7th Katz Commission hearing report; Intergovernmental Fiscal Review,1999 hearing report

FINANCE SELECT COMMITTEE
04 November 1999
FORMAL CONSIDERATION OF THE SEVENTH KATZ COMMISSION HEARINGS REPORT

This meeting has not been minuted. Attached is the committee report on the Seventh Katz Commission Hearings that appeared in the ATC of 8 November 1999.

Committee Report:
The Select Committee on Finance, having considered and examined the Seventh Interim Report of the Commission of Inquiry into certain Aspects of the Tax Structure of South Africa, referred to it, reports as follows:

A. Introduction
1. The Committee held public hearings to consider the Commission's report. The following stakeholders participated: The Katz Commission, the Financial and Fiscal Commission, the Department of Finance, the Western Cape Finance MEC, the Free State Finance MEC, Idasa, Die Afrikaanse Handelsinstituut and Sacob.

2. Executive summary
The Committee was guided by the report's findings and recommendations. In all the presentations it was clear that section 228 of the Constitution was a guiding framework. Several proposals were put before the Committee:
(1) Personal Income Tax (PIT) surcharge could be an additional means of generating revenue for provinces.
(2) The creation of tax room within the 25% tax receipt ceiling would imply that 5% of the tax receipt will be available to provinces.
(3) While the petrol levy is easier to implement, its side-effects need to be further investigated.
(4) The institution of a tourism/bed levy must be viewed against section 228 of the Constitution. However, it would seem that this section does create room for the institution of such a tax without supporting national legislation.
(5) Airport tax room (for the benefit of provincial governments).
(6) Rural land tax is a viable instrument for generating additional revenue for local government.
(7) The institution of a provincial surcharge would require a transition from the rebate system to an abatement system.
(8) Environmental tax, as a form of user-charge, is a viable source of additional revenue for provinces. However, this must be instituted on a case-by-case basis.
3. The Committee would still like to get more information on the following:
(1) The financial and cost implications of each proposal.
(2) Empirical evidence from other countries of the implementation of provincial taxation.
Since the Committee is aware that South Africa is both a unitary and a developing country, the question of fiscal federalism in South Africa must be viewed within these two paradigms.

B. Public hearings on provincial taxation (11 October)
1. Katz Commission
Given its current collection capacity, SARS cannot implement the PIT surcharge. South Africa's commitment to development will not be reflected if the poorer provinces suffer.
The fuel levy surcharge may be easier to implement, but would encourage cross-border shopping, benefit the richer provinces with their higher fuel consumption and decrease the accountability of provincial governments.
The commission recognises the benefit in fiscal devolution, but advises against hasty implementation of legislation.
It affirms that the total tax burden is not exceeded because of the tax liability/GDP ratio. Unless functional responsibilities about fiscal devolution and assigning taxes are agreed upon before taxes are devolved, revenue will be lost and fiscal imbalance will occur at the centre. The centre must give away some of its tax revenue for the tax burden/GDP ratio to remain at 25%.
It is feasible for a fuel levy to be taxed by the national government or provincial governments, but if applied only by provincial governments, they alone must finance more of its expenditure.
Presumptive taxes provide mechanisms for taxing hard-to-tax groups: Individuals and businesses, able to avoid paying large taxes, should be compelled to declare their actual tax. Taxation should be according to a governmental assessment on what they produce, not on what they claim to produce.
Because of the uneven distribution of economic wealth in South Africa, provincial taxation would affect poorer provinces adversely, and disparities would remain if equalisation grants from the centre do not remain so that poorer provinces can provide the basic services they would not otherwise be able to afford.
The principle of fiscal devolution is not recommended for immediate implementation, but must be symmetrical when all levels of government have the capacity to cope with the administration required and know what the economic impact will be.
If the tax revenue of provinces must remain the same, then increased administration costs that do not actually benefit anyone, should be avoided and must fit the context of South Africa as a developmental state that works to decrease economic disparities.
If fiscal devolution occurs, nine different fiscal deficits will exist, and it will be difficult to co-ordinate provincial budgets and maintain fiscal discipline to maintain macro-stability so that the central system does not disintegrate.

