Financial and Fiscal Commission: briefing

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Finance Standing Committee

16 August 2004
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Meeting report

FINANCE PORTFOLIO AND SELECT COMMITTEES: JOINT MEETING
17 August 2004
FINANCIAL AND FISCAL COMMISSION: BRIEFING

Co-Chairpersons: Mr T Ralane (ANC) and Dr Rob Davies (ANC)

Document handed out:
Financial and Fiscal Commission: Presentation to Committees
FFC: Submission for the Division of Revenue 2005/05

SUMMARY
The Financial and Fiscal Commission (FFC) briefed the Committees on its annual recommendations for the division of revenue between provinces for 2005/06. Among the main recommendations were: a need to beef up the revenue raising powers of the provinces; the allocation formula should be revised to take into account the fiscal disabilities of the different provinces; the social development grant should be removed from the provincial equitable share; during the transition to the Social Security Agency, social security might be funded via conditional grants or other appropriate mechanism and the basket of services that fall under social welfare services should be re-defined.

The FFC was concerned that municipalities were beginning to cede their future equitable share allocations as security in order to obtain loan finance. The local government equitable share is meant to ensure that municipalities are able to provide basic services, perform their functions and fulfil their developmental mandate. If a municipality ceded its future equitable share allocations, debt default by that municipality could divert its allocation to the creditor and could thereby compromise the delivery of constitutionally mandated basic services, the FFC felt.

MINUTES
Dr R Mokate, FFC Chairperson, said its roles included contributing to the development of the intergovernmental fiscal relations system, making recommendations on the equitable division of national revenue and advising on a wide range of issues like the criteria for allocations. It has nine Commissioners who are appointed for a five-year term. The Commissioners are expected to be independent and impartial in discharging their duties. The Commission reports to Parliament, provincial legislatures and organised local government. It has regular interaction with the National Treasury, national Departments and Statistics South Africa. Its budget is funded from the fiscus.

Mr B Khumalo, FFC Manager: Fiscal Policy Analysis focused on the provincial equitable sharing system. The Commission's proposals take into account the provisions of Section 214 (2)(a-j) of the Constitution. There is a need to beef up the revenue raising powers of the provinces. If provinces do not raise sufficient revenue they will have very little choice in terms of the mix of services that they would provide. The allocation formula should be revised to take into account the fiscal disabilities of the different provinces. The social security grants should be removed from the Provincial Equitable Share (PES) formula and moved to the national government. The social security grants are cash transfers to individuals and provinces do not control the take-up rates. If the take-up rates and grant amount increase there might be pressure on the other components of expenditure. This is exacerbated by the fact that provinces do not raise a significant amount of revenue.

The Early Childhood Development (ECD) programme needs to be incorporated into PES. The school age cohorts in the formula should take into account the five-year-olds that are turning six. The current education component should be augmented by at least the full amount of the conditional grant that was assigned to the ECD. It is useful to consider the entire school education system as a single component as far as basic education is concerned. The definition of basic education needs to be clarified.

With regard to health care services, the formula should be revised to take into account population groups with different medical needs. The use of public health facilities depends on the age composition of the population. The formula has two components, i.e. population covered by medical aid support and population without medical aid support. The volume of transfers for health is determined on the basis of the two variables, with the latter variable weighted four times more than the former. In the formula, population is the only factor used for allocating resources under the PES formula for health care expenditure and the population without medical aid is weighted four times. The reasoning behind this is that population without medical aid is likely to use four times the public health facilities provided by the provinces as compared to those with medical aid support. This is, however, based more on judgment than on any objective survey information.

The social development grant should be removed from the PES. During the transition to the Social Security Agency, social security might be funded via conditional grants or any other appropriate mechanism. The basket of services that fall under social welfare services should be defined. Cabinet has accepted this recommendation and put it into effected by establishing the Social Security Agency. The question is what amount of money should be taken away from provinces given the fact that provinces were already spending more than the formula allocates. Over and above the social security grant, the social development programme is also supposed to cater for the financing of welfare services.

An issue that arises with the shifting of the administration of social security grants from provinces is what happens to the financing of the welfare services element of the social development component. There is a need to investigate what actually constitutes the basket of welfare services, how the financing mechanism is determined, and who actually delivers the services. In terms of the budgeting process the status quo should remain and there is a need to budget together for welfare services and the social security grant until the basket of welfare services is defined.

