Medium term Budget Policy Statement: hearings

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Finance Standing Committee

03 November 1999
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FINANCE PORTFOLIO COMMITTEE

FINANCE PORTFOLIO COMMITTEE
4 November 1999
MEDIUM TERM BUDGET POLICY STATEMENT: HEARINGS

Documents handed out:
Slide Presentation: Ministry of Finance
Financial and Fiscal Commission
IDASA: Budget Information Service
COSATU Submission
Applied Fiscal Research Centre
National Institute for Economic Policy
Gensec's comments
Afrikaanse Handels Instituut (AHI)

MINUTES
Morning session
Ministry of Finance
Present on behalf of the Ministry of Finance was Minister of Finance, Mr T Manuel, the Deputy Minister, Mr M Mpahlwa, and Director General Ms M Ramos.

The Minister said that the media reporting on the Adjustment Estimates had generally saddened him. He went on to say that the request and approvals are not extra-ordinary, seeing that the requests were genuinely unforeseen and unavoidable. The Minister is of the opinion that South Africa does better than most other countries with regard to Adjustment Estimates. In many other countries, departments approach parliament two or three times a year for more money.

The Director-General said that as a further step to promote budget reform in departments, the Ministry is working very closely with departments to increase service delivery information. As for interest rates the Ministry is quite optimistic that lower rates will improve the growth of investments in the future. Consumer price inflation is also foreseen to decrease to 4,7% in the year 2002-2003, which will benefit the poor who cannot afford prices that increase because of inflation rates.

According to the Director-General the Ministry has three key goals for the Fiscal framework: to provide for social and development expenditure, in order that sufficient social services are provided to the people who most need these services; to reduce the burden of tax and to "create more space on the budget to pay for things other than interest" by lowering the budget deficit.

Comments and questions from members:
Dr G Woods (IFP) said that with macroeconomic projections, imports increase from -5,9 in 1999 to 9,6% in 2000, but decrease to 8,9% and 5,0% in 2001 and 2002 respectively. He then asked why this decrease is foreseen.
Ms Ramos said that the decrease in imports will be a result of a slow down that is foreseen in the economy.

Dr Koornhof (UDM) asked whether it is possible for the budget deficit to be decreased as it seems to be constant over the next three years.
Ms Ramos replied that what is important is that the deficit does not grow. What the Ministry does is to acknowledge the growth in the economy and at the same time wants to put more back into the economy whilst taking out less every year.

Finance and Fiscal Commission (FFC)
Mr M Morobe presented the views of the FFC on the MTBP statement (see
Financial and Fiscal Commission submission).

Questions and comments from members:
Mr Manie (ANC) said that in the formula a small percentage of the budget is allocated to local governments and this is a problem for local governments. He then went on to ask what the FFC's view are on this.
Mr Morobe in response said that the FFC always had the view that local authorities should also raise their own revenue, which will assist in the financial difficulties they find themselves in. The FFC is promoting the idea for a formula that will address this problem experienced by local governments. The current formula begins to address these things but there have been problems with the formula, and both SALGA and the Department of Constitutional Development are making investigations into this formula.

Ms Sonjica (ANC) asked how re-demarcation would improve the situation for local governments. Mr Morobe said that demarcation is going to create transition difficulties for local governments so in the short term this would not improve matters.

IDASA
Mr A van Zyl from the IDASA Budget Information Service presented their submission (see
IDASA: Budget Information Service submission)

Questions and comments from members:
Mr Chiba (ANC) said that Mr van Zyl raised the concern that the average pensioner receives almost R40 a month less (in 1994 rands) than in 1994. He said that hehad made his own calculations and had come to a different amount than the amount of R40 that was presented by Mr Van Zyl. He asked how this amount of R40 was calculated.

Mr Van Zyl said that in calculating the amount the rate of inflation was taken into consideration. The Chairperson said that the point made by IDASA is that pension increases must take consideration of the inflation rate.

Mr Saloojee (ANC) commented that he supported this view.

COSATU
The contingent for the COSATU submission consisted of Ms F Tregenna (Researcher), Ms L More (Legal Advisor) and Mr M Sweet (Head of research: NEHAWU). Ms Tregenna made the presentation on behalf of COSATU (see document attached).

Questions and comments from members:
Mr Mashimbye (ANC) asked whether there had been any research on the cost impact if the defence procurement deal had been postponed for another eight years.

Ms Tregenna responded that no research had been done.

Afternoon session
Present at the meeting were Ms Katerina Nicolaou from the National Institute for Economic Policy, Mr James Theledi from Gensec (Asset Management, a member of the Sanlam Group), Ms Tania Ajam of the Applied Fiscal research Centre, Mr Jac Laubscher and Mr Dawie Roodt from the Afrikaanse Handels Instituut (AHI) and also Mr Nick Barnardt (Chief Economist: AMB-DLJ Securities) and Mr Rudolph Gous (Rand Merchant Bank). The panel was described by the Chairperson as representing some of the top economists in the country.

Mr Barnardt commenced the presentation with the following comments:
He noted that the Minister of Finance's emphasis that moring had seemed to be on the development of indicators for service delivery, the fact that micro-efficiency is more important than the fiscal deficit and the question of the economic growth outlook. He stated that that over the past five years there has been zero job creation which effectively meant that there were 2 million people who were unemployed. It was regarded as a challenge to incorporate the needs of these people and the most important target remained the growth target. However, the balance between financial discipline and going-for-growth was an important one.

It was noted that the problem with going-for-growth was that it creates macro-financial risks, the risk being that the result could be too much inflation. He posed the question whether there was a limitation to growth? Economic growth resembled a rising tide and the balance of payment constraint was a feature of the cyclical upswing. The response to this was always to defend the currency; this desire to want to stabilise the currency resulted in a constraint on the growth of the economy.

