Today we are honoured to submit a short report to the Select Committee on Finance on the Division of Revenue Bill 2005.

The primary purpose of this report is to provide an overview of the Division of Revenue Bill as it relates to the core business of the dplg. The specific focus will be on critical fiscal transfers that are made to local government, namely through the Local Government Equitable Share (LGES), the Municipal Systems Improvement Grant (MSIG) and the Municipal Infrastructure Grant (MIG).

The presentation will highlight the key objectives of each grant, provide a brief overview of progress and challenges linked to the management of these grants and also outline concrete interventions that the Department is, and will be, pursuing to address identified challenges.

In the 2005 Budget Speech by the Minister of Finance, it is noted that nationally raised revenue is now distributed between the three spheres of government as follows:

• National Government – 37%;
• Provincial Government – 58%; and
• Local Government – 5%.

It needs to be noted that fiscal transfers to local government takes two principal forms, namely through an unconditional grant and various conditional grants.

Monies allocated to local government have increased from R14,8bn in 2004/5 to R17,2bn in 2005/6. We are of the view that as our democracy matures in the Second Decade of Freedom the focus on local government will increase and so will its developmental responsibilities. We thus welcome the trend of progressively increasing the proportion of nationally raised funds to local government, commensurate with its development and implementation functions.

The Committee also needs to note that the dplg has worked closely with National Treasury on the local government matters of the Bill. In principle we in agreement with the overall thrust and allocations set aside in the Bill, however we will highlight some issues, which we think require further refinement in the course of this presentation.

Chapter 13 of the Constitution of the Republic of South Africa, 1996 makes provision for an equitable distribution of nationally raised revenue to the three spheres of government. Key considerations, which need to be taken into account when making these allocations to local government include the:

1. Need for municipalities to be able to provide basic services and perform functions allocated to them;
2. Fiscal capacity and efficiency of municipalities;
3. Developmental and other needs;
4. Obligations of municipalities in terms of national legislation; and
5. Desirability of stable and predictable allocations of revenue.

In our President’s State of the Nation Address in May 2004, he indicated that government would undertake a review the local government equitable share formula. This in part was aimed at distributing financial resources to those municipalities with low fiscal capacity so that they are in a better position to deliver on their mandates.

We can report that, under the leadership of National Treasury, we have made significant progress regarding this review. For the 2005/6 financial year we simplified the equitable share formula, included an explicit revenue raising capacity correction component and revised the services component of the formula in such a way that it recognizes and reward municipalities that are making progress in accelerating the delivery of basic services.

The five components of the new formula are as follows:

The 2005/06 financial year is the first year of the gradual phasing of the formula. For the 2005/06 allocations, the new formula is applied to the additions to the baseline allocations, with the indicative allocations from last year’s allocations being fully guaranteed.

The new formula recognises the capacity of municipalities to raise their own revenue, i.e. their fiscal capacity. In addition, the formula recognises the progress made by municipalities in the accelerated implementation and delivery of basic services for the poor. It therefore rewards those municipalities that have invested in the infrastructure necessary for the delivery of basic services. Similarly, the formula penalizes those municipalities that are not delivering basic services, mainly as a result of limited investment in basic services infrastructure. In this way there is a dynamic link between the MIG (funds for infrastructure investment) and the equitable share grant (funds for the operational costs of delivery of basic services, within the context of existing infrastructure).

Therefore, through the services component a subsidy is given per municipality for the poor population receiving services and the poor population not receiving services. These subsidy figures are available.

On the whole, the impact of the revised formula, within the first phasing in period (2005/06) is beneficial to municipalities that have a low capacity to raise revenue. This is a significant observation, given that the main aim of the review was to adequately capacitate those municipalities with low fiscal capacity, as stated in the President’s State of the Nation address of May 2004.

Expenditure over the forthcoming MTEF period shows that the LGES will increase from R9,6bn in 2005/6 to R11,3bn in 2007/8. This represents a general upward trend of allocations to most municipalities.

The revised formula will however mean that some District Municipalities will receive a downward trend of allocations, largely due to the fact they do not provide basic services. This is also affected by increased migration from these areas to urban areas. Those municipalities that will receive increased LGES allocations are those who have extended basic infrastructure.