2. Financial and Fiscal Commission (FFC)
The Constitution allows provinces to levy taxes, including the right to flat-rate surcharges on the tax bases of nationally legislated taxes (but which does not affect nationally legislated taxes). The aim is to develop provincial governments into sustainable entities, since currently only 5% of provincial expenditure comes from provincially collected taxes.
The 1995 FFC recommendations in the report stated that -
(1) PIT surcharges are the most effective form of provincial taxation; and
(2) provincial taxation should be collected by SARS and, to avoid duplication, no provincial revenue collecting agencies should be set up.
Provincial taxation on nationally legislated taxes must be on the tax base, not on the resulting tax charge. A small technical change, whereby the current rebate system is replaced with an abatement system, would be constitutionally sound.
The limited capacity of SARS is not justification to stop the PIT surcharge; it merely delays implementation. Since the Constitution gives provinces the right to the PIT surcharge, the following is recommended:
(a) A strategy to factor in surcharges.
(b) Taxing powers, phased in over five years.
(c) An equalisation formula.
The surcharge is regressive: Richer provinces collect more than poorer provinces; nevertheless, any provincial taxation will likewise be regressive. Although the Katz Commission and the Department of Finance had investigated a wider range of taxation areas, the FFC is of the opinion that only the PIT surcharge is of a genuine material nature and that other taxes have too small a financial base.
South Africa is a unitary state, and while there are difficulties in the devolution of fiscal powers, the Constitution gives provinces taxation rights that are not harmful to the developmental nature of the government. South Africa needs fiscal devolution, and the only way forward is to see how to do it, not whether it can be done.
It is the constitutional right of provinces that provincial accountability should be the key aim of a new taxation system. The most cost-effective provincial taxation is the PIT surcharge, since it does not require provincial agencies.

3. Department of Finance
Provincial governments need transparency and accountability, but not at the cost of sound macro-economic policies and national growth and development.
Fiscal devolution gains are not always outweighed by the high risks in a developing country. The cost of fiscal devolution is high, but provinces need taxation powers to promote responsibility, and this will come with time. Parliament must decide whether the cost is too high. In view of this, the administrative and financial costs of implementing section 228 of the Constitution must be given consideration, and perhaps an amendment to that section may become necessary. Other taxation possibilities need investigation, since it is currently impossible for provinces to meet their expenditure.
In respect of taxation, the aim of the Constitution is developmental and at present fiscal devolution is unlikely to be an aid for poorer communities.
Although the national government tax room policy for provincial taxation is fully developed, the GDP ratio policy of 25% reduces the available revenue to the critical share formula. A shift in revenue of provinces will occur.
A PIT surcharge is not considered feasible.
Alternative taxation modes must be investigated.
A fuel levy surcharge must be approached with circumspection: Surcharges are onerous, cause economic distortion and are complex.
With planning, a draft national framework on provincial taxation could begin by the 2001 financial year.

4. Western Cape
It was recommended that provinces be given the ability to tax and raise their own revenue. With greater competitiveness among provinces, economic initiatives and an increased responsiveness to the electorate will emerge.
PIT should be constantly reviewed as a possibility; the surcharge on fuel is desirable; cross-border shopping should show competitiveness of provinces.
The principle of provincial tax should be a priority, and a mechanism should be designed for inclusion under provincial authority. Other forms of tax, such as tourism tax, should receive immediate consideration.