Mr Barnardt continued that the flexible handling of currency is very important and noted his belief that high growth, in spite of the inflation attached thereto, has long-term productivity benefits which outweigh the short term shortcomings. He stated that there should be between 4 - 5% growth in 4 - 5 years. It was conceded that there would be some inflation but the long-term productivity benefits could be disinflationary.

The other economists concurred with the submissions made by Mr. Barnardt, specifically the need for economic growth for long-term productivity benefits. The notion was that, even though growth would result in inflation, this was only a short-term result. Ultimately economic growth would result in greater productivity. Their contention was that the government's focus should be on the long-term. In other countries, economic growth was constrained for the short-term benefit of lower inflation because the ruling party needed the instant boost in the economy to remain in power or to win votes. Thus, long-term effects were not considered. However, as the ANC has a clear majority it does not have to play short-term politics and could act in terms of what would be of benefit to the country in the long run.

The Chairperson specifically noted that Ms Ajam of the Applied Fiscal Research Centre had much to offer in relation to the efficiency of government spending and savings, as the other panelists may have focused too much on macro-economics. (See
Applied Fiscal Research Centre submission)

The representatives from AHI proposed a different approach regarding the tax burden on persons with different levels of income. This approach emerges from the questions which were posed to them.

Questions and comments by the members
A committee member, concerned about the trade-off between inflation and growth, asked what the most important policy change would be to promote the desired growth.

Mr Theledi responded that the Minister talks about tax relief. The high income earners contribute toward savings but these people have been penalised through the high tax rates. He suggested that savings be promoted by reducing the tax rates.

Mr Gous replied that there is a serious lack of literacy and skills. He said that if we do not change the structure of our labour force then it does not matter what fiscal policy we have. Accordingly, this structural change should be the top priority.

Mr Barnhardt added that high inflation was bad for economic growth and that a conservative policy to follow would be to prevent inflation. The more you push down inflation, the more short-term growth you have. However, what the government should be targeting is long-term growth.

Another member of the panel suggested that they implement long-term solutions. Macro-economics should be regarded only as a framework as the most important considerations were at ground level. Education was identified as a key factor.

Dr Koornhof (UDM) asked how important it was to look at the size of the budget deficit and how it could be reduced?
Mr Theledi replied that you have to balance the balance sheet. If there are high interest rates then no-one can invest and people have to borrow. This results in the accumulation of debt and accordingly, there will be less to spend on social services such as education and health standards. Reducing or eliminating the deficit contributes to low interest rates.

Ms Nicolau added that even if the deficit GDP target is kept the same, you can still spend on social services without raising the deficit as long as the economy is growing. It was noted, however, that if you can squeeze the deficit then you will improve the savings parameter.

In response to a question by Mr Leeuw (ANC), Mr Barnardt said that if there was more fixed interest there would be less inflation. Mr Theledi added that there was competition between companies and in order for them to be able to compete there should not be inflexibility in the labour market.

Ms Ajam stated that the fiscal policy can create an environment conducive to growth. She noted that there should be immediate intervention in relation to the efficiency of government expenditure and savings. She stated that government has the direct hands-on levers to change these two items. She continued that committees also had a role in this regard, in that there should be interaction between the various committees in developing an efficient budget and overseeing the correct spending of that budget.

Questions posed to delegates from the Afrikaanse Handels Instituut (AHI)
A committee member asked what the future outlook for savings was and whether we were still taxed too high for change to occur?
The reply was that household savings arose from disposable income and that the tax burden had to be reduced. Mr Laubscher added that, with the current tax policies in place, he did not know from which source savings would come.

Dr Davies (ANC) asked whether it was being suggested by the AHI that the tax burden should be more regressive (this would mean for example that people with an income bracket of R 30 000 per year should be paying more tax and people with an income bracket of R 250 000 per year should be paying less tax).
The response was that the tax burden on the high income group could be reduced. The rationale was presented as follows: When you earn more money you move into the next tax bracket. This may be considered as a reason not to earn more money. Accordingly, the tax burden on the high income group should be reduced. Mr Laubscher added that people should be encouraged to save more, this would result in more rich people who could be taxed in the future. He added, that what should really be done is to increase VAT, but that this was too politically sensitive.

These comments were not well received by members of the ANC. Mr Laubscher was reminded that the notion of equality was of paramount importance and that the primary purpose was that of redistribution.

Mr Laubscher conceded that he was in fact a purist.

Professor Turok (ANC) asked whether it was not right and equitable that inequality should be overcome by taxing the advantaged.
Mr Laubscher replied that the country was losing professionals as the tax burden imposed upon them gave them a reason to leave.

The AHI was criticised in that they failed to consider that the primary purpose of government was to transform society so that there could be a better life for all.

Dr Luyt noted that in New York City, USA, there was no VAT on food and wondered whether we could do that here.
The response was that this was a bad idea as it would exempt everybody, both the rich and the poor. It would be a better idea to benefit the poor through expenditure. As a poor country we should try to spend less and cut the interest rate.

Dr Luyt tried to clarify the point he made by explaining that what he really meant was that food could be exempted from VAT but then the taxes could be increased in other areas.
The response was that it costs a lot to exempt specific items.

The meeting was adjourned.


Appendix 1:
Financial and Fiscal Commission

COMMENTS SUBMITTED TO PORTFOLIO COMMITTEE ON FINANCE
HEARINGS ON THE MEDIUM TERM BUDGET POLICY STATEMENT
NOVEMBER 3, 1999

INTRODUCTION
On behalf of FFC, I would like to thank and congratulate the MoF, DoF and Budget Council for yet another significant achievement producing the MTBPS, which yet again goes some way towards the consolidation of our evolving budget process.