The economic activity component carrying a weighting of 7 percent is a proxy for provincial tax revenue. It is distributed among the provinces on the basis of the share of remuneration of employees. Creation and maintenance of physical and social infrastructure depends on economic activity and the component is meant to support this requirement. There is no clear rationale for using remuneration data as a means to determine allocations. However, using economic activity, as a proxy for infrastructure maintenance is problematic as it is bound to be regressive. In making recommendations on the division of revenue, the FFC is required to take into account the fiscal capacities of the provinces and local government. The FFC had proposed a tax capacity equalization component because there was no enabling legislation for implementation of the revenues assigned to provinces.

The FFC believes that the backlog component is not servicing its purpose. It is suggested that backlogs should be funded through a conditional grant.

There are a lot of obstacles in the use of conditional grants. Provinces have very little decision-making powers and therefore there is very little innovation and creativity on the utilization of the grants. One would like to see some relaxation of the conditions.

Mr Josie added that conditional grants are recommended in areas where provinces have not made adequate allocation for meeting serious priorities. The backlog component was notional and it became clear that very little of the money was used for addressing infrastructure backlogs. The money is inadequate for infrastructure backlogs and ongoing capital needs. It is recommended that the component should be removed because it serves no purposes. Provinces do not have powers to borrow money and this compromises the delivery of constitutionally mandated basis services.

Dr H Fast (Manager: Parliamentary Office) dealt with the local government equitable sharing system (LES). The FFC proposed a formula for the LES: LES=S+B+I+T. The S (basic services) component is intended to provide basic services. The list of basic services needs to be specified and should reflect provisions in the Bill of Rights. The key principle is that everyone is entitled to a basic level of service but there might be different types of service delivery according to circumstances of a given municipality. The FFC has adopted an approach to estimate the cost of basis services. Unfortunately there is no reliable estimate as to what it costs to deliver a basic service. This is due to lack of data and absence of clarity on what constitutes a basic service. The methodology for measuring costs should not be too data intensive and calculations should be built up separately for each basic service.

The I component is for capacity maintenance and not capacity building. There is a need to define core capacity according to legislative obligations.

The FFC has expressed concern that revenue-raising capacity is not sufficiently captured in the current formula. In its submission for the Division of Revenue 2002/03, the FFC recommended that one overall revenue-raising capacity measure should be included in the local government equitable share formula.

The new Municipal Infrastructure Grant (MIG) combines infrastructure allocations of various Departments. Government currently has no plans to link the local government equitable share formula with the proposed MIG formula. If the MIG and LES are linked, government should take the need to achieve equity into account. One should also be mindful of the need to ensure that LES allocations keep pace with the installation of new infrastructure.

Municipalities in South Africa are beginning to cede their future equitable share allocations as security in order to obtain loan finance. The FFC was concerned about this practice. The local government equitable share is meant to ensure that municipalities are able to provide basic services, perform their functions and fulfil their developmental mandate. If a municipality cedes its future equitable share allocations, debt default by that municipality could divert its allocation to the creditor and could thereby compromise the delivery of constitutionally mandated basic services. Ceding equitable share revenue is constitutionally permissible. It would be preferable if some safeguards were applied to ceding of equitable share revenue. However, it should be noted that the provisions of the Constitution and national legislation provide an overall safeguard, that is, a municipality may not exercise its power to cede equitable share revenue in a way that undermines its ability to meet socio-economic and developmental needs.

Mr C vas Gaas (Manager: Budget Analysis) did a review of the intergovernmental fiscal relation system. He looked at previous recommendations by the FFC in the context of this year's submission. The costed norms approach was introduced for the 2001 Medium-Term Expenditure Framework (MTEF). It is an analytical tool used to identify constitutionally mandated basic services and measuring and costing outputs and outcomes to enable the setting of minimum and affordable national standards and norms.

In 2002, the Commission started with the process of identifying constitutionally mandated basic services and defining progressive realization of those rights. This involves defining target population groups to enable the measurement of take-up rates.

In last year's submissions, the Commission raised issues around performance monitoring. A distinction was made between financial inputs, service delivery outputs and policy outcomes. The Commission also looked at poverty targeting. This forms an important chapter of this year's submission. There are various costs and benefits of poverty targeting. It is important to measure the impact of government programmes on poverty reduction. Distinctions are drawn between income, capability and asset poverty. The FFC proposes that progressive improvements in policy output measures are a priority. One needs to know the take-up rate or access to each of the constitutionally mandated basic service. Independent and official administrative instruments should be instituted to assess the impact of government programme benefits and the quality or level of the service. A more consistent and precise official definition of the employment status of the economically active population, taking into account all sources of income, should be put in place in order to facilitate programme planning and budgeting.