We are fully aware that additional work on the LGES needs to be undertaken. In this regard areas of ongoing refinement and additional work will include,

1. Giving substance to the "development component" of the formula which is currently set at zero;
2. Agreeing on the best manner to fund the 21 development nodes and Free Basic Services in general;
3. Determining and re-assessing our approach to the four basic services;
4. Improving our definition and criteria for identifying the indigent; and
5. Addressing information asymmetry.

The Municipal Systems Improvement Grant (MSIG) is one of two conditional grants that the Department will be managing over the MTEF period. The primary purpose of this grant is to assist municipalities in developing in-house capacity to build the core municipal developmental systems so that they can perform their functions. These new systems include integrated development planning, performance management, financial management, community participation, effective administration and efficient service delivery mechanisms as well as Powers and Functions.

The MSIG is directed to municipalities through Districts and selected Category A and B municipalities. Key outputs of this grant include,

• Capacity improvement for stability and governance systems;
• Institutional systems aligned to IDPs;
• Implementation of assigned powers and functions;
• Implementation of municipal legislation; and
• Community participation as required in terms of Municipal Systems Act.

An important cross-cutting requirement and condition is that a District-wide Capacity Building Development Plan is prepared in consultation with Local Municipalities.

The MSIG is premised on the view that it is crucial that municipalities are supported to ensure that they are able to deliver on their mandate. The R582,2 million that is allocated over the MTEF period will thus play an important role in consolidating the core municipal systems. We are supportive of the need for a review of the grant to be undertaken in 2007. This review will take into account the overall progress we are making moving towards sustainable local government. Our current view is that is this Grant will need to continue beyond the medium term.

The allocation for 2004/5 financial year is R182 million and as at end of January 2005, an amount of R172 million (94.5%) had been paid to municipalities. Key outputs will be reported at the end of the municipal financial year given that most of the projects are currently being implemented. Specific priorities for 2004/5 have been:-

1. The municipal debt pilot project in the six metros as well as Buffalo City. The outcome of the project is to assist municipalities with debt management, eg. data cleansing and thereby an understanding of debt that may be recovered, and that which is irrecoverable;
2. IDP Annual reviews;
3. Project on Municipal Financial Statements;
4. Implementation of Performance Management Systems;
5. Development of Policies and By-Laws to give effect to legislation; and
6. Implementing Revenue Enhancement Programmes

The management of this grant has not been without its challenges. These include,

• The late submission of the MSIG Business Plans;
• Poor spending by district municipalities;
• Roll-overs at the end of the financial year;
• Non-compliance with the DORA, especially reporting requirements; and
• Lack or little consultative processes with local municipalities by districts in the compilation of business plans and in the implementation of projects.

Notwithstanding these challenges, the Department’s allocations for 2003/4 financial year of R150,4 million were successfully paid to municipalities. Important achievements were,

1. 54% out of the 154 Water Service Authorities has commenced with the Section 78 assessments (Municipal Systems Act, 2000) for appropriate water service provision;
2. 47 PIMS Centres were established in all 47-district municipalities by March 2004;
3. 234 out of 284 IDPs were reviewed for 2004/05 financial year;
4. 68% of municipalities are satisfied with PIMS support and assistance;
5. 92% of municipalities have established Performance Management Systems (PMS) frameworks;
6. 77% of municipalities participated in the Municipal Performance Excellence Awards; and
7. 53% of municipalities submitted their annual performance reports.

As we enter the next MTEF period, the Department is sharply focused on improving municipal performance and management of the MSIG. Specific actions to be undertaken will include,

• Ensuring that 60% of rollover funds should be spent before the disbursements of 2005/06 allocation;
• Re-allocating of rollover funds according to the new Capacity Development Plan;
• Identifying and assisting municipalities with low expenditure patterns; and
• Directing hands-on support to municipalities through Project Consolidate.

The MIG is our single largest fiscal instrument to eradicate municipal service backlogs and provide basic services to our people. MIG was established through the merger of a number of programmes of various sector departments.

The primary purpose of the MIG is to supplement municipal capital budgets to eradicate backlogs in basic municipal infrastructure utilized in providing basic services for the benefit of poor people and to eradicate the bucket system.