Establishing a credible budget is not an event but a process. Indeed, each iterative step in that direction establishes a point for continuous improvement.

It is indeed for that reason that whenever the FFC engages in these discussions, it will always always prefer to do so from the vantage point of clearly defined principles.

As provided for in terms of sections 4 (2)(a) and 7 (2)(a) of the Intergovernmental Fiscal Relations Act, 1997, the FFC has attended and even participated in these meetings..

The MTBPS, itself a product of the numerous meetings and processes I've just referred to, is in our view not only a reflection of how far down the line of greater budget transparency we've gone, but also of how far we still have to go.

Whatever the processes, the application of section100 of the constitution included, we have noted remarkable improvement in the way in which, provinces in particular - and as the minister we are sure would have reported - have improved on their ability to manage their budgets, within the attendent constraints.

That the MTBPS is reporting an improved debt to GDP ratio, decreasing interest payments, improvements in the collection of revenue ( national) an encouraging inflation climate etc, suggests a macro-economy that is responding to the prescriptions applied by government.

But of course that is only on one level. These improvements - their success or otherwise - are invariably always going to have to be measured against the extent to which they make the necessary impact :-
Generating sufficient resources to meet or cause to be met whatever programs government has prioritized;
Deepening efficiency and effectiveness of decision making processes - especially with regard to the development of the budget, e.g. co-operative governance;
On the ability of the economy to create jobs;
In facilitating increased access to basic social services;
Capital stock development, etc.

Equally important in this respect is the extent to which the underlying processes, leading to where we are today, are consistent, not only with what could be considered to be best practice for process management, but at least with the key tenets of Chapter 3 of the constitution.

FFC and the 2000 Budget
In contemplating what kind of submission we could make, we thought that it might perhaps assist you in your deliberations to share with you some insights that we believe must always be central to the consideration of the subject of revenue sharing between national, provincial and local government. Afterall it is you who, through the legislative process are going to be the final arbiters of the soundness of the proposals before you. Therefore, while this submission does not engage on the efficacy or otherwise of the numbers that are generated by the MTBPS, it is our considered opinion that underlying these would a bigger picture which all stakeholders in the intergovernmental fiscal relations environment must keep constant sight of.

The Constitution, the Financial and Fiscal commission Act, 1997 and Intergovernmental Fiscal Relations Act 1997, all regulate the way the FFC interacts with, and influences the budgeting process.

The Constitution in Section 214 (2) requires that the FFC be consulted before the Division of Revenue Act is enacted, and where there are any recommendations of the Commission, these must be considered.

In giving effect to this, the Intergovernmental Fiscal Relations Act, 1997, Sections 9 and 10 detail the procedures whereby this would be done.

Therefore, for the budget under consideration in the MTBPS before you, the Commission has - as we had advised this Committee earlier this year and the Budget Council in subsequent meetings - opted not to make any recommendations for the forthcoming fiscal year. This was, among other things, informed by the fact that it still forms part of the rollout of the first MTEF whose basic thrust we had welcomed.

Our approach has been based on a view we had expressed earlier on in the development of the current budgeting regime. This is that once a formula was adopted, either in full, or in amended form, it is advisable that it be allowed time to settle in, before any major changes were effected to it. Obviously as to when that would or should be is a moot point.

The FFC however, has considered the three yearly MTEF frameworks as providing a useful point of departure/reference/entry for any major proposals that may affect the structure of the formula. In terms of the 3 yearly MTEF framework, we are looking to develop a cycle that would coincide with its outer year, so that these inform the next three-year phase and beyond that the proposals would be addressing.

With regard to the above, I would like to refer you to the executive's perspectives on this, which are captured in the 1998 and 1999 Budget Reviews.

In 4.4.1 of the 1998 Budget Review it was stated that " the provincial equitable shares formula draws on the recommendations of the Financial and Fiscal Commission", and further that the allocations " adhere to the broad principles promoted by the FFC in its reports."

In introducing the current formula, it ( Budget Review) took "as its point of departure the recommendations of the FFC, particularly as they are presented in the Framework Document for Intergovernmental Fiscal Relations in South Africa ( June 1995 )... ."

Consistent with the previous year's account, the 1999 Budget Review goes further to urge stakeholders to " evaluate the system against agreed upon founding principles set out by the FFC in its Framework Document for Intergovernmental Fiscal Relations in South Africa, June 1995.

The Principle of Equity and the Constitutional Requirement of "Equitable Share"
While this matter is going to be covered at somewhat greater length in the proposals we are developing for submission in terms of our " Project 2001", I will raise them here because of their resonance with respect to the fiscal year under consideration.

While the Constitution does not speak directly to the issue of equity among sub-national governments, it however compels equity for individuals in terms of rights and entitlements to basic services. With respect to governments, its provisions relate to the provision of "equitable shares", this is particularly so in Section 227.

It is therefore clear that the Constitution approaches the requirement for equity in a particular manner, and requires the mechanism or structure of " equitable shares" to play a particularly important role in the financing of equity provided through programs of provinces and municipalities. However, one must hasten to make the point that the terms "equity" and "equitable share" are not synonymous with each other.

Our work in this regard is beginning to lead us to some conclusions with respect to equity and equitable shares:

With respect to equity:

1. Basic services such as access to adequate housing and health care services, sufficient food and water, social security, basic and further education, and so forth as elaborated under the Bill of Rights are fundamental rights to which everyone must have access.
2. Every child has additional rights to services, as elaborated under Section 28 of Chapter 2.
3. Certain of these rights must be subject to progressive realization, as governments must operate "within its available resources".