5. Idasa
The implementation of the surcharge on PIT was recommended as more equitable than current arrangements. Administrative arrangements for the collection of such tax are not insurmountable, and this increases provincial accountability.
The accountability of a province for any taxation must be considered before implementation.
There was general consensus on a surcharge and, for administrative reasons, the way it was imposed would determine whether it was equitable or not.
In the case of Gauteng's revenue, a PIT surcharge would actually mean a decrease from 43,2% to 40,6% under certain specific circumstances.
It was confirmed that the goal of the surcharge was to equalise the average per province and every citizen's constitutional right of access to a certain minimum standard of services, as well as to address the need for an equalisation mechanism between provinces.

6. Sacob
Regard should be given to the constraints of SARS in the efficient collection of taxes. Increased taxes administered by employers increase the burden of compliance on businesses.
It was contended that more may be gained from taxation by means of more efficient utilisation of existing taxes. Sacob opposed a proliferation of new taxes; the monitoring of new taxes and compliance thereof is difficult.
There was a suggestion of an alternative taxation instrument for provinces in the form of environmental taxes imposed on companies guilty of abusing the environment by polluting their surroundings.

7. Recommendations
The Committee recommends that, commensurate with the prescripts of the Constitution, provinces be given certain powers to raise revenue. However, this must not be done before the national legislation is in place.
The decision should not be made hastily, but needs to take into consideration the current reality of horizontal inequality, under-capacity and the lack of comprehensive and comparative data. The Committee further recommends that detailed studies be conducted on the following modes of taxation:
(1) Surcharges.
(2) Petrol levy.
(3) Levy on air tickets.
(4) Environmental levy.
(5) Tourism levy/bed levy.
(6) Moving away from the rebate system to the abatement system.
The Department of Finance should address the lack of capacity in SARS by hiring people with the relevant skills. Learning institutions in the country could be approached to design their curricula in such a way that the skills requirement of SARS is met.
Although the Constitution provides for greater fiscal autonomy, it does not say this must be done amidst the developmental challenges that the country is faced with.

8. Conclusion
The capacity of SARS for the administration of a surcharge needs to be determined. The relative importance of the permissible list of taxation powers must be determined. Government decisions must be made with absolute certainty that the poor are not disempowered, and the issue of tax room should be carefully scrutinised in order to ascertain how much juggling of the tax burden could be achieved.
Section 228 of the Constitution requires a national legislative framework on provincial taxation. The FFC will need to make recommendations in this regard, and national objectives should guide any decision on this matter.

Report to be considered.

The Select Committee on Finance, having considered and examined the Intergovernmental Fiscal Review, 1999, referred to it, reports as follows:

A. Introduction
The Committee held public hearings on 12 October to consider the Review. The following stakeholders participated: The Department of Finance, the Financial and Fiscal Commission (FFC), the Northern Province MEC for Education, Arts, Culture and Sport, the Free State MEC for Finance, the Western Cape MEC for Finance and Development Planning, Idasa and Cosatu.

1. Department of Finance
(1) The general consensus was that the document reflects the remarkable progress made by provinces and provides opportunity for discussion of vital issues.
(2) The significance of the document is that it identifies trends, allows comparison of provinces, and facilitates sectoral analysis and highlights disparities, having regard for inherited liabilities from Bantustan administrations.
(3) Remarkable improvements are recorded. The 1995-96 actual expenditure exceeded the budget by 20%. Democratisation resulted in a huge inflow of people, causing incredible expenditure as a result of enormous service delivery and inaccurate information from previous administrations. However, the 1997-98 provincial deficit of R5,8 billion is in stark contrast to that of 1998-99, where provinces emerged with a surplus of R1,1 billion.
Social services spending has steadily increased and accounts for 85% of provincial budgets, and progress in terms of debt repayment has been made.
(4) An important challenge to provinces is personnel expenditure, which makes up 61% of the budget. This rises to 79% of the budget, and all other non-personnel components of the budget, especially those of a capital nature, have been adversely affected. This is crucial, because it could mean that in future we will have teachers without classrooms and nurses without medicine.
(5) In financial terms, co-operative governance works well - increasing equity between provinces and a shift of funds towards poorer provinces. Provinces have achieved macro-stability and we are out of crisis management. Micro-reforms for improved service delivery should be the main focus.
(6) School enrolment has increased from 2,5 million in 1994 to 12,5 million at present. 90% of funds are spent on personnel, and spending has increased from R30 billion to R39 billion in three years.
(7) About 90% of welfare expenditure is devoted to social security and 10% to other welfare services.
(8) The budget for the period 1999-2002 indicates -
(a) cost surprises in terms of personnel expenditure;
(b) provincial pay-off of overdrafts; and
(c) that local government budget systems should be made internationally compliant within three years.
(9) Personnel costs in provinces are effectively expended if the quality of outcome gained is satisfactory.
(10) Persal and financial management systems installed in all provinces are compliant, and faults found lie with managers, not systems.
(11) Provinces engage in healthy provincial competition to be the most efficient and frugal in a democratic budgetary process.

