Financial Fiscal Commission Submission on Division of Revenue 2002/2003: hearings

NCOP Finance

26 August 2001
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Meeting report

FINANCE SELECT COMMITTEE

FINANCE SELECT COMMITTEE
27 August 2001
FINANCIAL FISCAL COMMISSION SUBMISSION ON DIVISION OF REVENUE 2002/3: HEARINGS

Relevant documents:

Financial Fiscal Commission Powerpoint presentation
Financial Fiscal Commission submission on the Division of Revenue 2002/2003
Western Cape Department of Finance response to FFC submission (see Appendix)

Chairperson: Ms D Mahlangu

SUMMARY
The Financial Fiscal Commission briefed the Committee on its submission on the Division of Revenue 2002/3. The Western Cape Provincial Treasury gave its response to the FFC submission.

The FFC's current focus is local government. Of great concern is local government's inability to meet its constitutional mandate of delivering basic municipal services. The Committee appeared to be impressed by the FFC's attempts to facilitate local government in meeting its constitutional mandates.

Discussion on the Western Cape Provincial Treasury response was delayed as the Committee had not had the opportunity to peruse the document prior to the meeting.

MINUTES
Members of the Western Cape provincial legislature attended the meeting and the Chairperson invited them to fully participate in the proceedings.

Financial Fiscal Commission (FFC)
The delegation comprised of Mr Murphy Morobe (Chairperson), Mr Jaya Josie (Deputy- Chairperson), Ms Hildegarde Fast, Ms Kim Bhiko, Mr Louis Kathan, Prof L Loots and Mr Phillip Van Reyneveld.

Mr Morobe gave a brief overview of the FFC's mandate and current. The FFC has the task of seeing that the distribution of revenue between the national, provincial and local sphere of government is made on an equitable basis. Much work has already been done on the national and provincial sphere. The focus of the FFC is now on local government.

Mr Josie reiterated the FFC's focus areas. He emphasised that a major problem was that constitutional mandates on basic service obligations were not being met. The need to have priority funding for health, education and welfare has already been identified. The next logical step for them was to identify norms and standards with which to achieve these aims. He was adamant that norms and standards would first have to be established before any review of the current equitable share could be envisaged.

Mr Josie briefly touched on the issues of the national equitable share and the provincial equitable share. On the national equitable share, he felt that constitutionally mandated basic services should be a priority and that criteria need to be set for the use of contingency reserves. As far as the provincial equity share is concerned, the focus areas has been on provincial taxes and capital grants. He stated that provinces should be given more autonomy on the collection of taxes and the rates that would be levied. This could be a major source of revenue for provinces.

Ms Fast continued with the presentation on the local government equitable share which has been focus of much debate by various stakeholders. Ms Fast felt that the FFC's recommendations in this regard would significantly facilitate the process.

Section 214(2) of the Constitution states that the equitable share should enable local government to provide basic services and to address developmental needs. Ms Fast stated that the problem is that there is no clear definition of what "basic municipal services " are. There seems to be a lack of consensus as people in general have different views on what basic services should be. To some it might be water and sanitation whilst to others it might be electricity and drainage. It is therefore apparent that the need exists for a clear definition of what constitutes a "basic municipal service".

Ms Fast stated that the FFC have used the Constitution and other legislation as a guide to set five criteria which would have to be met in order for a service to be classified as a "basic municipal service". They are as follows:
- Schedule 4B/5B of the Constitution
- Bill of Rights
- Essential for life (Municipal Systems Act definition)
- Promotes development (S153 (a) of Constitution)
- Highlighted in policy and legislation.

Some of the possible suggestions that the FFC has come up with are potable water, sanitation, municipal health, firefighting, stormwater drainage, refuse removal, municipal roads and electricity. However this list is by no means a closed list.

Another challenge facing the FFC was to calculate the actual cost to the municipality in delivering the basic services. This therefore necessitated technical changes to be effected to the current equitable share formula so as to take physical capacities of municipalities into consideration when making calculations. As usual funding was identified as an obstacle. In many rural areas residents do not have basic services due to the lack of infrastructure of their municipalities. The FFC suggests that in areas where municipalities lack infrastructure, cutbacks should be made on their equitable share allocations whereas increases should take place in their capital funding.
The rest of the presentation mainly dealt with the technical detail on local government infrastructure, borrowing and funding. For detail please refer to the attached documents.