With respect to equitable shares:

1. Equitable shares provided out of national revenue, at a minimum, include an entitlement to enable the provision of basic services by provinces and municipal governments. This suggests that equitable shares must be adequate and distributed appropriately so as to ensure that all citizens have access to those basic services for which the provinces and municipalities have service responsibilities, subject to the requirement to operate within available resources.
2. The Constitution envisages other allocations to sub-national governments, which may be made from national revenue. Such allocations may provide for services or functions, which are in addition to the provision of basic services. These additional amounts may be a part of provincial or local government equitable shares, or may be made from the national equitable share. Their provision may be conditional or unconditional. However, the equitable share must be provided unconditionally. Therefore, if conditions are attached to any allocation, that allocation must be made from the national equitable share.
3. Equitable shares must not incorporate a deduction made to reflect other revenue received, whether raised by the provincial and local governments themselves, or transferred from the national government to them. Nor are equitable shares to reflect actual differences in tax bases or tax effort of provinces and municipalities.
4. However, it is envisaged that provinces raise revenues they require to carry out their responsibilities. Provisions with respect to provincial and municipal taxation and to sub-national government borrowing are provided for in Sections 228, 229 and 230 of the Constitution. There appears to be no hindrances to national government developing an equalization program for such taxes raised, in order to provide for greater equity amongst governments' abilities to operate programs which go beyond the scope of basic services, provided it operates beside, rather than within, the provision of equitable shares.
5. In summary, there remains substantial scope for intergovernmental fiscal arrangements to contain a number of different elements, including the following:
· equitable shares of national revenue to meet basic services;
· equitable shares directed toward the provision of other than basic services;
· other unconditional allocations out of the national share to sub-national governments;
· conditional allocations out of the national share to sub-national governments;
· unequalized revenue raised by provincial and/or municipal governments under arrangements provided for in national legislation;
· revenue or other equalization programs from the national equitable share.

Equity and Taxation
There are two sides to "equity". Equity in the provision of services means that people in similar circumstances have access to similar programs, while those in different circumstances may benefit more or less from public programs, but nevertheless in a manner which is fair and just. In order to provide equity in the provision of services, equal per capita expenditure may not be sufficient. Cost and need factors may have to be developed to gauge the distribution of funds necessary to achieve equity in the provision of services. A second aspect of equity relates to taxation. Taxpayers in similar circumstances should pay similar amounts in tax for similar services. As well, jurisdictions levying similar tax rates on defined tax bases (i.e. making the same tax effort) should receive similar per capita revenue. Jurisdictions which make a greater tax effort through higher tax rates and jurisdictions which choose to make a lesser tax effort should either be rewarded or have their revenue stream reduced as a result of their respective decisions. Grant systems and equalization programs are used to address equity considerations.

The Constitution contains principles to guide the development of intergovernmental fiscal programs. A key component of these arrangements is the division of national revenue into "equitable shares" for each sphere of government. However, one would be mistaken to assume either that the equitable shares should necessarily be provided on an equal basis, or that the provision of equitable shares is the only intergovernmental fiscal mechanism available to address the issue of equity.
The review and assessment of previous recommendations of the FFC and of the approaches of the Department of Finance must consider the issue of equity, and not only from the perspective of the provision of equitable shares. The FFC recommendations, with respect to the intergovernmental fiscal arrangements for the 2001/2002 and subsequent fiscal years, must consider the appropriate division of national revenue into equitable shares, taking full account of the role other intergovernmental fiscal instruments, such as conditional grants or revenue equalization, are expected to play in the provision of service throughout the Republic.

At this point it is perhaps relevant to raise the matter of Local government. Accepting that reference is made to this sphere to some extent in Chapter 5 of the MTBPS, there seems from our point of view an urgency with which the problems there need to be addressed. While we can accept that on average it can be said that local government has the ability "to raise the bulk of its own own revenue", this however has the danger of obfuscating the real dilemmas that many local authorities are faced with. While it is true that the most high profile problems have had to do with issues of maladministration ( not unique to local government), there are as well significant structural, and built in historical factors that have contributed to the intractable position of many of these authorities. Some of these are obviously being discussed at the present moment at various levels, including at the level of the Budget Forum. However, it would seem that rather than having a situation where different entities are going around trying to determine what the best funding mechanism should be, it may be more prudent that a serious effort is made at consolidating these. With the local government elections scheduled to fall almost in the middle of the local government finacial year, and the new local government system expected to kick in immediately thereafter, the point cannot be overstated.

All in all, these are issues that speak to the acute fiscal imbalance that is so deeply ingrained in the system as it currently stands. We in the FFC fully recognise however that at the end of the day, budgeting is about choices with respect to revenue, expenditure allocations and the use of debt. That government, led by the Department of Finance in this instatnce, must make the choices which will ultimately provide financing for programmes. To that end it will be expected to make certain judgement calls based on its evaluation of both current and long term growth and prosperity for the nation. For our part, we would like to encourage broad based discussion on the fiscal issues, which should solidify acceptance of the fiscal framework.

A part of the work currently underway in the FFC, which we expect to finalise by April this year, would be to determine

· how information on program costs and needs, particularly those related to provincial responsibilities, can help to maintain an appropriate balance when the government makes its decisions on revenues, including the level of borrowing;
· how the decisions on deficit financing can, and should impact on the decisions around the vertical division of revenue, and
· under what circumstances, if any, should deficit and debt options for sub-national governments be factored into the decisions on the vertical division of national revenue.