2. Financial and Fiscal Commission (FFC)
(1) Financial management systems employed by provinces must be Y2K-compliant and must be able to detect ghosts in the system and stop the sending of cheques to those no longer employed by the State.
(2) It was noted that the review gives effect to the principles of accountability, transparency and efficiency.
(3) Understanding the budget process is vital for all participants, because a lack of information is disempowering.
(4) Two major concerns are the decline in capital expenditure and the consequences for subsequent generations. Spending on personnel is important, but leaving a tangible legacy of infrastructure is vital.
(5) It was noted that the elections in the middle of the next financial year means that new incumbents are confronted by existing budgets, the detail of which may be unfamiliar to them.
(6) Personnel expenditure should be viewed as investment in people and, as such, as capital expenditure.
(7) It was pointed out that oversight over the budget process, as well as that monitoring of money allocated for a particular task is indeed used for carrying out that function, should be exercised.

3. Northern Province MEC for Education
(1) The challenges for the Northern Province in 1994 were to incorporate four Bantustans and seven education administrations into a new province.
(2) It was considered that more money should be allocated to the Northern Province, because if the education crisis is not addressed, unemployment will continue apace.
4. Western Cape MEC for Finance and Development Planning
(1) The following concerns were raised:
(a) The crowding-out effect of the government's salary bill and the negative impact it has on service delivery is a problem that cannot be ignored.
(b) Own revenue side of province's budgets will have to be addressed with greater vigour. Finance MECs are required to be more innovative, as they are desperately looking to fulfil existing requirements, and there are not sufficient financial resources for them to become initiators.
(c) The Western Cape had to deal with two serious blows, leading to drastic cuts in capital expenditure:
(i) The deterioration of macro-economic conditions, which led to budget cuts.
(ii) The downward adjustment in the 1996 census figures of the Western Cape. This resulted in large cut-backs in the province's allocations.
(2) It is proposed that in future Statistics SA interact with provinces before presenting their census figures.
(3) The MTEF process has nevertheless allowed them to plan early and prepare a meaningful and balanced budget for the current and next two financial years.

4. Idasa
(1) The Intergovernmental Fiscal Review (IGFR) system does not appear to be working to increase social service expenditure on the poor. With tight fiscal constraints, there was a decline in budgeted capital expenditure, in "economic growth departments'" expenditure and in non-personnel budgeted expenditure, especially in health and education. Expenditure decreases were higher in poorer provinces, further increasing the impact on the poor.
(2) The reasons for these expenditure trends are the following:
(a) Provinces budget for reduced deficits and often surpluses in order to boost budget management discipline.
(b) Large expenditure items over which provinces have no control, expand and push out capital, economic support and non-personnel expenditure. For example, salary payments and social security payments use up more than 75% of provincial budgets.
Control of these two items is beyond the power of the provinces. Personnel expenditure is rigid because of the 1996 public service agreement regarding salary increases and the use of voluntary severance packages only, with no retrenchments. Social security payments are rigid because the national sphere sets payment levels and eligibility criteria. However, provinces cannot decide on the level and eligibility criteria of these grants.
Although such decisions are out of the provinces' hands, they were made to bear the financial consequences of national decisions and had to use other revenue to meet shortfalls.
(3) The remedies offered to counter these expenditure trends, were the following:
(a) The application of a horizontal formula.
(b) Making social security payments a conditional grant or shifting this function to the national level.
(c) Giving provinces greater power over human resources management with regard to salary levels and retrenchment.
(d) This submission used budgeted data and therefore did not specifically address the 1999 Intergovernmental Fiscal Review document, but instead focused on a critique of the system itself.