Discussion
The Chairperson commented that it seems that government has no idea of what the cost of basic service provision is. She asked what should the criteria be to determine local government contingency reserves.

Ms Fast stated that in the period 1995-1996 a survey was conducted and the outcome was that the cost of basic services is R86 per household. She did however emphasise that not much credibility had been attached to the figure and that it also had not kept up with inflation.

Mr Morobe added that the need exists firstly to identify what a contingency is. He pointed out that at present there are a whole variety of definitions for the term. Conformity in the use of the term must first be achieved before attempting to solve issues pertaining to it.

Ms T Essop (Western Cape Provincial Legislature) stated that not much had been said on the Capital Grants Model. She asked for clarity on it.

Prof Loots stated that there are two reasons for capital grants. The first being due to historical backlogs and the second is that government had inadequately spent on infrastructure and capital projects. He emphasised that the need exists for benchmarks to be set for capital spending. This would in turn help to identify what the capital base should be. The model in essence identifies what the asset capital stock is and also what the spending pattern is at present. If it comes to light that there are deviations from the ideal, the model makes provision for the development of programmes to deal with it. Prof Loots explained that they were able to set ideal estimates from benchmarks that they had obtained from overseas.

The Chair noted that there had been much discussion on the issue of local government having to fund health services. She asked whether the FFC supports the shift of health services funding to local government from the provinces.

Ms Fast stated that at present the proposed shift from provincial to local funding of health services only relates to environmental and preventative health but not to curable health, that is, treating the sick. She did forsee it including curable health in the future. Ms Fast stated that the shift from provinces to local government would take place in varying degrees in various provinces, depending on their capacities.

Dr E Conroy (NNP, Gauteng) stated that not much had been said on the possibility of surcharges being placed on personal income tax by the provinces. He added that in previous discussions it was decided that it would not be viable in the South African context. One of the problems identified was that some of the smaller provinces would not be able to generate sufficient revenue from the surcharges and as a result they would be in worse off positions than if they had received their equitable share.

Mr Morobe replied that the FFC still feels strongly about the possibility of surcharges being implemented on a provincial basis. He insisted that it would be the single greatest revenue generator for the provinces but stated that he was wary of the consequences if they should try to implement it in haste. The fact that certain provinces are financially stronger than others has been borne in mind by the FFC as tax equalisation mechanisms have been developed to address this.

The Chair asked whether the issue of councilor remuneration has been addressed.

Ms Fast stated that they have a submission on the issue and that it would be forwarded to the Committee shortly.

Western Cape Provincial Treasury
Mr C Ismay and Mr A Gildenhuys represented the Western Cape Provincial Treasury. Mr Ismay presented the province's detailed response to the FFC's Division of Revenue Report 2002-2003 (see Appendix).

The Chairperson was disappointed that the submission had not been forwarded to the Committee beforehand as it would be difficult for members to engage discussion on a document that they had not had opportunity to work through.

Ms Essop (Western Cape) suggested that members be given the opportunity to scrutinise the submission so as to engage in meaningful discussion with the provincial treasury. Mr Morobe (FFC) agreed with Ms Essop and asked that the FFC be given time to formulate a proper response to the submission. The Committee agreed to this and the meeting was adjourned.

Appendix:
WESTERN CAPE PROVINCE: DEPARTMENT OF FINANCE 27 August 2001

SUBMISSION TO THE WESTERN CAPE STANDING COMMITTEE ON FINANCE, DEVELOPMENT PLANNING AND GAMBLING RE COMMENTS ON THE FFC'S DIVISION OF REVENUE REPORT 2002 - 2003, JUNE 2001

INTRODUCTION
- The Committee Co-ordinator's notice of 26 August 2001, regarding the hearing in the above regard, has reference.

- In general, it is observed that the FFC's submission mainly serves to reinforce its prior recommendations to government, and does not depart from the principles underpinning earlier FFC recommendations.

- It sets out the principles and methodology that the FFC is presently employing, wishes to employ in the long run, or will employ in the interim in its advice on the division of revenue between the spheres of government, and amongst provinces and local authorities.