What we will be saying in essence is that our experiences so far, seen against the background of the constitutional foundations on which all our work is premised, is that equity and the search for balance in the the vertical divisionof revenue are not mutually exclusive.

The extent to which national programmes utilize a greater or lesser share of available national revenue is a very important decision of the government. It reflects the realization of national priorities and goals. Ultimately, the realization of national program requirements must be balanced against the realization of provincial and local program needs in the determination of equitable shares.

Of course such choices are particularly difficult in the absence of information concerning the needs and costs of achieving expressed goals and priorities. It is thus in the light of this that the core element of our current considerations for submission next year will consist of in depth proposals based on a needs and cost based approach. As well as providing a benchmark of norms and standards, it will provide the necessary framework to evaluate the effects of decisions made, and the progress towards long - term objectives.

Thank you.

Appendix 2:
IDASA: Budget Information Service
SUBMISSION ON MEDIUM TERM BUDGET POLICY STATEMENT 1999
4 November 1999

The Medium Term Budget Policy Statement (MTBPS) was universally lauded for the good news that it bore on the structural health of the economy and government finance. The budget deficit targets have been surpassed, the South African Revenue Service once again collected substantially more revenue than projected, debt and national government borrowing has largely been brought under control and inflation is at its lowest levels in 30 years.

The MTBPS (p.34) states that the budget framework must achieve a balance between three broad objectives:
Reducing the overall burden of tax, so as to reduce the costs of investment and job creation and release household spending power;
Lowering the budget deficit, to improve the sustainability of public finances and contribute to lower interest rates; and
Providing for the social, developmental and infrastructural expenditure responsibilities of the State

As a result of the success in meeting the first two goals substantially more funds are available in the system than had been projected in the previous MTBPS. Good financial management and increased tax revenue effectively produced a surplus over the projected revenue and expenditure plans. This gave government an opportunity to make new allocative decisions that were not viable when the previous budget was tabled. The MTBPS displays the government's decision to spend these funds on an arms procurement package and a further reduction of the planned budget deficit. The procurement package will consume R2,8 billion and R3.8 billion over the next two years respectively. The budget deficit that was estimated at 3.5%, 3% and 3% for 1999/00 to 2001/02 was reduced to 2.8%, 2.7% and 2.5% for these three years.

The MTBPS (p.64) states that the 1999/00 division of revenue sought to protect social services and basic service delivery despite the unanticipated slowdown in economic activity. It states further that in 2000/01, the revised economic projections will afford Government an opportunity to give attention to national functions while still allowing increased growth in social services expenditure.

The MTBPS (p. 49) claims that there had been a major shift towards social service provision over the past three years. On this basis, the government argues in the MTBPS that the medium-term priority should be on improving the efficiency and effectiveness of social spending as it grows moderately in the medium term.

This submission will comment critically on two aspects of the trade-off proposed in the MTBPS. First, the MTBPS loses an opportunity to address the backlogs in social services by allocating the revenue surplus to arms procurement and further reduction of the deficit. Second, it is not clear how the proposed efficiency gains in social service delivery will be achieved immediately in the absence of an agreed solution to public sector remuneration. Presuming efficiency gains in the absence of certainty on the largest cost driver in social service is of uncertain merit.

The MTBPS provides information not previously available to the public at this stage of the budget cycle. It is however very difficult to comment on the numbers that are provided without the more detailed spending plans contained in provincial and national Medium Term Expenditure Frameworks. We therefore welcome the Minister of Finance's announcement in Parliament on the 16th of August 1999 that a draft of the national budget will be released for comment before the end of the year.

The impact of the MTBPS on consolidated provincial and national government expenditure

The impact of the shift away from increasing allocations to social services on consolidated provincial and national government expenditure is shown in table 1 below.

Table 1: Service Shares and Growth (as percentage of total)

1998/99

1999/00

2000/01

2001/02

2002/03

1999-2002/03Average Annual Growth

Social Services

53.8

53.8

53.7

53.6

54

Education

27.9

27.5

27.7

27.6

27.8

6.4

Health

14.5

14.8

14.6

14.6

14.8

6.2

Welfare

11.4

11.5

11.4

11.4

11.4

5.8

Protection Services

Defense and Intelligence

7.1

6.6

8

8.3

8.5

14.9

Integrated Justice System

13

13

13.3

13.2

13.2

6.6

Economic Services

7

6.6

6.5

6.7

6.8

7.1

Infrastructure

14.8

12.3

11.1

11.1

11

2.4

Administration

4.4

6.3

6.6

6.4

6.4

6.7

Total

100

100

100

100

100

6.5

Source MTBPS p.57

The table shows that social services increase marginally as a share of the budget (form 53.8% in 1999/00 to 53.6% in 2001/02, and back to 54% in 2002/03). In contrast, Defence spending increases markedly as a result of the arms procurement program (from 6.6% in 1999/00 to 8.5% in 2002/03). Infrastructure spending suffers, declining from 14.8% of the budget in 1998/9 to 11% in 2002/03.

The extent to which national functions are being prioritised after the last three years of provincial increases can be seen in the next two tables below. The national share of the budget increases from 42.04% in the current financial year to 42.76% in 2002/03, while the provincial share declines from 56.48% to 55.66% over the same period. The local government share increases marginally over this period.

Table 2: The vertical division (R million)

1999/00

2000/01

2001/02

2002/03

National Equitable Share

71715

77429

82739

87207

Provincial Equitable Share & Conditional grants

96357

102770

108403

113507

Local Government Equitable share

2519

2830

3030

3233

Total

170591

183029

194172

203947

MTBPS p.66 Note: Local Government share etc.

