Division of Revenue Bill 2005 [B 8B-2005] Select Committee on Finance National Council of Provinces Lungisa Fuzile, Malcolm Booysen and Jo-Ann Ferreira 2 March 2005

Legislative requirements Section 214 of Const and IGFR Act Require an annual Division of Revenue Bill Section 10(5) of the Intergovernmental Fiscal Relations Act gives effect to Constitution in terms of Consultation processes for allocations with Budget Council, Budget Forum (BC, Minister of dplg and SALGA) and FFC Explanatory memorandum (Annexure E) on formulae etc Consultations culminate in Extended Cabinet with provincial Premiers and chairperson of SALGA

DOR: Schedules Schedules 1 to 7 Equitable Share allocations (Schedules 1-3) Schedule 1 divides eq share between 3 spheres Schedule 2 divides provincial equitable share between 9 provinces Schedule 3 divides local equitable share between 284 municipalities Conditional Grant allocations (Schedules 4-7) Schedules 4 and 5 generally or nationally assigned functions to provinces/ municipalities Schedules 6 on LG grants (no division by muni) Allocations by municipality in explanatory attachments Allocations-in-kind to LG (Schedule 7)

The explanatory memorandum Also attached to 2005 BR as annexure E Part 1: deals with how 10 factors in s214(2)(a-j) of Constitution were taken into account Part 2 Govt’s response to FFC proposals Part 3 deals with fiscal framework, Part 4 and 5 provide details on prov/local allocations Part 6 concludes with fiscal framework issues in prov/LG that need further work Appendices Appendices E1 & E2: Frameworks on all conditional grants Appendices E3 to E6: LG allocations by municipality for both national & municipal financial year Appendix E7: MIG (ring-fenced sanitation allocations) Appendix E8 Demographic data for Local Government Equitable share and Municipal Infrastructure Grant

Response of National Government to FFC Proposals Part 2 of Annexure E

Process to consider FFC proposals FFC Submission: DoR 2005/06 Focus is on three main sets of issues Part 1 deals with the provincial equitable sharing system Part 2 deals with the LG equitable sharing system Part 3 set focus on the intergovernmental system Response should be viewed against the review of LG and Provincial fiscal review Budget Council considered prov proposals Budget Forum considered LG proposals Premiers invited at Extended Cabinet Cabinet finalises div of revenue thereafter

FFC Provincial Recommendations Equitable share formula Regular revision of weights Education component Early Childhood Development Health component Welfare component Economic activity Equity and efficiency aspects Review of conditional grants transfer system Supplementary January 2005 proposals on social grant shift and capital grants model

Govt response to FFC provincial proposals Weights for components should be in line with spending and priorities Weights have been reassigned to take into account the shifting of the social security grant function, and share of education and health Health component should include utilisation, gender, age data Alternative information not available or unreliable Education component of ES formula School-age cohort data is retained ECD phase into ES formula by adjusting the age cohort to 5-17 Equal weighting proposed for school age and enrolment data Welfare component to be removed and funded as conditional grant Agree, with social grants now funded as a conditional grant Supplementary proposal also taken into account Econ activity to be included/re-designed in light of provincial taxes Govt supports policy to improve revenue capacity, but will take time Economic component retained at 1%, but now less than poverty component to effect redistribution

Govt response to FFC provincial proposals Equity and efficiency Hard to implement, difficulty in reliable cost differentials for same service Same problems as related to costed-norms proposal Financing provincial infrastructure Agree with FFC proposal on backlog component which is shifted from equitable share to the provincial infrastructure grant Lack of data for capital grants model means it cannot be implemented Re-allocation of Cond Grants when underspending, and need for review Government agrees with new re-allocation clause in DoR Bill Hospital grants will be prioritised for review Other grants will also be reviewed (mainly provincial, as LG grants rationalised

Govt response to FFC local govt proposals Avoid use of funding windows in the Eq share formula NG agrees, and new formula uses a component based approach Structure of the formula should be linked to constitutional requirements NG agrees with structure that includes a basic services (S) and institutional (I) grant Also agree on revenue-raising component Govt believes not practical to implement a spill over grant or deal with other legislative requirements (formula is indicative) Use of funding windows The definition of the core drivers is described in the in paper on LG govt grants tabled before the Budget Forum today. Of the two approaches under consideration – equitalisation is difficult to implement Structure of the formula LES = S (basic services) + B (constitutional & legislative responsibilities) + I (core admin) + T(tax equalisation) + m (spillover) Spill over grant was also proposed under the original 1998 policy document Difficult to implement spillover grant & with the creation of unicities the argument is much weaker National Treasury

