1. 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

2. 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

3. 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)

4. 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

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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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

14. 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

15. Fiscal Framework
Part 3 of Annexure E

16. Division of revenue framework Table E.2

17. 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

18. 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

19. 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

20. Summary of new formula

21. 3-year phasing Table E.8
National Treasury

22. Local Government Allocations
Part 5 of Annexure E

23. 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

24. 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

25. 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)

26. 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

27. 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

28. 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

29. 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 = R R1*Popln+R36 000* councilors

30. 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%

31. Clauses in the Division of Revenue Bill

32. 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

33. 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

34. 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

35. 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