municipalities.

The downgrades by rating agencies during March 2017 had resulted in fiscal slippage with a shortfall of approximately R50 billion required to consolidate the budget. This R50 billion cut to the budget could destabilise the system. While the initial aim of the fiscal consolidation was to stabilise the gross government debt to Gross Domestic Product ratio at 53% in 2018/19, it was now projected to reach over 60% by 2022, with debt service costs reaching 15% of the main budget revenue by 2020/21 and public debt was now starting to run away. Should further downgrades crystallise, it could result in significant international capital outflows, putting pressure on the exchange rate and inflation, and consequently on household budgets and consumption.

The Commission spoke to the major risks of a rising budget deficit and public debt. On the revenue side, the reliance on higher personal tax rates to fund the budget had largely been exhausted and given that increasing the VAT rate was likely to be severely contested by trade unions and pro- poor groups, government had a huge challenge to raise sufficient revenue to cover the revenue shortfall. The only other option was re-igniting growth. The second risk factor was public sector remuneration, which was seen to be inefficient and incompetent and overly-remunerated in relation to its productivity. The third risk factor was funding free higher education and training. The estimates of a potential cost of free tertiary education of between R30 billion and R60 billion would exacerbate the potential increase in public debt. The fourth risk factor was the expenditure on affordable infrastructure projects. Nuclear power deals to build eight nuclear power stations at a cost of over R1 trillion per deal was clearly fiscally unaffordable. The fifth risk factor was the drain on the fiscus stemming from the bailouts and guarantees given to State Owned Enterprises which were shifting resources away from programmes of higher priority. The sixth risk factor was corruption and fraud, where government was being compelled to purchase goods and services at a premium to market-related prices. These six risks would have a huge impact on the policy, delivery, and financing fronts.

The Commission also gave an overview of the 2018 Fiscal Framework, the Medium-Term Expenditure Framework Division of Revenue amongst the Three Spheres of Government, the Financial and Fiscal Commission’s Outlook on Revenue Performance, Revenue Tax Buoyancy, Nominal Growth Domestic Product and Tax Revenue Growth. On Revenues and Tax Proposals, the 2017 Medium Term Budget Policy Statement did not announce any measures to raise more revenues to plug the revenue gap, which could lead the credit rating agencies believing there was a lack of coherence and urgency on how the situation would be resolved. The key challenges to raising more revenues related to low growth and to a lack of trust in the effectiveness of government spending and hence, restoring confidence in public institutions and ensuring greater effectiveness of public policies would be key to creating the capacity to raise more taxes. Efforts to raise more tax revenue should now concentrate on expanding the tax bases through the reduction of deductions, credits and allowances and improving tax revenue efficiencies. There was scope to broaden the Value Added Tax base and improve its compliance.

The Commission spoke to Unallocated Resources, Expenditure by Economic Classification, the Medium Term Strategic Framework Goals and Progress to Date, Accelerating Growth, Infrastructure Investments, Social Spending Priorities, Local Government Issues, and the Revised Division of Revenue 2017/18.

The Financial and Fiscal’s recommendations were that:

  • Government should continue with a gradual programme of fiscal consolidation, which would entail reducing the budget deficit moderately but consistently over the medium term.
  • Government should continue to strengthen the Public Employment Programmes in anticipation of the impact of an economic downswing on low-skilled workers.
  • More effective government spending must be prioritised.
  • Efforts to raise more tax revenue should focus on expanding the tax base through the reduction of deductions, credits and allowances and through improving tax revenue efficiencies by lowering compliance costs for small businesses.
  • Unallocated contingency reserves should be safe-guarded and further drawdowns on contingency reserve should be avoided.
  • Spending on non-core goods and services should be further reduced
  • The Department of Human Settlements should ensure finalisation of the revised framework for the housing function – integrated planning, infrastructure, accreditation and financing.
  • A set of uniform rules and procedures should inform the granting of guarantees and bailouts to ensure greater accountability and therefore more prudent use of public funds.

