Public Hearings on the MTEF Figures for 2001/2002
Submission to The Select Committee on Finance
Compiled by: Donald Maphiri, Tania Ajam, Conrad Barberton
Research Associates
Applied Fiscal Research Centre
Presented by: Donald Maphiri And Conrad Barberton
23 August 2000
Introduction
We thank the Chairperson of the Select Committee on Finance for inviting AFReC to make a submission on the MTEF Figures 2001/02.
Our submission is divided into two sections: The first section deals with various aspects of the MTEF, and the second section deals with the FFC’s costed norms approach and provincial taxation. The main points of the submission are summarised at the end.
It is a fact that the introduction of MTEF has been a major innovation in the budget process. As a result this process has become more transparent in recent years and has served to support expenditure planning in government more effectively. The three-year spending envelope allows departments to have greater certainty about the resources available to them and therefore are better able to plan the deployment of their resources to meet their objectives. The first three-year expenditure framework was for the 1998/99-2000/01 period. The MTEF has thus completed a full three-year cycle. It should be mentioned that the introduction of the MTEF does not necessarily guarantee improved service delivery and/or flow of information. Continual improvements on the present achievements will need to be made to keep up with changing circumstances and needs. The experience that has been gathered over the past three financial years has highlighted a number of issues that need to be taken into account in the MTEF process. These include:
These issues are dealt with below.
It is generally accepted that baseline estimates refer to the cost of conducting existing programmes. The introduction of policy changes (namely, the introduction of new projects and programmes) are evaluated relative to the baseline. Forward estimates are provisional decisions by government about its intention regarding future spending on both existing and new programmes, as well as the phasing out of old programmes. The forward estimates are rolled over every year with the new estimate added for the last year of the relevant MTEF cycle. These estimates are, however, not binding on the government when it comes to compiling the current year’s budget. In addition the forward estimates are revised periodically to take account of policy changes, changes in economic conditions, and other new information on expenditure levels.
Internationally, the forward estimates tend to be projections based on current policy parameters. When the first forward projection for any MTEF cycle becomes the baseline for the current budget year the focus of the budgeting process is on making marginal changes to take account of new programmes or the termination of old ones. In South Africa, however, the MTEF guidelines say that proposed policy changes or shifts in priority should be accommodated within the responsible department’s medium term’s expenditure estimates. Where policy changes imply adjustment to forward estimates, they have to be made within the context of the annual medium term expenditure planning process. This implies that MTEF projections over the cycle cannot be treated as baselines for the relevant years because they reflect both existing programmes and policies as well as programmes and policies that still need to be approved.
In addition, Treasury has adopted a zero change approach to the aggregate value of the MTEF, i.e. departments have to keep within their initial allocations. So when they introduce new programmes they have to find the funding from within their existing allocation either by stopping old programmes or realising efficiency gains. In other words the South African forward estimates contain not only the cost of existing projects/policies, but also any policy changes as well. This means that policy changes are not as transparent as they should be, as they are embedded in the forward estimates. The result is that policy changes are not made in a transparent way.
In view of the above AFReC proposes that MTEF forward figures should distinguish between the costs of existing programmes and those of new programmes, and decisions to phase out programmes. This, we believe, will increase transparency with regards to decisions around trade-offs between new and old programmes, as well as improvements in the delivery of services. A useful format for presenting this information is the ABX format of presenting budget information which is discussed next.
Prioritisation and reprioritisation presuppose shifting resources away from low-priority activities to high priority activities and often from existing programmes to new ones. The determination of priorities becomes precise and realistic during the preparation of the budget. It is thus important that there should be mechanisms within the budget process that encourage the re-evaluation of policies and priorities and that facilitate the generation of policy alternatives. It is precisely for this reason that AFReC supports the use of the ABX format of presenting budget information to facilitate decision making around tradeoffs. This approach was initially advocated by the Presidential Review Commission on Public Sector Reform. It should be noted that ABX is not a system of budgeting in the same sense that performance budgeting is a system of budgeting. Rather it is a way of presenting budget information to facilitate the making of tradeoffs.