Govt response to FFC local govt proposals Assessment of municipal service cost Govt agrees on need to take services into account, so new formula differentiates between full and no services Formula is indicative, and getting cost info is difficult Equitable Share formula should be simple, and not too data intensive NG agrees to have a simple formula For modelling and analysis purposes we require more accurate measure of expenditure needs Revenue-raising capacity measure should be included in formula as a whole Rev component is introduced in eq share formula as a separate component and not just in I grant Assessment of municipal service cost The extent to which this can be achieved depend on reliable & credible information, and political consensus on the levels of basic service provision Review of the LES The new formula does give effect to the simplicity principle Need for alternative data given no Census in 2006 and the CRS will only be available on district level Revenue raising component The current structure (or windows approach) made it difficult to apply a revenue raising component National Treasury

Govt response to FFC local govt proposals Disbursement of capacity-building funds NG planning review of the capacity building grants Not planning an extensive formula, but criteria should be transparent Collection of municipal level data NG agrees it is necessary to collect such data Subsidisation of tariff charges of low-income households The formula targets poor households but real challenge is with regard to implementation Capacity building grants Capacity building grants will be phased out over the medium term & incorporated into the LES Allocation criteria should be published in Annexure E Collection of municipal data Govt is establishing a comprehensive data base that will be available to key stakeholders Will collect key revenue & expenditure info for policy making purposes Subsidisation of tariff charges of low income households Government issues guidelines, norms and standards on how the LES should be utilised National Treasury

Govt response to FFC local govt proposals Linking of MIG and Equitable Share Formulae already linked in many ways Both target poor households with appropriate incentives MIG has a performance component, taking capacity into account Ceding of equitable share revenue NG will consider guiding municipalities on how to cede part of their equitable share Not considering amendments to the MFMA at this stage Linking MIG and ES Basic services of component of LES take account of poor households with infrastructure MIG classify municipalities into high, medium and poor capacity MIG also has a limited lifespan of 10 years and will ultimately be incorporated into the LES Ceding of ES These guidelines will ensure that municipalities do not recklessly cede part of their ES & compromise their ability to deliver fbs National Treasury

FFC proposals on Intergov system Welcome contribution to the IGFR system Bulk of proposals are work-in-progress Proposals related to expenditure assignment, costed-norms,performance management,building institutional capacity, funding instruments for poverty-alleviation, and general improvement of management systems Expenditure assignment is complex and calls for greater cooperation Data management is key but not easy to improve on information systems to the point they are reliable and comparable

Fiscal Framework Part 3 of Annexure E

Division of revenue framework Table E.2

New Provincial Equitable Share Broad ranging review of formula undertaken All stakeholders consulted FFC recommendations taken into account Proposed formula consist of 4 components Education, health, institutional and basic Two additional components Poverty component to make the formula redistributive Takes into account education and health pro-poor policies Takes into account pro-poor nature of developmental welfare services Economic activity component to take into account revenue raising capacity of provinces

New Provincial Equitable Share Provincial equitable share formula Education component Uses both school enrolment and census data (school-age cohort) each weighted equally The weight (51 per cent) is based on average education spending for the past three years (excluding CGs) Health component Based on people with and without medical aid and is weighted at a ratio of 4 to 1 The weight (26 per cent) is based on average health spending for the past three years (excluding CGs) Institutional component Allocated equally across provinces (11,1 per cent) and the weight is politically set at 5 per cent Basic component Population share of each province in the country’s population Weight is the residual of all other weights

New Provincial Equitable Share Provincial equitable share formula Redistribution is effected by using by assigning a weight of 3 per cent to poverty and 1 per cent to economic activity The basic component is assigned a residual weight of 14 per cent Phasing-in the formula New formula results in shifts in provincial equitable share baselines Social security grant function shift impacts as well Propose a 3-year phase-in of new equitable shares

Summary of new formula

3-year phasing Table E.8 National Treasury

Local Government Allocations Part 5 of Annexure E

Local Government priorities Bulk of pro-poor spending is in provinces and local government Accelerate the rollout of free basic services Electricity, water and sanitation, refuse removal Municipal infrastructure development MIG to provide the infrastructure to rollout free basic services Contributing to job creation Facilitate better planning and decision making Capacity building Building in-house capacity in planning, budgeting and financial management

Local Government Allocations National allocations are an important and growing source of revenue for municipalities Comprise about 12 per cent of total LG budgets, but can be as high as 84 per cent in some municipalities Increases by R5,4 bn over the next 3 years R1,7 bn for infrastructure, R3,7 bn for ES Total allocations grows to R21,5 billion in 2007/08 from R14,7 billion in 2004/05 Equitable share is most significant comprising 56 per cent of allocations in 2005/06 allowing greater discretion at local level Equitable share increase to R11,4 billion in 2007/08 from R7,7 billion in 2004/05