- Some new aspects contained in the FFC submission are:
· Much more attention being paid to the funding mechanisms for local government.
· Increasing attention to the use of basic service costs as determinant of the division of revenue amongst provinces (also amongst local authorities).
· A formula-base for capital grants to provinces.

- The FFC proposals are not quantified which makes it difficult to evaluate the proposals properly.

DATA
The FFC stuck to the costed norms approach as far as the provincial equitable share is concerned, albeit in a slightly more refined way. The criticism levelled at their previous proposals in this regard is still valid, namely that such an approach requires acurate data about a number of issues before it can be applied to the equitable division of revenue. Also see paragraph 4.4.2 below.

NATIONAL REVENUE (PAGE 4)
The description of "total national revenue available for equitable division" is questionable in view of the wording of section 214 (1) (a) of the Constitution that refers to "the equitable division of revenue raised nationally among the national, provincial and local spheres of government". It can be argued that all nationally raised revenue is available for the equitable distribution, and not only the net result after provision is made for debt servicing costs.

BASIC SERVICES (PAGE 18)
- The overall impression of the submission is that the FFC made a reasonable attempt to give practical content to the list of factors in section 214 (2) of the Constitution that must be taken into account when the actual division of revenue is made. It is, however, mentioned in the submission that further research is intended to provide "clear definitions of constitutionally mandated basic services and other constitutional obligations" in order to assist in the determination of the equitable division of revenue. Such research should be undertaken as soon as possible.

- Legislatures are responsible, in terms of the Constitution and in accordance with the classic division of powers, to provide a check on the executive and thus to monitor its performance. Courts on the other hand do rarely interfere in political judgements about the allocation of funds in a budget, but it should be able to pronounce on the way effect is given to the constitutional requirements of arriving at an equitable division and whether constitutional mandates are being fulfilled. It can only do so if the financial equalisation process or equitable share mechanism is constitutionally described in a way that would allow for objective assessment.

- Reference is made to recent court judgements that impacted in some way on the question of funding of action plans to fulfil the constitutionally mandated basic service obligations as referred to in the Bill of Rights. It is essential that the implications of the provisions in the Bill of Rights on budgets in all three spheres of government, but more so on all the sub-national governments, be properly considered with a view to improve the equitable share mechanism as suggested by the FFC. No province or municipality can afford to spend huge amounts on complex litigation regarding the allocation of funds to the respective provincial or municipal functions, while they barely have sufficient funds to give effect to their respective constitutional mandates to provide basic services. Although provinces and municipalities might argue that their equitable shares should simply be proportionally increased to give effect to the realisation of the right of access to housing and other socio-economic rights, it is a complex matter that warrants further research and consideration.

- There are a few dangers involved in the use of the costs of basic services in the division of revenue, as envisaged by the FFC:
· Given that provincial finances took long to stabilise, stability in provincial allocations is now seriously needed in order to allow greater attention to service provision rather than to fiscal adjustments. Any new equitable share formula that disrupts stability should be avoided for this reason, whilst if the new methodology does not lead to any significant shifts, it could be asked whether it makes any contribution at all.
· The information needs of the new approach are immense, and subjective decisions on what is basic, needs to be made at each step along the way. For example, in Education one needs to determine the "basic" teacher-pupil ratio at each level of education, for different types of schools, and for different subjects. In addition, decisions would need to be made about the "basic" qualifications and seniority of teachers required, the learning materials, furniture, etc. All schools and parent bodies would then in future be able to argue that these "basic" levels of inputs must be provided, thus forcing provinces to ensure that their education funds are allocated as per basic costs, without consideration to other priorities and long term planning.
· Provincial discretion is likely to be reduced if provincial funding becomes largely based on costs determined for basic services, with the underlying assumption that such services are constitutionally mandated. That places an effective floor under the value of such services to be provided by provinces before they can use any discretion in expenditure decisions. If a province wishes to expand Health spending to higher levels and funds this by reducing its funding of Education below the FFC-determined basic cost of education, it may possibly face pressure and even litigation to force it to provide at least the basic costs as determined for Education.
· This problem may be reduced if the costs of basic services is set low and provincial funding considerably exceeds the basis costs of services. The question that then arises, however, is whether this approach then contributes anything new.
· The only alternative way of using the FFC approach without reducing the funds over which provinces have discretion would be to change the vertical split, to the benefit of provinces. This may seem warranted, given the great demands being made on provincial governments to meet social needs, but the FFC does not really address this question.