The MIG will be measured by the number of new households receiving water, sanitation and new electricity connections, the number of jobs created through the utilization of guidelines prepared by the Expanded Public Works Programme and the number of households that have had their bucket systems replaced with alternative and improved sanitation systems.

Key conditions of the MIG include,

• Prioritisation of residential infrastructure;

• Adherence to labour intensive construction guidelines;

• Finalisation and complete expenditure of previous CMIP and DWAF allocations;

• Prioritisation of eradication of the bucket system; and

• Adherence to reporting requirements.

Over the MTEF period, the investment in municipal infrastructure in South Africa will be unparalleled, compared to previous allocations. For the MTEF period government has set aside R21,19 billion to be allocated through the MIG. Part of this amount is a ring-fenced figure of R1,2 billion for the eradication of the bucket system.

Steady progress can be reported on the implementation of the MIG. The allocation for MIG in 2004/05 was R 4,4 billion. By the end of February 2005 total transfers stood at R3,7 billion (i.e. 85%). Actual expenditure on the ground is R2,3 billion.

Progress has also been made in creating job opportunities. Over 3,7 million person days of employment was created, of which women benefited 30% and youth 33%. Over 800 SMMEs were utilised and 52 Black Economic Empowerment projects were undertaken on MIG projects thus far. At the end of the financial year, updated statistics will be available on all these areas.

A brief assessment of the status of MIG projects shows that at 3312 MIG projects have been registered thus far. Of this amount, 408 projects are completed and the remainder are in various stages of planning and implementation.

A number of challenges have affected the speedy and effective roll-out of MIG. Critical among these have been the following:

1. Lack of transitional arrangements: The programme roll-out was been brought forward by two years and full implementation started in April 2004/5. This earlier implementation required the dplg and other key national departments to fast track the commencement of the MIG roll-out processes.
2. Verification of 2004/5 Projects: The status of the committed Consolidated Municipal Infrastructure Programme and Water Services projects from DWAF were not confirmed. The dplg was obliged to verify the projects so as to avoid possible wasteful and fruitless expenditure that would be experienced due to unconfirmed status.
3. Poor capital investment planning at a local level: Projects, including committed projects, seem not to have been planned properly at a local level. Some of the projects identified for implementation during 2004/05 did not go through the required pre-implementation phases.
4. Non-Compliance with DORA and Reporting: It was decided during July 2004 to change from a quarterly transfer system to a monthly system due to the unsatisfactory performance and reporting of municipalities.

The Department has undertaken a range of actions and adopted key decisions that will allow us to address the key challenges to ensure that MIG targets are met.

At a strategic level, we will focus on ensuring that Project Consolidate succeeds. We will also continue to support the capacity building initiatives of sector departments and provinces. Some of our specific milestones include,

• Submitting Cabinet Memorandum on municipal infrastructure backlogs (2005).

• Completing a backlog monitoring system design by April 2005.

• Undertaking the 1^st round backlog baseline information by July 2006.

At an operational level we will focus on a range of tasks. These will include ensuring that all MIG funds are spent within the determined timeframes, establishing Project Management Units in all relevant municipalities and undertaking workshops on MIG capital planning and administrative processes.

A Management Information System (MIS) for MIG is presently also being finalised. All sector departments are participating in this process. The interim monitoring system and manual data gathering was started in 2004 to monitor the implementation of MIG. The final system has been tested, piloted and the phased–in approach will be used to implement the systems in the municipalities from 1 April 2005.

The 2004 Division of Revenue Act stated that all municipalities should receive MIG funds directly from dplg by 2006/07. In light of this dplg has added 71 municipalities in the 2005/06 financial above the 88 that received funds in the 2004/058.

The Division of Revenue Bill, 2005, is an important piece of legislation that will assist us to consolidate the gains that we have made in local government transformation since 1994. Effective and efficient fiscal transfers to local government are a necessary feature of our system of cooperative governance.

The intergovernmental fiscal relations system has being undergoing a steady process of refinement and improvement. This has included the provision of greater fiscal certainty and predictability to municipalities and the rationalization of key conditional grants to local government.

We are confident that some of the key challenges we have identified can be addressed effectively through initiatives such Project Consolidate, which will see the whole of government, including the legislature, providing dedicated and appropriate support to our 284 municipalities.

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