Table 3: The vertical Division (as percentages of total)

1999/00

2000/01

2001/02

2002/03

National Equitable Share

42.04%

42.30%

42.61%

42.76%

Provincial Equitable Share & Conditional grants

56.48%

56.15%

55.83%

55.66%

Local Government Equitable share

1.48%

1.55%

1.56%

1.59%

MTBPS p.66 Note: The table excludes local government conditional grants.

The shift in spending towards national functions benefits primarily the Defence budget (MTBPS p. 53). The share of non-interest spending that the Defence budget consumes will increase from 6.7% in 1999/00 to 8.5% in 2002/03. These changes are the result of the arms procurement package that is worth between R21,3 billion and R29,9billion (if all aircraft options are taken) over the next eight years. We are aware that the opportunity for debate on the arms procurement deal has passed. It is important that the nation sees clearly the impact of this deal on our resource allocations.

Table 4: Defence spending as percentage of the total budget

1998/99

1999/00

2000/01

2001/02

2002/03

Defence

11.4

11.4

14.6

16.1

17.3

Total

160.9

169

181.9

193.1

204.2

Defence %

7.1%

6.7%

8.0%

8.3%

8.5%

Source: MTBPS p.56

Neglected categories of Social Spending
The MTBPS (p. 12) states repeatedly that the quality and efficiency of social service delivery needs to improve and that spending alone will not solve delivery problems. It also implies that enough money is already allocated to social service delivery and that the new challenge is to make these funds go further (p 49). We have consistently supported this argument in our work, however the argument does not hold for all social service programmes and does not take account of unexpected revenue increases. We present two examples below.

In July 1999 the new Education Minister stated that while "the government has contributed more than R 1 billion to the National School Building Program, it may require twelve times that amount to meet the backlogs identified in the School Register of Needs. This is well beyond the reach of the normal budgets of provincial education departments, which in recent years have suffered sharp decreases in the funds allocated to school building and services (Asmal 1999)."

The second example concerns the increases in Old Age Pensions since 1994. In only one year since 1994 have old-age pensions grown in real terms. The average pensioner receives almost R40 a month less (in 1994 rands) than in 1994, as shown in the table below.

Table 5: Real and Nominal Changes in old age pensions

Rand Amount

% increase

CPI core Inflation Rate

Real Increase/Decrease

1994/95

395

-

-

-

1995/96

410

3.8%

7.1%

-3.3%

1996/97

430

4.9%

8.6%

-3.7%

1997/98

470

9.3%

8.1%

1.2%

1998/99

490

4.3%

7.6%

-3.3%

1999/00

520

6.1%

7.7%

-1.6%


The national government also spends on a growing number of important Poverty Relief and Jobs Summit projects. These projects are targeted at the rural poor because they have fewer economic opportunities and lower access to social services. The amount allocated to such projects is budgeted to grow from R800m in 1998/9 to R1.5bn in 2001/02. Significant funds for job-creation and training will also be mobilized over the next three years via the Usobomvu fund and the Skills Development Levy.

While these projects are of great importance they are limited in scope, making up only 0.5% of the consolidated budget in 1999/00. These high profile, low expenditure initiatives should not divert attention from the larger budget items such as Health, Welfare and Education and local government functions that have a greater effect on more poor people.

Efficiency gains and personnel expenditure
Governments remuneration policy is the key component driving efficiency gains for social service provision. The MTBPS (p13) states that the government is developing a remuneration policy that, while allowing for appropriate pay increases, will see total personnel spending grow in line with inflation. This policy will be designed to improve the consistency between available resources, Government spending priorities and human resource development in the public service (p.55). As shown above, the MTBPS projects personnel spending growth of 5.4% per year.

Table 6: Consolidated National and Provincial spending by economic type

2000/012001/2002

2002/03

Personnel Expenditure

82.2

85.6

90.4

95.4

100.2

Other Current Expenditure

66.1

71.7

78.4

83.6

89

Transfer payments

43

39.7

43.7

46.1

49

Goods & supplies

23.1

32

34.7

37.5

40

Capital Spending

12.7

11.7

13.1

14.1

15

Acquisition of Assets

7.5

8

9.2

9.8

10.6

Transfer payments

5.2

3.7

3.9

4.3

4.4

Total

161

169

181.9

193.1

204.2

Source: MTBPS p.54

Table 7 Consolidated National and Provincial spending by economic type as shares of the total

Outcome 1998/99

Revised 1999/00

2000/01

2001/02

2002/03

Personnel Expenditure

51.1%

50.7%

49.7%

49.4%

49.1%

Other Current Expenditure

41.1%

42.4%

43.1%

43.3%

43.6%

Capital Spending

7.9%

6.9%

7.2%

7.3%

7.3%

Total

100.0%

100.0%

100.0%

100.0%

100.0%

Source: MTBPS p.54

Given the outcome of wage negotiations this year, where government unilaterally implemented a 6.8% rise, it is likely that negotiations on a new remuneration policy leading to a reduction in average benefits per civil servant will be tough.

Since 1996, government has made several commitments to reduce the wage bill, either through rightsizing the civil service or restructuring within. Several times these efforts have been frustrated at the negotiation table, most recently by the demand by unions for audits before negotiating new rightsizing tools. We are concerned that a lengthy negotiation process will impact at least on year 1 of the medium term projections. The outcome of such negotiations may mean less savings than government envisaged throughout the period.

In the absence of an agreed new remuneration policy, rank and leg promotions alone add approximately 1.5% to the total wage bill. Medical Aid and Housing costs combined are rising by similar proportions per year, as more employees become eligible. Together with increases in line with inflation, the wage bill can therefore rise by as much as 8% a year. In the 2000/2001 spending year this may mean over expenditure of R2 billion.