- A major theme of the FFC submission is that minimum national standards should be defined for constitutionally mandated services, and that the equitable share allocation to provinces should be linked to the cost of provision of these minimum standards. To the extent that the level of standards within the Provinces exceed the service standard level set through national policy, this could result in a reduction in the Province's equitable share. The clear definition of minimum standards for basic service delivery, as pointed out by the FFC, could help to mitigate concerns expressed in court judgements that the equitable share does not address the progressive realisation of socio-economic rights. But such an approach has two main preconditions:
· The definition of minimum standards is essentially a political, not a technical exercise. Internationally, it has been very difficult to get politicians to commit to strictly defined minimum standards of service delivery for which they will be held accountable by the public. It is highly unlikely that the situation in South Africa would differ much from the international experience, yet without very precise definition of standards, it would be difficult to cost such services in some cases such as health care.
· Even if minimum standards were clearly defined, there are currently no effective costing systems across departments and cost data are sparse. This has been acknowledged by the FFC in their submission. Before implementing a minimum standards approach, there needs to be thorough understanding of the cost structures and cost drivers pertaining to the services in question.

- The provinces need to consider the impact of rigidly defined minimum standards on the flexibility of its budget. Currently provincial governments do not have much discretion in allocation of its budget - social security spending, personnel spending and conditional grants are, by and large, outside the control of the provincial government. Creating fixed minimum standards in other services like health could possible reduce the degrees of freedom remaining in the provincial budget, depending on how these standards are defined and at what level they are set. It is not clear what the impact of these minimum standards would be on fiscal risk, and this should be studied further. If, for example, a macroeconomic shock decreases the total equitable share amount available to the province, but minimum standards create a spending "overhead", then declining equitable share, coupled with very limited own revenue resources and rigidly defined minimum standards on the expenditure side could expose the province to fiscal risk. This may be exacerbated by litigation brought against the province should it not be able to deliver on the minimum standards under fiscally constrained circumstances.

PROVINCIAL BORROWING (PAGES 23-27)
The FFC (page 27) endorses the cautious approach to provincial borrowing adopted by the National Treasury until such time that the necessary capacity for debt management is developed. This prudent approach is to be applauded. However, some provinces, may be in a position to acquire such capacity relatively quickly, its prerogative to exercise its constitutionally conferred powers should not be foreclosed permanently. A coherent provincial borrowing framework should be put on the table as soon as possible. The FFC's proposal "In the absence of provincial borrowing, the national sphere should make capital grants available to provinces. Alternatively, national government should take responsibility for the bulk of capital expenditure, even in the provinces." This might be an option in the short term, but in the long term this practice may dilute provincial accountability (i.e answering to the national sphere rather that the province's citizens) and may create problems such as a lack of coordination between capital and operating budgets, especially in respect of maintenance.

PROVINCIAL TAX (PAGES 19-23)
- The FFC has proposed a review of the current equitable share formula to take into account pending provincial tax legislation. It is very important that the equitable share is not re-adjusted to create disincentives for the province to exploit fully its own revenue potential. This would be in conflict with section 227(2), which states that "Additional revenue raised by provinces or municipalities may not be deducted from their share of revenue raised nationally, or from other allocations made to them out of national government revenue. Equally, there is no obligation on the national government to compensate provinces or municipalities that do not raise revenue commensurate with their fiscal capacity and tax base."