5. Cosatu
(1) The presentation expressed concern about contradictory elements in the report, namely a desire for increased fiscal discipline versus commitment to improved service delivery. It elevates fiscal discipline to an untouchable principle.
(2) It called on both the select and the portfolio committees on finance to table legislation on amendments to money bills.
(3) Its concern is that provincial squeezing does not lead to increased efficiency. Efficiency should be measured by outcomes and not by budget surpluses. Social needs are not subordinated to fiscal targets. Provinces must continue to deliver to the public and budget surpluses should not be the result of deliberate cost-cutting exercises.
(4) Macro-economic policy can advance or regress provincial development. Development objectives appear to be replaced by budget deficit objectives as a result of GEAR policies. A review of the entire GEAR strategy is called for. Provinces could spend all allocated resources and still not meet basic needs.
(5) It is disingenuous to single out personnel expenditure as the culprit to be blamed for insufficient capital expenditure and non-personnel current expenditure.
(6) A shift towards devolved collective bargaining in the public service is noted. This would have a destabilising effect on the public service as a whole.
(7) Capital expenditure can have "multiplier effects". It has the potential to stimulate local demand and boost local growth. Capital spending is a true investment in building a prosperous economy. The falling capital expenditure is a particular concern, for example expenditure on transport, roads and public works - crucial for integrated economic development. 1996 to 1999 reflects a 24% fall in real expenditure in all provinces.
Aggregate capital expenditure was almost halved from 1996-97 to 1999-2000, falling from 8,67% to 4,65%. The cuts tend to be sharpest in provinces most in need of economic development.
(8) It is proposed that -
(a) review should start by attempting to quantify the remaining social backlogs, calculating the resources needed to meet these backlogs and developing short-, medium- and long-term strategies;
(b) IGFR shift from praising provinces to prioritising the meeting of basic needs; and
(c) the Department of Finance commits itself to inclusion of data from local government level in future reviews.

6. Recommendations
The Committee hereby recommends as follows:
(1) Active steps need to be taken to ensure that all provinces have installed Persal and Financial Management Systems that are able to detect ghosts in the system so that payments are made only to those currently in the employ of the State.
(2) More investigation is required on the high personnel expenditure in relation to non-personnel (capital) component of the budget. The following emerge from this:
(a) Would an increase in personnel expenditure "crowd out" capital expenditure?
(b) Could personnel expenditure be categorised as a component of "human" capital expenditure?
The Committee requires additional input from State Expenditure and Finance.
(3) The provinces themselves would have to optimise the collection of user-based provincial revenue.
(4) The Committee would, in future publications of the Intergovernmental Fiscal Review, like to see the following:
(a) A similar review on local government finances.
(b) A quantification of the level of social services purchased, indicated by the current spending pattern.
(c) A periodic release of the Review with necessary adjustments.

7. Conclusion
The Committee commends the Department of Finance for instituting this study, as reflected in the Review. The study is a watershed in the evolution of provincial budgetary procedures within a unified South Africa. It is comprehensive and egalitarian in its approach since it demonstrates provincial commitment to social services, and introduces stability and predictability in intergovernmental fiscal relations. It also helps to incorporate expenditure needs of the provinces thereby promoting interprovincial equity.

Report to be considered.