Members said that unpaid bills of R26,4 billion from the previous year by provinces, for example, were a concern, because they were a hidden debt and a risk that needed to be mentioned on a quarterly basis and provincial departments had to be held accountable. Another concern was the capacity of SARS to collect taxes. Members asked if the Commission could suggest proposals on its comment that the Medium-Term Budget Policy Statement had “no detailed plans of action”. What needed to be done to increase confidence between government, business and consumers? What was the Commission’s view on increasing corporate taxes and what would be the negative effects if such increases were implemented? What were the Commission’s views on capital outflows? Did the Financial Intelligence Centre have enough skilled people? Was government not aggressive enough on corporate taxation?  Members said there was a view that the mining, manufacturing and agricultural sectors were based on obsolete production methods and there was a need to invest in innovation and research and development. What was the Commission’s comment and how should these sectors be modernised? Members wanted to know what was meant by the term “reduction of deductions”. Members said State Owned Enterprises were a noble idea, but were surviving on debt which was being shifted to government. What was the Commission’s opinion on State Owned Enterprises which appeared not to know where they were going? Was the private sector playing its role to decrease unemployment? Members said that the poor bore the brunt of paying e-tolls because they lived further from their workplaces and so were paying more tolls. Members said the contingency reserve was not serving its purpose if it was being used to bail out State Owned Enterprises. What concrete proposals could the Commission give to bring the economy up to its fast track growth trajectory? Could the Commission give specifics on programmes that needed termination or consolidation? What proposals could the FFC give to strengthen intergovernmental relations and co-ordination so as to strengthen infrastructure development and planning? Members said that in Malaysia departmental monitoring was on a weekly basis and this was a strategy that needed to be looked at. Members said that gross debt was expected to rise to 53% by 2018/19 and this should not be allowed to happen.

Meeting report

Briefing by Financial and Fiscal Commission (FFC)
Mr Dan Plaatjies, Chairperson, FFC, stated that currently the main problem was that the 2017 Medium Term Budget Policy Statement (MTBPS) was formulated against a backdrop of an economy mired in low growth. Economic growth projections had been revised downwards for the next three years and the low and fragile growth acted as a dead weight on the country’s ability to raise tax revenues. It also meant that South Africa was missing out on the benefits of the global upswing as economy had become decoupled from the world economy and this was a matter of concern. The MTBPS recognised that low confidence in the economy was almost a ‘structural constraint’ but the MTBPS did not reflected any detailed plan of action to address the negative situation and confidence-building aspects. Fiscal risk relating to threats against the stability of the fiscal system had implications for provinces and municipalities. He spoke to the economic performance and noted that Fiscal and Monetary Policy as instruments for promoting growth had reached their limits and that medium-term growth forecasts were consistently revised downwards which meant government had to look elsewhere and there would have to be a transition to look for growth at the subnational sphere as most of what was driving the growth was lying in the provinces and municipalities.

Dr Ramos Mabugu, Research Director, FFC, spoke to public finance developments and said these were influenced by the downgrades by rating agencies, Standard and Poor’s (S&P) and Fitch, during March 2017, which meant that South Africa has ceased to be an investment-grade rated country for the first time in 18 years and triggered negative market reactions. As a result, fiscal slippage has ensued and the main budget deficit, would now be 4.7% of GDP in 2017/18, compared with a 2017 Budget projection of 3.5%. In other words, a shortfall of approximately 1.2% of GDP (R50.8 billion) was required to consolidate the budget. This R50 billion cut to the budget could destabilise the system. While the initial aim of the fiscal consolidation was to stabilise the gross government debt to GDP ratio at 53% in 2018/19, it was now projected to reach over 60% of GDP by 2022, with debt service costs reaching 15% of the main budget revenue by 2020/21. Public debt was now starting to run away.

Government expenditure at 33% of GDP was skewed towards current spending, a wage bill at 35%, and the debt service costs of 15% of the budget did not give room to create growth. He then to State Owned Enterprises and said should further downgrades crystallise, it could result in significant international capital outflows, putting pressure on the exchange rate and inflation, and consequently on household budgets and consumption.