- Year after year the FFC recommends that tax room should be created for provinces and this time around is no exception (p 7, 19 - 23). So far little attention has been given to these proposals. The current Provincial Tax Regulation Bill, which is an attempt to give effect to the constitutional requirements in section 228 (2) of the Constitution, has constitutional defects and does not really help provinces in developing more own sources of revenue. The current discussion by the FFC of various potential taxes and the potential yield it can produce for provinces is quite useful. Provinces should utilise these proposals to their benefit in a progressive and asymmetric way. It is, however, respectfully disagreed with the suggestion that environmental taxes are inappropriate for provinces "for efficiency and administrative reasons". If a province decides to levy an environmental tax, e.g. a tax on the emission of pollutant gasses by motorvehicles, it can be administered and collected effectively by way of an addition to a vehicle's licence fee. A vehicle owner should then be required to have the vehicle tested by the relevant testing station/traffic authority on an annual basis and the emission tax can be levied on submission of a certificate to the license authority stating the emission level of that car.

- The principles of good government, including responsibility and accountability, suggest that governments should be responsible for raising substantial portions of their revenue and deciding over the expenditure themselves in accordance with their constitutional mandates. This implies that provinces should progressively utilise their tax room in order to fill the current accountability deficit that exists because of the fact that provinces receive more than 90% of their revenue through the equitable share mechanism. An alternative or an additional way of addressing this need is to create a bigger say for provinces at a national level when decisions are taken about the level of taxation and the actual division of revenue.

- With regard to the Provincial Tax Regulation Bill the FFC suggests "…..the provincial equitable share formula may need revision. The "T" element may need to be activated and used to equalise tax revenue capacity." Given that additional provincial tax revenue are most likely to be very small, the costs of complicating the equitable share formula to accommodate these changes have to be weighed up against the benefits (which may be marginal).

CAPITAL GRANTS MODEL (PAGES 27-29)
- In its Capital Grants model, the FFC uses Australian data as the norm by which "efficient" levels of capital expenditure are determined. Australia's per capita income is seven times that of South Africa, thus South African capital needs for social services cannot possibly be estimated from this data. Using an inappropriate benchmark has implications not only for the envisaged "ideal" level of capital stock (thus perhaps encouraging over-investment in fixed capital whilst recurrent expenditure needs may be greater), but the ratios between the capital stock per capita in Health, Education and Welfare in Australia are unlikely to be ideal for South Africa. Thus the South African structure of health services, in terms of its split between private and public provision, makes the Australian benchmark largely irrelevant. Using an "international capital stock benchmark" drawn from Australia may thus be problematic. The ideal capital stock level is a policy decision, which must be appropriate to the South African context. International benchmarks can be useful reference points to calibrate the model, but the process should not become too mechanistic.

- Provinces are in desperate need for capital infrastructure projects as part of the fulfillment of their constitutional mandate, but due to the particular equitable share formula and the lack of own sources of revenue and effective borrowing powers, it is essential that alternatives routes of funding should be investigated. Providing capital grants from the national government share of revenue to provinces can provide such alternative way of funding.

LOCAL AUTHORITIES (PAGES 31-67)
- The greater attention to local authorities is welcomed, given the new dispensation with regard to such authorities and the fact that their funding has not yet received much attention from the FFC in the past. However, some of the comments regarding the costs of basic services approach at the provincial level referred to in paragraph 4.4 above, also apply to the local government level.

- At local level, the FFC (on page 55) suggests that "….In the short term, the per capita expenditure in the district may be used to gauge the level at which the provisions of health services meet equity requirements throughout a health service authority". But this assumes that an equitable allocation automatically results inequitable service delivery - this might not always be the case, especially in a capacity constrained environment.

- Furthermore, census statistics are to be used as the basis for these calculations and local government own revenue contributions would be included with provincial allocations in a particular district to determine expenditure. The problems related to census data accuracy and determination of the local government share must be taken into account.

- With respect to infrastructure funding at local government level, it is worthy of mention that the maintenance and further development of the capital stock related to primary health care services appears not to have been considered.

- With reference to the option proposed on page 56 the manner of phasing in of equitable allocations need to be spelt out. It will also be necessary to place some cap on both local government and provincial allocations and once again the method by which the equitable share allocations would be adjusted to promote equity needs to be clarified.

GENERAL
- Any research into the constitutional and economic content and effect of the equitable share provisions should include recommendations on incentives for provinces to perform better and to increase their financial capacity.
- Criticism on current Finance Equitable Share Formula does not receive any specific attention in the FFC submission

- The general deduction is that the formula is too theoretical and much more work needs to be done to determine whether data is available before implementation of new proposals or when these are made.

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