If growth in personnel expenditure does outstrip projections in a context where social spending does not increase, important categories of non-personnel expenditure (eg. Text books and medicines) will come under pressure. The Idasa submission on the 1999 Budget illustrated that personnel expenditure growth has been squeezing out current expenditure items in the Health and Education sectors.

Conclusion
This submission draws attention to a major shift in government spending priorities in the new MTEF period. The deficit has been reduced below the initial GEAR targets. National government in general and the Department of Defence in particular will spend an increasing share of national revenue while social service and infrastructure departments will stabilize and decline.

The proposed motivation for these changes is that sufficient resources have been shifted to social services and that efficiency of delivery should be the next goal in these departments. The consolidation of social service expenditure will allow government to restore the allocation of departments that have endured severe budget cuts over the last 5 years, such as the Defence department.

We have argued in this submission that firstly not all programs within social service expenditure are adequately funded. To return to the examples from the Welfare and Education sectors:
According to the Welfare Department just over R1,8 billion was paid out in Old-age pensions in the first four months of 1999 (personal communication). From this we can project a total expenditure on old-age pensions of R5.4 billion for the current financial year. The cost of the proposed arms procurement package for 2000/01 alone (R2.8bn) could roughly translate into an almost 50% increase in Old-age pensions levels.

Alternatively the proposed arms procurement package is worth between R21 billion and R29 billion. This amount could cover the amount needed for classroom backlogs (R11 billion) twice over.

Secondly we have argued in this submission that the proposed efficiency gains in social services are likely to take longer to materialise than proposed in the MTBPS. They will certainly not be available in the first years to increase pensions or reduce backlogs in Health and Education.

While we have supported a program to reduce deficits in the past, the greater than expected revenue generation should be used as an opportunity to significantly reduce backlogs in social services without adding to expected government borrowing. Instead, the poor have been asked to wait again.

Appendix 3:
Applied Fiscal Research Centre
presented by Tania Ajam Deputy Director

Medium Term Budget Policy Statements 1999
November 4,1999

Framework for evaluating the MTBPS
Every budget system essentially seeks to achieve three main objectives:
1. Aggregate fiscal discipline refers to Government's ability to control its total expenditure over time
2. Allocative efficiency is promoted when Government is producing the right mix of services to meet its objectives (i.e. public allocation of expenditures is effective)
3. Operational/delivery efficiency occurs when the maximum amount of public service outputs is being generated from the available resource inputs.

In other words, fiscal discipline asks whether government has indeed adhered to its stated budget constraint. Allocative efficiency asks "Is government doing the right things?" and operational efficiency asks "Assuming government is doing the right things, is it doing them in the right way?". This provides a useful framework for evaluating Government's 1999 Medium Term Fiscal Policy Statement (MTBPS 1999).

Aggregate fiscal discipline
The spending plans for the next three fiscal years described in the MTBPS1999 are fiscally prudent in that they project increases in non-interest expenditure without compromising Government's medium term deficit reduction goals. To some extent, the dividends from Government's conservative fiscal stance over the past number of budgets are being reaped. The Government is also benefiting from improved revenue collections.

Table 1: Primary balance in terms of revised medium term framework (R bn)

1999/00

2000/01

2001/02

2002/03

R billion

Revised

Revised

Revenue

194.0

210.7

227.3

243.0

Expenditure

216.6

234.2

251.6

267.9

Interest on debt

44.7

47.6

50.8

53

Deficit

22.6

23.5

24.3

24.9

Primary deficit/surplus

-22.1

-24.1

-26.5

-28.1

Note: primary surplus = expenditure - interest payments - revenue = conventional deficit - interest payments
Source: Calculated from table 3.3, MTBPS 1999, page 39

The economic assumptions underpinning the three-year expenditure plans are realistic and therefore lend credibility to the MTBPS 1999. This credibility is further enhanced by the more comprehensive coverage of the public sector by the new fiscal framework. Indeed, the increased transparency engendered by the advance publication of government's fiscal intentions promotes such credibility and adherence to fiscal discipline.

However, it must be noted that the projections would seem to indicate that the primary surplus of the preceding fiscal years will be increased over the MTEF planning horizon. Under these circumstances, it becomes absolutely imperative that the effectiveness and efficiency of public expenditure be improved while fiscal discipline is maintained (in areas such as education, health and the integrated justice system). If non-interest expenditure growth is being constrained in the medium term, then clearly improved service delivery requires an increase in the efficiency of public spending. This is especially true in the light of an economic environment where unemployment is high, labour absorption is sluggish, and personal savings are low. While these are indeed structural problems which are outside the direct purview of fiscal policy, improving the productivity of public expenditure is important in supporting growth.

Allocative efficiency
Fundamental questions centre around the vertical division of nationally collected revenue. For instance, is it appropriate that the consolidated local government equitable share (including conditional grants) should remain at 1.5% (of the revenue pool after topslice) over the coming three year period? It is however literally impossible, at present, for informed technical analysis to emanate from civil society due to insufficient information. The Department of Finance stresses the political nature of the decision-making process underpinning this phase of the intergovernmental resource allocation process:
"Although analyses of functions being performed by different spheres and the impact on service delivery of different funding levels must inform the vertical division, it fundamentally remains a political decision about the relative priorities of these functions" (Budget Review 1999, p 258).

