Financial and Fiscal Commission
Comments on Local Government and the Equitable Share
Presented to the Portfolio Committee on Local Government,
15 March 2000
1. The Financial and Fiscal Commission and municipal finance
The Financial and Fiscal Commission (FFC) is required by the Constitution to render advice and make recommendations to all the relevant legislative authorities (local, provincial and national) on Issues related to:
· The equitable sharing of national revenue between the national, provincial, and local spheres of government;
· Provincial and municipal powers and functions;
· Provincial and municipal borrowing powers.
This presentation addresses one such issue, namely the local government equitable share. This document does not make specific recommendations on the actual amount of the equitable share, as such recommendations are currently not possible owing to the state of flux in the local government sphere: municipal boundaries are about to change quite significantly, policies around local government revenue sources have not been finalised, and new legislation is to be implemented in the near future. Rather, this document highlights key issues around the equitable share which need to be addressed if a sustainable system of local government finance is to be developed and accepted as fair and equitable by all the stakeholders involved.
2. Data Issues
The design of a system of local government finance has been long been complicated by a lack of data (a problem not unique to the local sphere). In the interim, however, a few comments can be made about the presentation of data in the Budget Reviews of 1998, 1999, and 2000.
The information over the three years is not consistently presented, and there is an ad hoc approach to the classification of funds flowing to local government. For example, bus subsidies of R1,409 million and community-based public works funds of R274 million for 2000/01 are classified as agency payments and included for the first time in the Budget Review 2000. This inclusion significantly inflates the "total transfers" of R6,709 million to local government, and it may be misleading as it implies that the funds are directed to local government to execute its constitutional functions.
This is more than an issue of semantics, for the arbitrary classification of funds as "transfers" clouds the debates around the allocation of nationally raised revenue to local government, and the debates then focus on definitions and classifications rather than on the substantive issues at hand.
A further consequence of this inconsistency is that comparison of local government transfers from year to year is not easily facilitated. For example, the Budget Review 1999 Indicated an equitable share allocation of R2,480 million for 2000/01 and the actual allocation has fallen rather short at Rl,867 million, but the presentation of the information makes it difficult to ascertain whether the difference is owing to a real decrease in the equitable share allocation or a shifting of equitable shares into conditional grants (such as the restructuring grant of R300 million).
The FFC would thus suggest that a more consistent approach to the classification of funds be developed and that the rationale for the classification of transfers be provided. This classification would need to show the clear links between funding and constitutional functions. The Budget Review 2000 marks a significant improvement in this regard and could be used as the basis for future Budget Reviews to enable easy comparison.
Tracking the numbers in the Budget Review is not sufficient in itself. It is also important to understand the processes by which the decision to allocate an amount less than the projected amount was arrived at. An analysis of the participation of the various stakeholders in these processes would be useful, certainly from the Portfolio Committee's point of view.
3. The Vertical Division In its publication, Local Government in a System of Intergovernmental Relations in South Africa (1997), the FFC stated that two principles should underlie the determination of the equitable share to local government, namely:
· Sufficient resources should be provided to match the services that municipalities are constitutionally required to deliver;
· Persons in different jurisdictions should receive reasonably comparable levels of public services at reasonably comparable levels of tax effort.
These two principles have informed the Commission’s new "costed norms" proposals to the allocation of revenue to provinces. Preliminary recommendations in this regard have recently been published.
Research with regard to local government is more difficult, as there is insufficient information available on the actual costs of basic service delivery and the tax bases of municipalities. Significant initiatives are under way to address the data issue: the Department of Provincial and Local Government is in the process of developing a comprehensive fiscal database, and the Department of Finance is introducing standardised budgets for local government.
As these data become available, it will be important to measure the fiscal gap between what funding is needed to execute constitutionally required functions and how much revenue is actually received. The Commission wishes to explore the applicability of its "costed norms" approach to the local government sphere, as discussions around the vertical division of revenue amongst the national, provincial, and local spheres of government can be enriched by the development of some objective indicators.
