1. Mandate and Objectives

This submission is the Financial and Fiscal Commission’s annual commentary on the Division of Revenue Bill. Its Constitutional and legislative mandate follows from S 214 (1) of the Constitution and given effect on the Intergovernmental Fiscal Relations Act of 1998 requiring consultation between the Commission and the Minister of Finance fourteen days prior to the introduction of the Bill.

2. Methodology

In preparing its commentary on the Division of Revenue the Commission takes into account the equitable division of revenue amongst the three spheres of government and amongst provincial and municipal governments. General factors are first evaluated using criteria drawn from section 214(2) of the Constitution. Second, commentary received from Parliament finance committees as well as that of other stakeholders in government and the public sector is taken into account. Finally, the Commission undertakes its own independent research to inform its response to the Division of Revenue..

Subject to data availability, this document emphasizes a quantitative analysis of trends over the past ten years to provide context and to indicate fiscal and institutional capacity to meet national policy objectives. This is compared, where feasible, with projected trends for the forthcoming medium-term budget and planning cycle. Past trends give an indication of development of fiscal and institutional capacity against which realistic targets can be set.

The document begins with an Executive Summary and Introductory chapter. Chapter 2 reviews the dialogue with Government over the Commission’s recommendations and is a direct response to Government’s comments contained in Annexure E of the Budget Review documentation. Chapter 3 reviews macroeconomic policy trends and assesses the performance of Government against its economic and fiscal policy objectives relating to economic growth, employment creation and poverty reduction / redistribution. These policies might be viewed as constituting the national interest and include making provision for national debt obligations Chapter 4 reviews expenditure trends for the three spheres of government over the preceding ten years. Chapters 5 and 6 assess performance in the delivery of those social and infrastructure services Constitutionally mandated as basic in the Bill of Rights and generally delivered by provincial and municipal governments.

The Commission uses the budget analytical framework it introduced in its 2001 and 2002 submissions. Herein trends in real spending growth, coverage of eligible populations and impacts on income, capability, asset and accessibility poverty are assessed against national policy objectives expressed as policy targets.

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The Financial and Fiscal Commission is legislatively mandated to make annual recommendations with respect to the forthcoming division of revenue. Government responds to these recommendations in Annexure E of the Budget Review document that accompanies the Division of Revenue Bill. The Commission comments on Government’s response in the context of its previous recommendations.

1. Vertical Division and Function Shifts

In 2003, Government agreed to shift the function of the administration and disbursement of social assistance grants from the provinces to national government and establish the South African National Social Security Agency. The establishment of the national agency is due to be implemented in FY 2005. The FFC notes that this function shift has necessitated a review of the component weightings in the Provincial Equitable Share formula with the removal of the social development component.

In reviewing the fiscal framework for provinces, the Commission reiterated its recommendation that the provinces need to augment provincially raised revenues through the implementation of Section 228 of the Constitution and take advantage of the provisions of the Provincial Tax Regulation Process Act. Government, while not responding directly to this recommendation reduced the weighting for the economic activity component, (which was meant to be a proxy for tax capacity) a step which may be construed as an indirect incentive for provinces to increase provincially raised revenue.

The Commission review of the formula argued for and hence agrees with the removal of the Backlogs component in favour of a conditional Provincial Infrastructure Grant. However, the Commission needs to further interact with government with the respect to the relative weights for economic activity component and the newly introduced poverty component. The Commission views the issue of poverty targeting in a holistic manner and therefore suggests that further work, including a detailed assessment of all transfers in the system is required in order to determine the appropriate trade-off between poverty and economic activity. This would be in line with the criteria in S 214 (2) a-j of the Constitution.

The Commission also welcomes the expansion of the PES formula to incorporate (ECD) Grade R and the equal weighting of school age population and actual enrolment. While the FFC agrees with Government’s concerns with data constraints with respect to the healthcare component, it also emphasises the need for the Department of Health to prioritise the collection of the relevant data. The FFC also notes that government did not address the issue of welfare services financing in the formula, given that from the social development component, only social security grants and their administration will move to national government. It is important for government to provide clarity on the basket of services that provinces are expected to provide and the appropriate funding mechanism.