The ABX budgeting consists of three components:
Note that with the information presented in these three ‘budgets’ it is possible to make rational tradeoffs between existing and new programmes and to plan both the phasing out and the phasing in of programmes over time. Once a new programme from the B-budget is approved by Cabinet (and where relevant parliament) it would be shifted to the A-budget and phased in as part of the existing set of policies the department has to budget for and implement. Similarly when programmes are phased out they would be gradually removed from the A-budget.
There is a fundamental difference between three-year incremental budgeting and an MTEF based on cost drivers and policy adjustments. The former is not different from conventional incremental budgeting where current budgets are increased by some margin for the following year. The introduction of the MTEF was an attempt to move away from this kind of budgeting to a budgeting system based on the actual cost of service delivery. The latter system takes cost drivers and policy adjustments into account when making forecasts over the MTEF period. Figures based on these factors should be more realistic and support effective service delivery.
Our view therefore is that unless departments identify comprehensive and relevant cost drivers during budgeting and quantify their exact level of costs, there is a risk of budgeting in South Africa to boiling down to incremental budgeting with a three-year horizon. Therefore the problems associated with incremental budgeting will not be resolved. Ideally, the MTEF should be preceded by a move to performance budgeting so as to lay a credible foundation for fiscal resource allocation. The following prerequisites are therefore indispensable:
As noted above key to an effective MTEF is the implementation of a performance budget. This would put in place a firm foundation for the projection of costs and outputs. In addition both the ABX format of presenting budgets idea noted above and the ‘scorekeeper’ idea noted below would contribute to the effective use of the MTEF in public decision making.
In order to ensure the integrity of the MTEF a ‘MTEF scorekeeper’ is needed to maintain the MTEF baseline and to record the impact of new (approved) policies on the MTEF. Currently, departments maintain their own MTEF numbers and the national and provincial treasuries review and compile these into consolidated MTEF tables. It is our view that the treasuries should play a far more active role in maintaining the integrity of their respective MTEFs by acting as ‘scorekeepers’. Very briefly we envisage that the role of the scorekeeper would entail:
The idea is that the scorekeeper ‘referee’ the MTEF process to ensure that departments play by the rules and ‘keeps’ score of the current state of the MTEF. The idea is not for the scorekeeper to do the MTEF thinking for the departments. Rather the departments are the ones that instruct the scorekeeper when to make changes, and what changes to make. The scorekeeper would check that any adjustments to the MTEF proposed by a department comply with the rules for making such adjustments and then record the results of the adjustments. The idea is to develop a MTEF with integrity.
This section discusses certain aspects of the costed norms approach to the division of nationally collected revenue proposed by the FFC, as well as the issue of provincial revenue raising powers.
In a perfect world, of perfect information and zero research costs the FFC’s costed norms approach would undoubtedly be a sounder instrument of resource allocation across spheres of government than the current approach used by Treasury. In a second best world where information is not available and the cost of research to obtain such information is very high, the FFC has to make use of all sorts of proxies to measure what it really wants. In such a world, it is by no means certain that the FFC’s proposed costed norms formula is a better intergovernmental resource allocation instrument than the Treasury formula. In the ideal world the FFC’s formula based on a costed norms approach would be irreconcilable with the Treasury’s approach. In the second best world, it is probably possible (and may be desirable) to include some of the FFC’s recommendations into the Treasury’s formula, thus creating a hybrid formula where certain components are based on costed norms and others based on the proportional division of revenue approach used by Treasury.
For instance. AFReC has consistently argued that for social security it would make more sense to allocate funds based on actual cost of grants, rather than the proportional demand for such grants as is currently the practice. It should be possible to estimate the demand for social grants in each province with a high degree of accuracy and therefore to calculate the exact amount of nationally collected revenues each province requires in order to meet this statutory obligation. This approach would obviate the current problem where increases in social grants put pressure on other expenditures especially social welfare services.
Overtime the ‘proportional components’ of such a hybrid formula could be converted to take account of costed norms as explicit norms and standards for other social services are set by national government and explicit baseline unit costs are established with the implementation of performance budgeting.