4. The Horizontal Division
Once the vertical division has been determined, local government's share must be divided equitably amongst municipalities. The achievement of equity in the horizontal division is a significant challenge, as there are tremendous variations amongst municipalities with regard to both expenditure and revenue.
4.1 Revenue sources Every municipality will have some measure of tax capacity, which is the potential revenue it can derive from its jurisdiction. Tax capacity consists of different components, or revenue sources, each of which needs to be evaluated for its potential yield. As outlined below, the yield from different sources varies quite significantly.
Property rates
In rural areas, much of the land is not subject to property rates, either because the land has been located outside the boundaries of urban municipalities or because the land falls within "tribal" areas. Indeed, some of the newly established municipalities will have a minimal property rates base. Over time, much of this land will be brought into the property tax net, but until this is achieved, compensation for the lack of property tax revenue will be necessary.
Service charges
There will be some measure of cross-subsidisation of service charges within municipal areas, and a municipality with a high proportion of poor people will receive relatively little income from service charges. The shortfall could be made up by intergovernmental transfers, indeed the current system is designed to ensure that all residents receive reasonably comparable levels of public services. The extent to which this system achieves that needs to be monitored.
RSC levies
These levies are collected from businesses, so a district municipality with a limited commercial and industrial base can collect very little. This uneven distribution or business activity, which is related to the spatially discriminatory policies of the past, therefore also requires a measure of equalisation.
Consolidated Municipal Infrastructure Programme
These funds are available to municipalities upon application, and a clear trend in the allocation of funds has been the lack of CMIP funds flowing to municipalities which are located in rural areas and which lack the capacity to apply for and spend the funds. The programme needs to be evaluated in this regard, as the most pressing needs are in the municipalities which have not benefited from the programme, but at the same time cognisance must be taken of the lack of absorptive capacity of many municipalities.
Loan finance
Access to this source of funding is restricted to municipalities with acceptable credit ratings and the capacity to meet the financial reporting requirements of lenders. Indeed, the majority of loans to local government are held by the metros and secondary cities. As with the other revenue sources, then, the distribution of this revenue source is highly uneven. One possibility that could be explored is the building of a link between capital subsidies and loan finance (e.g. matching grants).
4.2 Expenditure
The cost of executing constitutionally required functions varies according to a wide variety of factors, some of which are listed below.
Infrastructure backlogs All municipalities have infrastructure backlogs, but the overall proportion, relative to population, varies considerably. Municipalities are required by the Constitution to provide services sustainably, and adequate infrastructure is the necessary precondition for this. Backlogs impact in a variety of ways; for example where roads are in very poor condition - as In many rural areas -motor vehicles have a shorter lifespan.
Location
Municipalities located far from larger urban centres face higher costs in the delivery of services, and this impacts on many of their functions. For example, municipal officials must travel long distances to attend meetings outside their jurisdictions, consultants charge for more time owing to travel considerations, and it is more expensive to attract skilled officials to remote areas.
Credit ratings
Municipalities pay higher interest rates if their credit rating is poor. Human resource capacity and revenue are decisive factors in this regard.
4.3 Conclusion: horizontal division
The current system of intergovernmental transfers takes poverty into account, which serves to address the variations in revenue from service charges. As noted above, it is not sufficiently complex to take cognisance or the variations in both revenue and expenditure, and the FFC would evaluate any proposals according to the extent to which they equalise for both tax capacity and expenditure differences. The establishment of a comprehensive fiscal database will go a long way to providing some of the data for the development of a more effective formula.
5. Transitional costs
In its submission on the Division of Revenue to the Portfolio and Select Committees on Finance, the FFC noted its concern that the considerable transitional costs associated with the demarcation process and implementation of Municipal Structures Act and Municipal Systems Bill are not catered for in the 2000/01 Budget. There will be many once-off costs associated with the transition, but it should not be assumed that all of this assistance will take the form of direct transfers to municipalities. A variety of support mechanisms are needed, which may include the development of special task teams, which operate at district, provincial, or national level.