Background of review Old formula had limitations The new formula responds to the following: Section 227(1) – provision of basic services Policy imperatives such as: Poverty and free basic services The fact some poor people do not have access The need to support institutions of governance Variations in capacities of municipalities to raise their own revenue (The President’s call)

Structure of Formula Accordingly the formula has the following components: Grant = Basic Services (BS) + Development (D) + Institutional Support (I) - Revenue Raising (RRC) +/- Stabilisation Constraint (C) D will be set at zero for now

Policy choices by component Basic services component 4 services are recognised Water, sanitation, electricity and refuse removal Households with services funded at R130 pm while those without services are funded at R45 pm (about 1/3) The R130 figure comes from a dplg study Future research will need to improve on the cost of providing free services Within basic service component the other policy decision is the choice of poverty line A relatively low poverty line like R800 is more redistributive than R1600, which tends to shift allocations towards urban municiplaties This raises the question of growing urban poverty For the model now, R800 is proposed

Revenue raising capacity component New innovation of the new model It uses imputed revenue Imputation takes account of: RSC levies in As and Cs, and Property taxes in As and Bs Imputation is necessary because of lack of and incomplete data The methodology is non-arbitrary and is cushioned from inaccurate data from individual municipalities A “tax rate” of 5% is imposed on potential revenue An amount R1,2 bn is thus reallocated through the BS component

Institutional component Recognises the need to fund institutions of governance National government subsidises rather fully funds the function Elements in the component presume that: Fixed contribution to each municipality An element that recognises that the cost of administration may increase with the population serviced An element that subsidises councilor remuneration Therefore: I = R350 000+R1*Popln+R36 000* councilors

Summary of overall impact Population Indicative (Rands) Final Allocation: unconstrained % change Final Allocation: with guarantees Western Cape 4,524,335 453,727,271 497,331,204 9.6% 495,111,576 9.1% Northern Cape 984,314 219,716,996 246,590,376 12.2% 246,296,484 12.1% Eastern Cape 6,436,763 1,456,726,085 1,453,187,101 -0.2% 1,559,609,445 7.1% Free State 2,706,775 646,402,055 857,982,705 32.7% 782,029,142 21.0% KwaZulu Natal 9,426,017 1,703,711,013 1,781,307,558 4.6% 1,853,275,728 8.8% Mpumalanga 2,868,380 557,229,224 638,121,060 14.5% 607,643,192 9.0% Limpopo 5,496,148 1,182,064,835 1,266,244,958 1,264,877,933 7.0% North West 2,986,498 603,847,431 724,120,154 19.9% 682,552,712 13.0% Gauteng 9,390,546 1,519,940,088 1,678,479,884 10.4% 1,651,968,789 8.7% Grand Total 44,819,778 8,343,364,999 9,143,365,000 Total Metros 14,679,241 2,076,166,713 2,297,784,182 10.7% 2,242,187,819 8.0% Total B's 30,140,537 5,015,374,265 5,431,906,414 8.3% 5,501,016,759 9.7% Total C's 1,251,824,020 1,413,674,404 12.9% 1,400,160,423 11.8% Percentage Metros 32.8% 24.9% 25.1% 1.0% 24.5% -1.5% Percentage B's 67.2% 60.1% 59.4% -1.2% 60.2% 0.1% Percentage C's 15.0% 15.5% 3.0% 15.3% 2.1%

Clauses in the Division of Revenue Bill

Division of Revenue Bill 2005 Number of substantive amendments Social assistance now a conditional allocation. This has significant fiscal and moral risks for national government. New clause inserted to regulate roles and responsibilities of national government and provinces Different arrangements for Schedule 4 grants, especially hospital and infrastructure grants Cash management reforms related to CPD accounts with SA Reserve Bank for equitable share and social assistance allocations to provinces Housing accreditation of municipalities Alignment with MFMA now that it has taken effect 1 July 2005 Role of category C and B municipalities Number of technical amendments

Social Dev and Schedule 4 grants Social Development poses biggest moral risk Schedule 4 allocations supplement the funding of programmes funded from provincial and municipal budgets duties of transferring and receiving officers included in separate clauses CAPEX budgets to be appropriated on the votes of provincial departments responsible for functions and not that of provincial public works department to ensure clear lines of accountability

New clauses Transfers by public entities to municipalities Social Assistance Transfers and Social Assistance Administration conditional allocations Integrated Housing and Human Settlement Development allocation Water Services Operating and Transfer Subsidy allocation Duties of transferring national officer and receiving officer for Schedule 4 allocations Category C municipalities and related allocations Matters relating to internal audit units Re-allocation of allocations after stopping Non-committed Schedule 5 and 6 allocations Preparations for next financial year Unauthorised and irregular expenditure

Deleted clauses from 2004 Act Section 5(7) on withholding municipal equitable share Transfers of assets to municipalities Interim arrangements for re-allocations Funds follow transfer of functions or obligations