It is our view that the FFC’s costed norms approach cannot be implemented in education, health and social services in the short term for a number of reasons:
In essence the FFC is trying to overcome the proportional split approach of the Treasury formula where the relative allocation may or may not accord with the actual cost of service delivery. (As noted above the tension between relative share and actual cost is probably most acute in the area of social welfare grants where the norms are well defined and entitlement is set at national level.). But to the extent that the FFC’s cost projections are not accurate, their costed norms approach will not necessarily overcome this problem. What the FFC’s current proposals do is that they set a figure for say – average unweighted cost per learner in a province; then they weight it by factors which are likely to impact on the relative cost off service provision to arrive at an adjusted cost factor – eg (special versus ordinary learners, rural vs urban etc). But how accurate are the initial cost estimates, how accurate are the adjustments? Until we have a budgeting system that can deliver on these questions we simply don’t know! In addition the FFC does not present any sensitivity analysis in its final document so we can gauge nothing about the possible variances and their impacts on costing.
The FFC is trying to estimate a production function (which is essentially the ratio of inputs to outputs). But outputs are not well defined – what is the cost of a "basic education" - is it taken as years spent in a classroom or in terms of educational performance. So what are we costing the average cost of? Secondly the FFC makes the point that parameters should be policy-invariant i.e. out of the control of provincial governments. But this is assuming there is some notional least cost production function on which the FFC can base its average cost information. But varying the input mix is within the control of provinces. And by using historic cost data as the basis for the projection of average costs for the "normative" production function, surely violates the objective of policy invariance. In fact if the (actual) average cost is used in this way, how is it different from Treasury formula which uses past expenditures to determine the weightings given to each are of expenditure?
This is especially true since the FFC are using proxies like learner type rather than actual cost. How accurate is the production function when using proxies as instruments? Is it sufficient that the factors modifying the "average cost" should be policy invariant, or should the "average cost" be policy invariant as well (which would be the case given a normative least cost benchmark production function)?
The weightings on the current formula for dividing revenues across spheres reflect provinces past expenditures on the social services. As far as can be determined, in 1998 and 1999 they were based on some weighted average of province's past expenditures and MTEF projections. This year it is stated explicitly that they "reflect a 3-year average expenditure on these services" (Explanatory Memorandum, page 11). The use of expenditures to calculate the weightings is problematic because it amounts to nothing more than a sophisticated form of incremental budgeting. It is also well known that the baseline for these expenditure patterns was primarily determined by apartheid spending priorities. Moving towards costed norms would be a step in the right direction, but we need to be certain that the average costs we use do not simply reflect past expenditures in a different guise yet again.
To conclude this brief discussion: the most important consideration when devising a method for dividing nationally collected revenues between the different spheres of government and then dividing the provincial equitable share between the provinces is that the outcome of the process must be generally regarded as "substantially fair". It is simply not possible to devise an objective method for ensuring that the division is 100% fair. Roleplayer’s very definition of what is fair differs depending on their interests and who’s interests they are representing. Moving towards a costed norms approach is likely to foster a greater sense of "fairness", although it runs the risk of becoming extremely complicated. This brings us to the second most important consideration, namely whatever method is used to make the division of revenue it should be both simple and understandable. This inevitably means making certain generalisation about the demand for services in each of the provinces and the cost of service delivery. To seek to incorporate every factor that either increases or decreases the demand for or the cost of services in each of the provinces would result a very complicated, technical formula that very few people would be able to understand. There would always be pressure to make the formula even more comprehensive and therefore even more complicated. The result would be technocrats would take control of he formula, rather than it being an instrument of policy.
The structure of South Africa’s fiscal constitution assigns most of the buoyant taxes such as corporate income tax, personal income tax and VAT to national government. This means that – unless the Constitution is fundamentally amended – provincial governments will in the foreseeable future remain heavily dependent on intergovernmental transfers and a revenue sharing process in which nationally collected revenue is allocated across and within the various spheres of government. However, there is also a clear indication in section 228 of the Constitution that provincial legislatures should have at least some latitude in raising their own taxes and flat rate surcharges on national tax bases. In addition, there is the cogent argument of the FFC that provincial tax powers could enhance accountability at the margin.
The Constitution requires that provincial taxation be regulated by national legislation, and already there is movement towards an "allowed list" – a menu of tax options which would be open for provincial governments to pursue. In crafting the enabling framework for provincial taxation, AFReC offers the following considerations:
In summary this submission makes the following points: