1. Financial and Fiscal Commission 20 March 2018
Briefing to the Select Committee on Appropriations on the 2018 Division of Revenue Bill
Financial and Fiscal Commission
20 March 2018

2. Background
The 2018 budget was tabled under a climate of difficult economic and fiscal conditions
The low growth environment will continue to place downside risk on the fiscal framework
Nonetheless, the Commission welcomes the manner in which the budget responded to the risks
Credibility of the budget remains intact
Core expenditure has been protected
Deficit is expected to decline in the medium term
Commission makes this submission in terms of Section 214 (1) of the Constitution and Section 35 of IGFR Act

3. Technical Changes To The Division of Revenue Bill

4. Overview and general assessment of the 2018 division of revenue bill(1)
The 2018 Bill comprise a number of technical changes to enhance IGFR processes and improve revenue and expenditure management
Clause 8(4) (a): Treasury no longer required to approve when municipalities pledging a conditional grant or a portion thereof as a security for any obligation
Municipality must now notify the transferring officer of its intention to borrow and give the transferring officer 21 days to comment before obtaining the approval of the municipal council
National Treasury will determine the format and dates for the submitting financial and non-financial reports for any project funded under pledging arrangements
These changes are supported because:
They are in line with Commission’s 2018/19 recommendation that National Treasury should improve access to credit markets for large cities to allowing them to use their infrastructure grant funding allocations to leverage private capital, and
They place responsibility and accountability for such approval where it should be, namely the municipal council and lender

5. Overview and general assessment of the 2018 division of revenue bill(2)
A new clause 30 (2) (d) requires that provincial transfers to municipalities should be accompanied by service level agreement concluded between the province and a municipality.
The Commission welcomes this addition because:
Alignment of funding and functions is key to efficient service delivery and eliminating intergovernmental fiscal disputes over funding and outputs.
In its 2012/13 Submission, the Commission recommended that delivery functions of each function should have a legal bases to avoid impinging on the lawfulness of the budget

6. Overview and general assessment of the 2018 division of revenue bill(3)
Clause 21(7) makes provision for the new Provincial and Municipal Housing Emergency Housing Grants
The grants are intended to provide funding to provinces and municipalities for provision of temporary shelter assistance to households affected by disasters
Going forward government need to explore alternative mechanism for financing and managing disasters holistically
The Commission made several recommendation in relation to disaster financing in 2013/14
Clause 27(4) (b) requires provincial departments of health and education to review their Infrastructure Delivery Management System (IDMS) annually
The Commission supports these changes and is of the view that an annual review of the IDMS should include a capacity building plan monitored by the Treasury to ensure effective and sustainable project implementation

7. Overview And general assessment of the 2018 division of revenue bill(4)
Clause 27(5), allow local municipalities to apply and qualify for the Integrated Urban Development Grant (IUDG), envisaged for the 2019/20 financial year.
The IUDG will be a combination of different local government conditional grants.
The introduction of the IUDG is line with the past Commission recommendations on consolidation of local government conditional grants.
The Commission supports the initiative by government to support non-metropolitan municipalities which face urban development challenges. The clause should explicitly specify the types of municipalities that are eligible for the grant as it is not targeting all non-metropolitan municipalities.
The 2018/19 Commission submission estimates that 53 municipalities can be categorised as Urban

8. National Fiscal Framework

9. MTEF division of revenue amongst the three spheres
R billion
2014/15
2015/16
2016/17
2017/18
2018/19
2019/20
2020/21
Real Annual Average Growth over 2018 MTEF
Division of available funds
Outcome
Revised
Medium-term estimates
National departments
490.0
546.1
555.7
599.9
628.6
685.9
736.6
1.5%
Provinces
439.5
471.4
500.4
538.2
571.0
611.8
657.5
1.3%
Equitable share
359.9
386.5
410.7
441.3
470.3
505.0
542.4
Conditional grants
79.6
84.9
89.7
96.8
100.7
106.7
115.0
0.4%
Local government
87.6
98.3
102.9
110.7
118.5
126.9
137.5
1.9%
41.6
49.4
50.7
55.3
62.7
69.0
75.7
5.2%
General fuel levy sharing with metropolitan municipalities
10.2
10.7
11.2
11.8
12.5
13.2
14.0
35.8
38.3
40.9
43.6
43.3
44.8
47.8
-2.3%
Total
1,017.1
1,115.8
1,159.0
1,248.8
1,318.1
1,424.6
1,531.6
1.4%
Division of revenue amongst three spheres characterised by muted growth increases over 2018 MTEF
Commission welcomes real growth in the equitable share allocation to municipalities over the 2018 MTEF period –Local government equitable share allocation grows by 7.5% in 2018/19
Conditional grant allocations to provinces and municipalities will bear the brunt of government’s need to cut and reprioritise spending

10. Sectoral Issues

11. Social Sector and the DoRB
The Provincial Social Sector account for 35% on national budget
Basic Education receives a total allocation of R246 b or 17% of non-interest spending in 2018/19
Health receives R205 b in 2018/19 growing at a nominal average rate of 7.8% over the MTEF
Social development allocations constitute 17.7% of total non-interest spending and grows at a nominal average rate of 9%
Social sector cost of employment (COE) is increasingly crowding out goods and services and Capital spending
There is need to balance staffing shortages and rising COE spending and declining productivity in the sector
Clause 30 (2) d of the Bill on signing of service level agreements should be extended to interdepartmental delivery arrangements

12. National social service and The DoRB
The social development budget for which national government is responsible is rising rapidly (Amounts to R287 b in 2018/19)
The Social protection (Grants) allocations equates to national health allocations (13% of non interest spending)
There is a need for linking grants to social development outcomes at the provincial level (health and skills training)
Higher education receives the highest growth in allocations at a nominal average rate of 13% over the MTEF
The implementation of December 2017 policy pronouncement on fee-free higher education cannot be regarded as a once-off shock to the fiscus –
There is a need for detailed plan for rolling-out of fee-free higher education, its quality and throughput and the anticipated impact on the fiscus going forward

13. Infrastructure and the DoRB
Infrastructure spending is the biggest casualty of consolidation
Projected spending over the MTEF is expected to remain constant
SOEs will continue to remain the biggest driver of capital spend (R115 b in 2018/19)
Provinces and municipalities account for 23% and 20% of capital spend respectively
Planning and procurement efficiencies are needed to improve the growth effect of capital spending

14. Provincial and Local Government
Fiscal Framework

15. Provincial Fiscal Framework
 R’million
2017/18
2018/19
2019/20
2020/21
Annual Average Real Growth Rate
PES
441.3
470.3
505
542.4
Conditional grants
96.8
100.7
106.7
115
Real Annual Growth Rate
1.1%
2.1%
1.9%
1.69%
-1.5%
0.7%
2.3%
0.49%
The provincial fiscal framework [inclusive of conditional grants] has declined by R18.3 billion over the 2018 MTEF in comparison to 2017 MTBPS
Despite these significant reductions, both the PES and conditional grants are still expected to grow on average at above the rate of inflation over 2018 MTEF, implying provinces should still be able to maintain the delivery of constitutionally mandated basic service delivery
However, infrastructure grants have taken the brunt of the cuts, with R13.7 billion deductions over the 2018 MTEF. If efficiencies don’t improve, we are likely to see delays in addressing health and education infrastructure backlogs as a result

16. Provincial fiscal framework [cont.]
Provincial Equitable Share formula
Government has announced in the 2018 Budget that the PES formula is under review
The initial phase will consist of improving the quality of data that is being used in the formula. The second phase of the review will align the health and education components
While the Commission welcomes these enhancements, these should be viewed as the first stages of a more in-depth and extensive review process that incorporates previous FFC recommendations
E.g. A review the PES formula can’t happen without a review of the expenditure and revenue assignment functions of both national and provincial governments
Requires strategic oversight support from National Government to avoid disruptions to service delivery plans
Briefing on the 2018 Division of Revenue Bill

17. Provincial grants budget analysis
Provincial conditional grants have been reduced significantly over the 2018 MTEF
major reductions are with respect to the human settlements, education and health sectors

18. Provincial grants budget analysis
Human Settlements Development Grant: Reduced by R7.2 billion despite its good performance (average expenditure of over 96% over the last 5 years)
The Commission is of the view that this significant reduction in the baseline will further reduce housing outputs already on the decline in recent years while housing backlog is on the rise
Health Facility Revitalisation Grant and the indirect component of the National Health Grant reduced by R511 million and R309 million respectively
While these reductions are not significant, the Commission is of the view that they are likely to negatively affect the provision and maintenance of key health infrastructure which is vital for the piloting and the rollout of health reforms

19. Provincial grants budget analysis
Despite its good spending performance, Education Infrastructure Grant (EIG) has been reduced significantly by R3.6 billion, while the HIV and Aids Grant (Life Skill Education) has been reduced by R51.9 million
The Commission holds the view that cutting the baseline of EIG which is key to provision of school infrastructure will negatively affect the condition of school infrastructure and learning process as well as learning outcomes
The under performing School Backlogs Infrastructure Grant which should have been incorporated into EIG in 2017/18 is allocated a further R3 billion over the 2018/19 MTEF
The HIV and Aids grant has been reduced mainly due to underspending
Commission supports the principle of shifting funds to performing programmes. It emphasises the importance of finding the root cause of poor performance and addressing those challenges instead of reducing allocations on the basis of poor performance

20. Local government grants
The local government sphere is set to receive a total of R383 billion worth of transfers over the 2018/19 MTEF; a drop from the R364 billion that the sector was envisaged to receive in the 2017/18 MTEF.
The envisaged cuts in local government grants explain the drop in the amount of transfers to the sphere.
The Commission   notes that these reductions are unfortunate but understandable in the context of the current fiscally constrained environment.
The local government will account for R3.2 billion (or 12%) of the R26.4 billion worth of baseline reductions in the 2018/19 financial year.
The Commission notes that the Local government equitable share  and the General Fuel Levy are sparred from the cuts affecting many other transfers.
In fact the LGES and all its three components (i.e. basic services, institutional and community services) will continue to grow during the 2018 MTEF (average growth of 11%): The Commission welcomes the decision as the two funding streams have a direct positive bearing on the livelihoods of poor households.

21. Baseline reductions to Local government conditional grants
Over the MTEF, municipalities are set to receive R136 billion through direct conditional grants and 21.8 billion in the form of indirect conditional grants.
The local government conditional grant baselines will be reduced by a total of R13.9 billion over the MTEF.
The largest cuts will be experienced by four grants, namely the INEP, MIG, Public Transport Network grant and the USDG.
The bulk of the reductions in rand value terms will come from the MIG which will experience a R5.6 billion cut over the 2018 MTEF or R1.5 billion in 2018/19.

23. Distribution of LG Transfers
Despite the cuts, Grants per poor household shows:
Rural municipalities continue to receive more money (R10500) relative to urban municipalities (R4700 for metros)

24. Local government grants
The reductions in conditional grants seem not to follow any clear cut pattern, serve for the fact that they fall disproportionately on bigger grants (in terms of value). The cuts ignore some of the more widely accepted criteria such as historic performance of the grant.
The reductions also fall disproportionately on infrastructure grants (e.g. MIG, USDG, INEP and PTNG), contrary to the nation’s development thrust of an infrastructure-led growth. Sooner or later this burden on infrastructure grants would be self-defeating as infrastructure will deteriorate and become inadequate for continued provision of basic service thereby hurting the poor
The Commission would propose that in future, a more rigorous analysis of the performance of each grant is done before the cuts are done. It is also important that in the near future some rigorous analysis is undertaken to ascertain the impact of such reduction on households, business and economy at large - and to draw lessons for future

25. Concluding Remarks and Way Forward
The Commission is in agreement with general thrust of 2018 Division of Revenue Bill
Commission commends efforts by Government to protect social spending and Local Equitable Share in particular
Commission supports proposed conditional grant cuts on condition that going forward Government (a) addresses identified weaknesses in the criteria used to cut the grants when used as instrument of consolidation and (b) puts in place monitoring and evaluation plans of the cuts after a certain period to see and evaluate how it's impacting current and future service delivery
Commission supports proposed new conditional grants, subject to matters raised in this submission
Government has responded adequately to Commission recommendations and indicated actions underway at implementing the recommendations

26. Matters For Noting
The 2017 budget announced an establishment of the NHI fund in 2017/18 through changes made to medical tax credit
This proposal is only allocated R64 million in 2018/19 while most of the funds are allocated to NHI conditional grants
Wage bill negotiations could worsen the already tight fiscal position of provinces if agreement reached is in excess of expectation
Funding for higher education should be accompanied with measures to improve quality and throughput
There is need to continue reviewing the vertical division of revenue to ensure alignment with responsibilities of each sphere

27. FFC Website: www.ffc.co.za