In respect of capital grants, the Commission proposed that Government utilise the FFC capital grant scheme model for the equitable allocation of infrastructure grants to provinces. Provinces will qualify based on the state of their capital stock for a backlog and a maintenance pool of funds. While the backlogs component is conditional, provinces have the flexibility to choose their priority sectors. The FFC will engage with government in assessing the availability of sector specific data so as to target sectoral infrastructure backlogs.

The Commission welcomes the Government’s endorsement of a components-based approach rather than the ad hoc use of funding windows, which has characterised the development of the L.E.S. formula.

The Commission also welcomes Government’s inclusion of a more direct revenue raising capacity component in the revised LES formula. The Commission has noted the problems associated with measurement and accepts the interim proxy measure introduced by national treasury. The Commission will continue with its work on the identification of appropriate measures for revenue raising capacity.

The Commission will also continue with its ongoing work of researching the costs of a basket of municipal services. This exercise, the FFC reiterates will be enriched if government can define the list of the basic services that all municipalities are expected to deliver.

The Commission is developing the approach of relating performance in spending, delivery and developmental impact to national policy objectives against varying norms, standards and targets as a means of linking policy and planning.

In the recent past, the Commission has argued for Census and survey planning to generate and/or verify the data on norms, coverage rates and on poverty and development at local level

Apart from welcoming consideration of these associated systems issues, Government has not provided specific responses to these proposals.

Over the past decade, economic growth has averaged 2.75% p.a. Government seeks to shift towards a more investment-led than consumption-led growth path and has set an investment target of 25% of GDP in order to lift the average growth rate to between 5% and 6% pa. The current proportion of investment to G.D.P. is 16%. Public spending on infrastructure increased from 5.3% to 5.5% of G.D.P. between FY 2001 and FY 2004 and is projected to rise to 6.25% over the 2005 medium-term cycle.

Savings constitute the funding source of investment. Government has reduced its dis-savings from 6% to 1% of G.D.P. over the past 10 years and is signatory to the Financial Services Charter aimed at raising household savings through improving access to banking services.

Over the past decade, the growth of employment has approximated half that of G.D.P implying labour saving technological progress. Further, the labour force of mainly young adults has been increasing at well above the population or economic growth rates. This poses a challenge for poverty reduction given the close correlation between unemployment and income poverty in South Africa.

A decline in public sector employment during this period has contributed to this trend. More recently, Government has expanded the Public Works program aimed at providing community infrastructure and stimulating the use of more labour-intensive employment in the construction sector. A target of 1 million people accessing public works employment has been established but, together with current rates of employment growth, this will provide less than half the jobs required to halve unemployment by 2014.

Within the labour force, many jobs are being casualized whilst skills shortages constrain productivity and hence economic growth. A target of 80 000 learnerships have been established by the Sectoral Education and Training Authorities.

A norm of 25% of GDP to nationally raised revenue was established in Government’s Growth Employment and Redistribution macro-economic policy document. This norm has served as a target for improving national revenue raising capacity. Coupled with controlled spending over the past decade, the general government deficit was reduced to well within the 3% international benchmark as indicated in the table below. The deficit is projected to average 4% over the 2005 medium-term budget cycle. Between FY 1994 and FY 2004, the Debt : GDP ratio has fallen from 49% to 37%.

Similar norms or targets have not been set for general government (including municipalities, social security funds and extra-budgetary institutions), nor for the public sector (including financial and non-financial public enterprises), suffice it to say that government has sought to manage debt levels by not providing guarantees to those entities and introducing the Provincial Borrowing Act and the Municipal Finance Management Act

Table 3.3 Trends in Fiscal Capacity Ratios (1994 – 2002)

The Constitution allows government to use deficit funding to finance capital, but not current spending. Until FY 2002, the value of general government investment was less than the deficit, implying the use of deficit financing for operational purposes. The primary cost-driver in general government’s budget has been the take-up of social assistance grants.

A decline in debt servicing costs over the past decade has enabled an accelerating real growth of funds available for division.