There is also a need to introduce new budgeting systems and to link this to strategic plans. The government is in the process of introducing accrual output based accounting systems. There is a need to look at the costs and benefits of introducing new budgeting systems. This is important because new systems come with their own extra human resource, IT and operational costs. The question is whether the new system would lead to improvements in efficiency and effectiveness in service delivery and information flow. Rather than introducing a new system there should be an identification of, amongst others, what the outputs and outcomes are meant to be, the data that is required and the data gaps.

Mr Josie focused on the availability of data and its relationship with service delivery. It is difficult to measure service delivery without reliable data. The equitable share allocation heavily depends on population numbers and household income as a measure of poverty and this is inadequate. It is difficult to measure poverty. It is important to define poverty within the confines of what the Constitution obliges the government to do. The question of data becomes important in this regard. A census is conducted every five years but in most instances the information is outdated by the time it has to be used. The government should pool municipal household surveys. The government should provide a definitional norm for household income poverty.

Discussion
Ms S Asiya (ANC) asked how the data collected by Statistics South Africa helped the Commission in its work.

Dr Mokate replied that the Commission has a close working relationship and interacts intensively with the State in order to carry out its function. Statistics South Africa is an important role player. The FFC is entitled to request information from various organs of the State in this regard.

Mr N Nene (ANC) said that part of the FFC's mandate is to make annual recommendations on the horizontal and vertical division of revenue. He asked how serious the recommendations of the Commission are taken and whether the Commission was satisfied with the impact of its recommendations on the division process.

Mr J Josie replied that Parliament is better placed to know if the Commission's recommendations are taken into account. The FFC reports to Parliament and Parliament in turn has the responsibility to ensure that the recommendations are considered. The budget review process captures the way government responds to the Commission's recommendations. The government accepts many of the recommendations. In cases where the government has some reservations, one finds that the basic principles of the recommendations are accepted. There might be some questions regarding the timing of the recommendations. The whole notion of an MTEF cycle was a recommendation by the FFC. Even the idea of costed norms was not rejected but qualified and accepted as an analytical tool. There is a strong sense that the FFC plays an important role in influencing the process. The Commission does all the budget analysis.

Ms R Taljaard (DA) said that there is an increasing reliance on the assistance of the FFC by government especially on the implementation of the Municipal Finance Management Act. She asked how one strikes a balance between the FFC's oversight role and the increasing pressures to also function as an advisor in the implementation of legislation.

Mr Josie agreed that the Commission plays an oversight role and that there was a need to strike a balance between how the Commission makes recommendations and at the same time plays its oversight role. The Commission "hides" behind the Constitution and other legislation. The Constitution provides that there has to be provision of basic services. There might be a cut-off point for any allocation to ensure that there is progressive service delivery. The Commission uses the considerations mentioned in Section 214(2)(a-j) of the Constitution in making its recommendations and playing its oversight role.

Mr Ralane agreed that the responsibility to ensure that the Commission's recommendations are taken into account lies with Parliament. Committees should go through all of the Commission's recommendations and see which recommendations were not taken into account.

Dr R Davies noted that the FFC recommended that the powers of provincial governments to raise revenue should be increased. He asked if the FFC had any view on the impact this might have if provinces did it unevenly. He pointed out that there are newspaper reports indicating that the motor licensing fees are higher in the Western Cape than in the Eastern Cape and some of the car rental companies are taking their cars to the Eastern Cape for licensing. This means that there might be some transfer of revenue from one province to another. He said that it is important to encourage infrastructure programmes to be labour absorbing.

Dr Mokate replied that the issue of raising revenue was dealt with in the Constitution. It is a dimension of intergovernmental fiscal relations. Not all taxes should be collected by the national government. Within the Constitution, the Commission is required to look at tax capacities and efficiencies within the different spheres of government. The Commission observed that there were provincial and local sphere taxes that were already in place and the question is whether they are being utilized. It is also important to find out if there is further room for them to raise their own revenue. Some governments would have a greater tax base but the question is whether the governments are putting maximum efforts into raising revenue from the available base. Given the disparities between provinces one needs to look at tax equalization mechanisms in order to ensure that revenue-raising capacity does not exacerbate the inequities. Because of lower tax rates in one province or municipality there might be a shift of economic activities. The kind of recommendations that the Commission made would not have this kind of impact. If any unintended consequences arise the Commission would make recommendations on how to tackle them.

Mr Khumalo added that the Constitution indicates that there is a need to avoid the imposition of taxes that would have negative consequences for a province. The Western Cape story is an intriguing phenomenon but it has not lost out on revenue. The question is how big the migration is and what sector is involved. The difference in taxes between the Eastern and Western Cape does not necessitate great migration to such an extent that Western Cape has to lower its taxes.