While there can be no doubt that budgeting is essentially a political process and not a purely technical one, it is important that these political decisions on the available affordable policy options be informed by information on costs, likely impact on service delivery outputs, the likely outcomes in terms of impact on communities, and the likely incidence of public expenditure. Our concern is thus not as much with the quantum of the equitable shares accruing to national, provincial and local government (upon which we can only speculate), but with the quality of the information on a technical level which should underpin such a process. AFReC's recent experience in costing the Child Justice Bill underscored to us the dearth of information on costs and outputs.

The Ministry of Finance has indicated that it favours a move towards output-based budgeting which would contribute substantially towards improving the quality of information (Budget Review 1999, page 252). However, it is disconcerting to note that the long-awaited White Paper on Budget Reform (initially due for release in 1997) has not yet materialised. The MTBPS does convey some reassurance that Government will "shortly" announce its budget reform programme, which we await with eager anticipation. The Public Finance Management Act of 1999 (PFMA) was aimed at "getting the basics" in place, and makes some provision for improved accountability on the basis of measurable objectives. The specific relationships between outputs, outcomes and managerial and political accountability were however not explicitly delineated and the Act does not go as far as it could in promoting performance management. This is in contrast to what the Department of Finance in its 1999 Intergovernmental Review attributes to the PFMA Act:
"Third, the Act promotes accountability for performance …. The Minister or MEC is responsible for policy matters and the outcomes of public spending. The head of department is responsible for outputs and policy implementation and is directly accountable to Parliament for the management of public funds." (page 2.4).

It is crucial that the proposed budget reform programme clearly articulate these relationships to ensure consistency with other elements of public sector reform. The need for the implementation of a budget reform programme that will generate the appropriate information to support legislative oversight is pressing, especially if Parliament changes the basis on which it appropriates funds, from whole departments to specific programmes.

One of the aims of the MTBPS is to promote participation of the Parliament, the provincial legislatures and broader civil society in the budget process. However, the articulation between these hearings on the MTBPS and the Division of Revenue Bill is at present not clear. Ideally inputs from these hearings as well as the contribution of the FFC should feed into debates on the Division of Revenue Bill. A concern is that the Division of Revenue Bill is tabled on the same day as the national budget (as required by the Intergovernmental Fiscal Relations Act of 1997). In essence therefore Parliament is debating a fait accompli, and it is not clear how the proceeds of hearings on the MTBPS would impact on Division of Revenue Act. This is in contrast to countries such as Sweden where broad allocations are approved by Parliament well in advance of Budget Day.

Operational/Delivery efficiency
The MTBPS has made increased allocations to Government's key spending priorities such as the integrated justice system, HIV/AIDS, poverty alleviation etc. But increased allocations are clearly a necessary but not sufficient condition for improved service delivery. More attention should be placed on the role of effective budgeting and financial management in supporting service delivery.

The MTEF should be applauded as a very important first step in the quest for value-for-money in the public sector. The link between the MTEF's financial projections and actual service delivery will remain tenuous unless explicitly addressed by appropriate changes to the current budgeting and financial management systems in the public sector. The Minister of Finance has indicated that selected national and provincial departments will be piloting service delivery objectives, indicators and targets that will help assess service outputs when budgeting. These budget reforms must be supported by appropriate reforms in reporting, monitoring and evaluation and other performance management systems.

International experience has clearly demonstrated that for budget reform initiatives to be successful, they must be underpinned by broader managerial reforms. It is relatively easy to change budget formats. It is considerably harder to re-orient management behaviours towards performance and value for money. To do so requires that the incentives created by budget reforms be aligned with other public sector reforms. There has been recognition of this by the Department of Finance:
"Consistent with broader transformation of the public service, budget reform will devolve accountability to departmental heads to manage personnel and other inputs effectively and efficiently in pursuit of improved service delivery" (Budget Review 1999, p 24).

These issues will presumably be dealt with in the long awaited White Paper on Budget Reform.

Conclusion
While the MTBPS performs excellently in terms of fiscal discipline and indicates that substantial improvements in allocative efficiency are likely in the near future, a more intense focus on performance management systems for efficient public resource use is still required. This will no doubt be crucial to the next phase in the unfolding financial and fiscal reform programme in the South African public sector.

However, there are certain critical issues surrounding the budget process which should be considered by Parliament:

1. Submitting and passing of the Division of Revenue Bill in advance of the budget
There are various options which could be explored in this regard, which would enhance Parliament's oversight role. The following scenario is illustrative of one of these options. At present the intergovernmental budget process can be broken down into three stages:
(1) 1. the division of revenue between the spheres of government, which culminates with the enactment of the Division of Revenue Bill.
(2) 2. the determination of the broad resource envelopes for departments and departmental clusters within which they have to develop programme budgets.
(3) 3. the detailed specification of each department's programme budgets.
Currently, Parliament has to consider all three allocations simultaneously, which could compromise its ability to exercise effective oversight. The publication of the MTBPS gives some prior information on the first two stages in the allocation process, but parliament is not called upon to approve these broad allocations. An alternative could be for Parliament to approve each stage in the allocation process prior to the next stage of budgeting commencing. This would suggest that the budget could be passed in roughly three stages:
(1) 1. Around October: Parliament could be presented with and approve an indicative division of revenue between the spheres of government.
(2) 2. Around November: Parliament (the National Assembly) could be presented with and approve broad indicative allocations for each national department or cluster of departments.
(3) 3. February: Parliament could be presented and approve final departmental budgets which give details of programme expenditures and service delivery outputs.

2. The need for Parliament to as far as possible expedite the budget reform process in the interests of improved oversight. This could include obtaining more information on rationale underpinning the vertical split for instance. Given that departments will be moving towards performance targets within a broader context of performance management, Parliamentary committees should exercise oversight over the action plans for linking budgeting and financial management with service delivery, in key departments.

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