Over much of the past decade, real interest rates have exceeded both the economic growth rate and global average interest rates. The high interest rate regime may have discouraged fixed investment and encouraged speculative inflows. Between 1999 and 2002, the exchange rate exhibited extreme volatility.

Over the past 10 years, the central feature of monetary policy has been development towards continuous inflation targeting, which was adopted in 2003 and which has been successful in keeping inflation below the maximum 6% limit. Inasmuch as exchange rate volatility is the result of high real interest rates and inasmuch as the high costs of capital are fuelled by high inflation and transitional uncertainties, persistence is required in inflation targeting to break the cycle of inflation, interest and exchange rate instability.

As of 2005, Government has adopted an Administered Prices Index to monitor the public sector’s compliance with the inflation target.

Reprioritization of spending towards social assistance grants and household infrastructure services over the past ten years have resulted in a significant shift of expenditure to provinces and municipalities respectively. On the other hand revenue raising by provinces has declined despite the fact that the Constitution accords the revenue raising powers. On the other hand municipal own revenue raising has increased. Table 3.1 shows trends in vertical fiscal imbalance.

Table 4.1 Trends in the Vertical Division (1994 – 2002)

Over past 10 years, the composition of nationally raised revenue has shifted from personal income, sales and international trade taxes to corporate income, payroll and property taxes; making the system more income progressive.

The general trend in national government spending over the past ten years has seen a declining share going to economic and infrastructure services and a rising share to financial and administrative services and the integrated justice sector. More recently, a policy drive to increase the rate of public investment has reversed this trend.

Provincially collected revenue as a proportion of provincial government revenue declined from 5% to 3% over the past 10 years. Approximately 15% of intergovernmental grants are conditional and primarily intended for use in infrastructure provision and institutional capacity building. Approximately 85% of provincial revenue is derived through the unconditional Provincial Equitable Share (PES) grant. Until 2005, the PES was designed to provide for the operational and capital costs of providing social assistance grants, basic education and health services as well as the maintenance requirements of provincial road, agricultural and social service infrastructure.

Over the past ten years, the composition of provincial spending has shifted in favour of social development (+7%) and away from health (-2%), education (-5%) and until recently from economic and infrastructure services such as transport and agriculture. Whilst capital spending has been growing faster than average over the past five years, spending on maintenance has declined.

Provincial budget allocations and spending patterns have served to reduce horizontal fiscal imbalance over the past decade.

The proportion of municipal revenue derived from intergovernmental grants has increased from 12% to 14% over the past decade. Metropolitan authorities derive between 3% and 8% of their revenue from intergovernmental grants, whilst rural municipalities derive between 60% and 90% of their revenues from such. The composition of grants to municipalities has shifted from 2/3 to 1/3 conditional during this period.

Municipal spending patterns illustrate a trend common across all three levels of government, namely the more rapid growth of operational than capital spending and maintenance spending. Municipal government spending patterns have not contributed to the reduction of horizontal fiscal imbalance over the past decade. Whilst nationally raised revenue enables redistribution, sub-nationally raised revenues tend to perpetuate inherited disparities.

Until 2005, the Constitutionally mandated basic social services of social assistance and welfare, education, health care and food adequacy have been the functional responsibilities of provincial governments and, with the exception of food programs have been funded through the unconditional Provincial Equitable Share grant. Social assistance grants are due to be transferred to a national agency. A conditional grant which is ringfenced for this function will be used as an interim funding mechanism until the National Social Security Agency is established.

1. Social Development

The take-up rate for grants has been accelerating since the introduction of the Child Support Grant in 1997 and averaged 18% p.a. over this period. At 8% p.a., the real growth rate of spending has been lower than the take-up rate. Most take up has been of the Child Support Grant, which is valued at between one quarter and one fifth of the pension and disability grant. More recently, the HIV-AIDS pandemic has provided momentum for rapid take-up of the disability and foster care grants. Since FY 1998, per capita grant values have increased at slightly higher than the Consumer Price Index.

Official statistics indicate an increase in the poverty rate between 1995 and 1999. However, the positive role of social assistance grant take-up in alleviating poverty has not been isolated.