Ms Taljaard noted that the Commission is proposing some changes to the formula despite current changes in policy. She used the establishment of the Social Security Agency as an example. She asked how one conducts fundamental policy review whilst there are so many outstanding bits of policy that still need to be finalised and have material impacts on the formula itself.

Dr Mokate replied that the FFC has always operated within an environment where there are constant policy changes. However, this is no reason for the Commission to stop making recommendations. As the Commission makes recommendation, it indicates the impact policy changes would have and the principles that should be taken into account.

Mr Khumalo added that the allocation formula relies on demographics. Every year the Commission updates the demographics in response to population projections. The population projections in between censes do not always give accurate pictures of what has been happening to the population dynamics. The formula should be able to adjust to changes.

Mrs R Joemat (ANC) asked how the restructuring would alleviate the problem of unemployment.

Mr Josie replied that government might include labour intensity as a condition to the grant.

Mr Asiya found it difficult to understand why the Commission could make important recommendations based on questionable data.

Mr E Sogoni (ANC) felt that there is a need for a debate on the issue of provinces raising their own revenue. He found it difficult to understand the formula used in the allocations. He indicated that most of the tertiary health institutions are located in either Gauteng or Western Cape provinces. This forces people who want to access them to move to those provinces. He asked if the formula took this into account. He wondered if the FFC gets feedback on the ability of provinces to fully utilise their allocations. The PES allows provinces to prioritize their expenditure. He was concerned that if conditions attached to conditional grants are relaxed provinces might divert the money to some other projects.

Mr Khumalo replied that the fact that most of the tertiary health institutions are found mainly in two provinces puts the demand for their services on a higher level. There is a conditional grant that was designed to specifically took this into account. The FFC would in the near future unpack the decisions that were taken in relation to the allocation of the grant.

On the relaxation of conditions he said provinces have different capacities to use the grants. If one says that all provinces have to adhere strictly to the conditions then innovation in the use of the grants would be stifled. There might be a case for relaxation of some of the conditions. There is legislation to ensure that funds allocated for national priorities are not diverted to other projects.

Mr T Vezi (IFP) was concerned about the lack of capacity to spend available funds. He asked if the Commission had any ideas on how to address this problem. He commented that people always say that the Eastern Cape is the poorest province but tend to forget the demise of the economic system in the province was brought about by the mining industry.

Dr Mokate replied that the question is what Parliament has to do in terms of its oversight role. It is important to identify the location of the problems.

Ms Taljaard said that it is important to know the link between the roll out of the expanded public works programme and the operation and maintenance of the infrastructure that would be constructed in accordance with the MIG. She asked how one could formalize the link and if there are any legal impediments that the Commission had identified.

Dr Fast replied that if a municipality has only 20% of its population that has water infrastructure the maintenance cost would be lower. One option is to scale back the equitable share allocation. The difficulty is that at the same time there is a huge obligation to put capital infrastructure in place. So if one takes away with one hand then more should be given with the other for capital infrastructure. There is a need for further work on how to formalize the link and one needs reliable data to do this.

Ms Taljaard noted that the Commission alluded to possible amendments to the Municipal Finance Management Act to deal with revenue ceding by municipalities. Concerns were raised about the chapter dealing with debt management when the legislation was enacted. She asked if the Commission had any specific amendments in mind.

Dr Fast replied that the FFC monitored the MFMA process. It is not surprising that there are some problems being encountered. The problems relate to Sections 48(3) and (4). Because of their specific phrasing they do not apply to the ceding of equitable share revenue.

Mr V Xaba (Chairperson of the Standing Committee-Kwazulu-Natal Provincial Legislature) said that there is a debate on whether the weight attached to welfare is correct given that a number of provinces had seen exponential growth in their social welfare budget. He noted that the Commission is still not prepared to increase the school age cohorts and go beyond the age of sixteen. There are over-aged learners who are still in school, not because they have repeated some classes, but because they started schooling late.

Mr Khumalo agreed that some of the weights are no longer appropriate. With regard to education, he said that the double weighting should be ended. If the age cohorts still have to be taken into account there should be 50-50 weighting of school age cohorts and school enrolment. In some poorer provinces learners start going to school at a later age given the distance they have to walk to school.

Dr Davies said that it is one thing to say that most allocations are made to municipalities that have higher unemployment but this does not guarantee that the municipalities themselves would employ more labour intensive techniques. One is talking about "a" and not "the most" labour absorbing technique. The FFC should continue to do research on this.

The meeting was adjourned.

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