Mr Plaatjies spoke to the major risks of a rising budget deficit and public debt. On the revenue side, the reliance on higher personal tax rates to fund the budget had largely been exhausted and given that increasing the VAT rate was likely to be severely contested by trade unions and pro- poor groups, government had a huge challenge to raise sufficient revenue to cover the revenue shortfall. The only other option was re-igniting growth. The second risk factor was public sector remuneration, which was seen to be inefficient and incompetent and overly-remunerated in relation to its productivity. The third risk factor was funding free higher education and training. The estimates of a potential cost of free tertiary education of between R30 billion and R60 billion would exacerbate the potential increase in public debt. The fourth risk factor was the expenditure on affordable infrastructure projects. Nuclear power deals to build eight nuclear power stations at a cost of over R1 trillion per deal was clearly fiscally unaffordable. The fifth risk factor was the drain on the fiscus stemming from the bailouts and guarantees given to SOEs which were shifting resources away from programmes of higher priority. The sixth risk factor was corruption and fraud where government was being compelled to purchase goods and services at a premium to market-related prices. These six risks would have a huge impact on the policy, delivery, and financing fronts.

Ms Sasha Peters, Senior Researcher, FFC, gave an overview of the 2018 Fiscal Framework. The real growth in expenditure, at 2.6%, was projected to far outstrip growth in revenue, which was expected to decline by 0.6%, with revenue projected to fall short by R50.8 billion, and this would have a knock-on effect on borrowings. Over the 2018 MTEF period, growth in revenue was projected to recover through new tax measures to estimated real annual average of 2.3%.  Speaking to the MTEF Division of Revenue amongst the Three Spheres of Government, she said this Division of Revenue would be characterised by low growth increases over the 2018 MTEF. The main drivers of growth were allocations to municipalities, particularly the equitable share allocation and the potential for a spike in indirect grants to provinces.

Ms Peters spoke to the FFC’s Outlook on Revenue Performance, Revenue Tax Buoyancy, Nominal GDP and Tax Revenue Growth, and said to sustain tax revenue the growth rate needed to be improved because there was a strong correlation between tax revenue and GDP. On Revenues and Tax Proposals, the 2017 MTBPS did not announce any measures to raise more revenues to plug the revenue gap which could lead to the credit rating agencies believing that there was a lack of coherence and urgency on how the situation would be resolved. The key challenges to raising more revenues related to low growth and to a lack of trust in the effectiveness of government spending and hence, restoring confidence in public institutions and ensuring greater effectiveness of public policies would be key to creating the capacity to raise more taxes. Efforts to raise more tax revenue should now concentrate on expanding the tax bases through the reduction of deductions, credits and allowances, and improving tax revenue efficiencies. There was scope to broaden the VAT base and improve its compliance.

On Unallocated Resources, there had been significant drawdowns from the contingency reserve over the 2018/19 MTEF in the 2017 MTBPS when compared with the 2017 Budget, while the amounts being put aside were far from adequate for government to mitigate any unforeseen events. The Commission’s view was that reducing the contingency reserve in an environment of increased uncertainty and rising social demands limited the fiscal buffer necessary to protect public finances.

Ms Peters spoke to Expenditure by Economic Classification, noting that the compensation budget outpaced inflation by, on average, 1.8% over MTEF period. Should wage bargaining agreements be more than the predicted range, government’s fiscal position could worsen, leading to a higher debt to GDP ratio. The Commission was of the view that both government and unions should aim to reach a settlement that supports government’s current fiscal position as this would be in the best interests of the country’s economy. More could be done to realise savings around expenses relating to goods and services, like for example, travel and subsistence costs.

Mr Eddie Rakabe, Programme Manager, FFC, spoke to the Medium Term Strategic Framework Goals and Progress to date and said there was a decreased likelihood of achieving its economic growth targets and various interventions were needed, including reducing and removing uncertainty in key sectors, improving governance, adding value and raising the job-intensity of exports.

Other targets were close to attainment, for example health and education, and the emphasis should shift towards improving the quality of outcomes. Speaking on accelerating growth, budget and policy interventions were growth neutral, as there appeared to be structural barriers. The MTBPS did not contain any structural interventions. On job creation and unemployment, unemployment was reaching 2002 levels and that budget responses should focus on re-skilling and monitoring of public employment programmes (PEP) programmes. Infrastructure Investments remained a key spending priority to drive growth and employment, however the FFC’s concern was that the growth and jobs effect of previous infrastructure spending was muted. SOEs were the key drivers of infrastructure spending and leakages, in the form of delays and cost overruns, undermined growth and job effects. At the same time provinces and municipalities lacked a sustained focus on infrastructure spending and on the efficiency and productivity of this spending, where capital spending cuts were commonly used to address budget pressures. He spoke to Social Spending Priorities on health and education and human settlements and on broadband, where the continued delays in assigning spectrum had significant social and economic implications for South Africa. The Commission welcomed the work underway to license broadband spectrum and the fact that the bulk of additional telecommunication spectrum was ready to be allocated immediately, however, no reference was made to delivery and/or progress timelines to provide clarity on when these processes would be finalised.

Dr Mkhululi Ncube, Manager, spoke to local government issues. The FFC, welcoming the addition of R1.9 billion to the baseline allocation, the bulk of which would go to Local Government Equitable Share (LGES), as this would cushion the poor from the risks associated with low economic growth. The Commission, however, remained concerned at the continued subdued growth rates of the LGES. To ensure that this did not compromise the delivery of basic services, municipalities might need to promote more efficient utilisation of available resources and find other alternative revenue sources. The FFC welcomed the intention to introduce performance incentives within the Municipal Infrastructure Grant for intermediate cities and within the Public Transport Network Grant. Incentives should be based on clearly defined performance indicators. Municipalities should review their internal management structures so that resources were used efficiently and effectively and improve their revenue management, billing and debt management systems, impose cost reflective tariffs, avoid incidences of underspending, and inefficient procurement processes.

On the Revised Division of Revenue 2017/18, the FFC noted that projected underspending remained unchanged at R3 billion and that the Department of Cooperative Governance and Traditional Affairs had the largest rollover and increased the extent of its roll-overs from R27.9 million in 2016/17 to R73.2 million in 2017/18.

Mr Plaatjies then spoke to the FFC’s recommendations. The recommendations were that:

  • Government should continue with a gradual programme of fiscal consolidation, which would entail reducing the budget deficit moderately but consistently over the medium term.
  • Government should continue to strengthen the Public Employment Programmes in anticipation of the impact of an economic downswing on low-skilled workers.
  • More effective government spending must be prioritised.
  • Efforts to raise more tax revenue should focus on expanding the tax base through the reduction of deductions, credits and allowances and through improving tax revenue efficiencies by lowering compliance costs for small businesses.
  • Unallocated contingency reserves should be safe-guarded and further drawdowns on contingency reserve should be avoided.
  • Spending on non-core goods and services should be further reduced
  • The Department of Human Settlements should ensure finalisation of the revised framework for the housing function – integrated planning, infrastructure, accreditation and financing.
  • A set of uniform rules and procedures should inform the granting of guarantees and bailouts to ensure greater accountability and therefore more prudent use of public funds.

Discussion
Mr C De Beer (ANC; Northern Cape) said that unpaid bills, for example provinces which still had R26,4b of unpaid bills from the previous year, were a concern because they were hidden debt and a risk that needed to be mentioned on a quarterly basis and provincial departments had to be held accountable. Another concern was the capacity of SARS to collect taxes.

Mr O Terblanche (DA; Northern Cape) asked if it was correct that the 6 000 jobs that the EPWP created were not really permanent jobs

Mr N Gcwabaza (ANC) asked if the FFC could suggest proposals on its comment that the MTBPS had “no detailed plans of action”. What needed to be done to increase confidence between government, business and consumers? He sought clarity on the FFC’s comments on fiscal slippage. What was the FFC’s view on increasing corporate taxes and what would be the negative effects if such increases were implemented. What were FFC’s views on capital outflows. Did the FIC have enough skilled people? Was government not aggressive enough on corporate taxation?  There was a view that the mining, manufacturing and agricultural sectors were based on obsolete production methods and there was a need to invest in innovation and research and development; what was the FFC’s comment and how should these sectors be modernised? He asked for clarification of the use of the term “reduction of deductions” as related to increasing the tax base.

Ms D Senokoanyane (ANC) said SOEs were a noble idea, but were surviving on debt which was being shifted to government. What was the FFC’s opinion on SOEs which appeared not to know where they were going? She asked if the private sector was playing its role to decrease unemployment. Departments were underspending on infrastructure. The poor bore the brunt of paying e-tolls because they lived further from their workplaces and so were paying more tolls. She spoke to inadequate school infrastructure and the lack of municipal service to schools. She said small, rural municipalities were in a shocking state lacking even water. She said the contingency reserve was not serving its purpose, if it was being used to bail SOEs out. This needed to be looked at because the contingency reserve was not there to do bail outs.

Ms Phosa asked what concrete proposals the FFC could give so that the economy could be brought to its fast track growth trajectory. Could the FFC give specifics on programmes that needed termination or consolidation? What proposals could the FFC give to strengthen intergovernmental relations and co-ordination to strengthen infrastructure development and planning?  

Mr De Beer said the Malaysians had departmental monitoring on a weekly basis and this was a strategy that needed to be looked at. Gross debt was expected to rise to 53% by 2018/19 and this should not be allowed to happen.

On illicit capital outflows and whether there were enough skilled people in the FIC, Mr Plaatjies said the FFC had not looked at it, but in the following year the FFC would be looking at inefficiency and corruption.

On government policy and improving confidence of business and consumers in government, the Social Compact between government, business and labour was an institutional arrangement in the economy and issues such as the trickle-down effect, needed to be relooked at.

On what role the state had to intervene and to supervise, the FFC’s view was that the Social Compact needed to be relooked at because ‘confidence was the cheapest currency’. Politics was not creating a feel-good factor for investment and there was a disjuncture between government institutions and its people.

On the role of the private sector, he said there was a need for the private sector to invest but also for government to provide regulatory and policy certainty. He said the first part of the Minister of Finance’s speech did grapple with these issues but were not extensive on the macroeconomics.

There was a need to look at investments in the economy and at what new role there was for business and what their role in investments could be.

On public debt, it was the old story of provinces and national departments not paying municipalities what was owed to them. Two to three years ago Treasury had withheld some of the municipal transfers because of municipal debt to Eskom. Municipal councillors needed to be held accountable and provinces also needed to be held accountable.

On e-tolls, issues of compliance needed to be sorted out because the revenue was required to pay for the repayment of toll road loans.

Dr Mabugu clarified the fiscal slippage. A good financial principle was to pay as much as possible of current expenses from revenue. If revenue was greater than expenses this was the public debt and in the case of South Africa this had been coming down to as low as 0.5%, but the trend in 2017 showed that it was increasing.

On “reduction of deductions” Ms Peters said it was on deductibles such as donations, corporate social responsibility investments which lead to less tax being paid.

On programmes that needed to be terminated or consolidated, Mr Rakabe said that the DPME had laid a foundation through the review work it had done. The FFC’s proposals were that the Small Business Development funding needed to be consolidated.

On alternative funding for municipalities, Dr Ncube said it depended on the funding mechanism for municipalities. Some municipalities were dependant on transfers, especially small, rural municipalities.  Efficiencies needed to be increased. Alternative revenue generating mechanisms were: improved access to capital markets, TPPs; tolls and levies and Private Public partnerships.

On whether government was aggressive enough on corporate taxation, Dr Mabugu said that South Africa was aggressive enough based on benchmark exercises on emerging markets, but that it was a tricky question. There was not much room to manoeuvre. Where there was room to manoeuvre was in VAT. Emerging market VAT was around 16%, however there were other issues that needed to be balanced with this option because implementing it would be ‘biting the growth that one was seeking to ignite’.

On interventions around infrastructure and its maintenance, the theme of the FFC’s 2015 submission had been that and he would send those recommendations to the Committee.

On SOEs, Mr Plaatjies said they played an important role in the economy but questioned the role they were playing in the micro-sectors.

The Malaysian experience was an important one, but the difference to South Africa was that in Malaysia their fast track growth plan was legislated, whereas South Africa’s Operation Phakisa was not.

Mr De Beer said government needed to get expertise in all vital positions to succeed.

On the FFC’s concern of the continued subdued growth rates which would mean that municipalities would need to make more efficient use of their resources and find other alternative revenue sources, Ms Phosa asked what other alternative revenue sources the FFC had in mind.

Ms Phosa said the FFC could provide written responses to questions that had not been answered in the meeting.

The meeting adjourned.   
 

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