2. Education

Despite average growth of the number of school-going age children of 1.74% p.a. between 1996 and 2001, learner enrolment declined by nearly one million learners. This may have been the result of policies to reduce "errors of inclusion" such as over-age learners.

Since 2001, learner enrolment has been increasing at 1.27% p.a., still below the growth of the school-going age population. Enrolment targets have been established for all the component programs of basic education namely; Early Childhood Development, primary and secondary school education, Further Education and Training and Adult Basic Education and Training. Real growth rates in spending have also accelerated and are projected to average 2.3% over the 2004 medium-term cycle.

Between 1996 and 2001, adult literacy rates improved (83% to 89%) whilst the proportion of adults with post-secondary education increased from 23% to 29%.

3. Health Care

Spending on primary (clinic) and secondary (hospital) health care averaged 2% between FY 1996 and FY 2001 and has accelerated to an average 4% since. Spending on hospitals has lagged that of primary health care provision in clinics. While not a functional assignment of municipalities, local governments have provided almost half the government’s primary health care services

There has been clear improvement in targets set for coverage of antenatal care, immunization and tuberculosis treatments. Mortality rates have been increasing however and this is probably due to HIV-infection. In 2003, HIV incidence was officially estimated at 11.3% of the population.

4. Food Adequacy

The Child Nutrition Grant has identified a target population of 4.58 million poor children. Less than 1% of provincial budgets are set aside for food adequacy programs. However, 4% real growth in these programs was projected for the 2004 medium-term budget cycle. The impact of this program on the nutritional status of children has not been measured yet.

Household infrastructure services that may be Constitutionally mandated as basic include housing, land and water. Sanitation, waste disposal and electricity might be implied through the environmental health mandate. Transport services enable access to other basic services and hence serve a complementary role in the provision of other services. Municipalities are the primary delivery agents and several cross-municipal public entities are involved. Most capital funding is through special purpose conditional grants or utility fees.

1. Education and Health Care

There has generally been a very low rate of expenditure of capital budgets for Education and Health.

 

2. Housing

The delivery rate of housing over the past decade has exceeded the rate of household formation. On average, approximately 161 400 housing opportunities have been delivered annually with a peak in FY 1997 of

296 000. The national housing department has set a delivery goal of 338 000 houses per annum.

The value of the housing capital subsidy did not keep pace with inflation until FY 2001 and household income brackets have not changed since 1995. The housing spend has decelerated since FY 2001 and is projected to continue declining over the 2004 medium-term. The operational implications of the housing capital expenditure are passed onto municipalities

3. Water

Between 1996 and 2001, the proportion of households with reticulated access to water increased from 60% to 62%. The current norm is 50 litres per person per day within 200meters of the dwelling. Full access to water services is targeted for 2008.

Since FY 2001, municipalities have increased their capital spending but reduced their operational spending whilst the regional Water Boards have reduced their capital spending and increased their operational spending in real terms on the provision of water.

The proportion of households with water-borne sewerage or VIP toilets increased from 50% to 55% between 1996 and 2001, whilst the proportion receiving municipal waste disposal services increased from 53% to 57%. Coverage improvement in the metropolitan areas was less substantial. This could be as a result of rapid urban migration of the poor. Full access to adequate sanitation is targeted for 2010.

Coverage rates for connections to the national or municipal grid increased from 57% of households to 70% between 1996 and 2001. Government has targeted full coverage by 2012.

Regional Electricity Distributors are being operationalized from 2005. The distribution of electricity surpluses and the implications of that for municipal billing systems are being addressed.

In FY 2003, provincial governments undertook 57%, municipalities 30% and national government 13% of road construction and maintenance spending. Between FY 2000 and FY 2004, provincial spending on roads increased by 11% p.a. in real terms whilst spending on bus, taxi and train subsidies increased by 6.5%.

This submission can further develop its "costed norms" based budget analytic methodology to consider the object of the Division of Revenue Bill to co-ordinate policy planning with budget preparation. Consideration can be given to the process of norm and target setting in relation to current capacities. Indicators can be developed for data availability, stability and institutional capacity. To be comprehensive, the integrated justice system should be evaluated as a Constitutionally mandated basic service.