Fiscal Responsibility in South Africa

Ismail Momoniat, National Treasury, Republic of South AfricaWebsite: www.treasury.gov.zaIsmail.Momoniat@treasury.gov.zaKenneth.Brown@treasury.gov.zaDondo.Mogajane@treasury.gov.za

Background

Introduction• SA is not a federal country, but a unitary

country that is highly decentralised administratively and fiscally since 1994

• Three spheres of govt, with local govt distinct sphere, not a creature of provinces

• Focus will be on provinces and not local govt• Focus of presentation is on initial lessons

after only 11 years of democracy – Too early to draw conclusive lessons– Lessons apply to SA, and cannot be applied to

another country, so no attempt to apply these to a complex and highly populated country like India

System of Governance in SA• National, 9 Provinces, and 284 Municipalities • Provinces

– School education, health, social grants (Social services)– Housing, Provincial Roads, Agriculture– Poor fiscal capacity (own revenue 4%, national grants 96%)

• Local government– Water, electricity, refuse removal, housing infrastructure,

municipal roads– Significant fiscal capacity, but varies between municipalities

(Urban metros over 95% own revenue, Rural 30%)

• National government– Over half actual spending on defence, justice (courts),

prisons and police– Other: higher education, admin, policy, regulatory

Fiscal capacity and functions• Non-interest R362,6 bn out of R417,8 bn

budget for 2005/06– Servicing debt at R53,1 bn, contingency res R2bn

• Provinces receive R209,3bn (57,7%)– 9 provincial budgets aggregate to R215 bn– Own Revenue only 4% : Motor car license fees, gambling

• Local Government receives R17,1bn (4,7%)– Only one third of spending on public goods (no revenue)– Two thirds spending user charge services (water/electricity)– Taxes: Property taxes, regional levies (to be phased out)– Own revenue around R90bn

• National Govt budget is R109bn (37,6%)• Revenue-sharing system (Constitution)

– Size of grant depends on functions & fiscal capacity

Division of revenue2003/04 2004/05 2005/06 2006/07 2007/08

Prelimin. Estimate

R million outcome

National departments 108 459 121 101 136 262 146 800 157 817

Provinces 161 494 185 354 209 273 229 282 248 236

Equitable share 144 743 164 084 134 706 146 757 157 678

Conditional grants 16 751 21 270 74 567 82 525 90 558

Local government 12 396 14 757 17 159 19 708 21 461

Equitable share 6 350 7 678 9 643 10 515 11 371

Conditional grants 6 045 7 080 7 516 9 193 10 090

Non-interest allocations 282,349 321,212 362,694 395,790 427,513 Percentage increase 15.4% 13.8% 12.9% 9.1% 8.0%

State debt cost 46,313 48,901 53,125 56,603 59,381

Contingency reserve – – 2,000 4,000 8,000

Main budget expenditure 328,662 370,113 417,819 456,393 494,894 Percentage increase 12.7% 12.6% 12.9% 9.2% 8.4%

Percentage sharesNational departments 38.4% 37.7% 37.6% 37.1% 36.9%

Provinces 57.2% 57.7% 57.7% 57.9% 58.1%

Local government 4.4% 4.6% 4.7% 5.0% 5.0%

Percentage growthNational departments 11.7% 12.5% 7.7% 7.5%

Provinces 14.8% 12.9% 9.6% 8.3%

Local government 19.1% 16.3% 14.9% 8.9%

Medium-term estimates

Comparisons with India• Vertical imbalance is dealt with through

revenue-sharing, with some fiscal powers for provincial and local govts

• We have a Fiscal and Financial Commission– It is permanent but has ADVISORY powers only– National govt makes final proposal subject to

approval by 2 Houses of Parliament • Each govt in each sphere has power to determine its

own budget• Each govt in each sphere accountable to own elected

legislature• Greater and compulsory reliance on consultations

and co-operative governance

Constitution of SA• Section 214 requires annual Division of

Revenue Act• One national law applies to all provinces and

municipalities– No need for each province or municipality to have

separate legislation on fiscal responsibility– PFMA applies to all national and provincial govts,

and MFMA applies to all municipalities– How do we get consistency in fiscal responsibility

objectives between states and between national govt?

• Uniformity and precedence of national economic policy, taxes etc

Tax Assignment• National govt has 4 biggest taxes

– Personal Inc Tax, Corporate Tax, VAT, fuel levy• Provinces can legally impose a surcharge on

PIT and fuel levy, but do not as prefer revenue-sharing arrangement

• Provinces have motor car license fees• Municipalities have property taxes and

surcharge on electricity/water• National legislation can regulate exercise of

taxation powers of sub-national govts, given need for tax harmonisation and national economic policy objectives

Borrowing Powers

• Provinces and municipalities can only borrow for capital beyond a financial year

• Provinces and municipalities can borrow for bridging purposes within a financial year

• Provincial borrowing regulated by legislation • Provinces have non-revenue generating

activities, and minor tax powers– Should they really borrow?

• We are open to giving more tax and borrowing powers in future, but need to ensure expenditure efficiency first

Intervention powers

• Specified and narrow intervention powers where a province or municipality fails to exercise its powers or responsibilities

• National govt can intervene in a province in terms of section 100 of Constitution

• Province can intervene over municipality ito section 139 of Constitution

Key Fiscal legislation in SA• Constitution

– Chapter 13 of Constitution• National Acts of Parliament

– Intergovernmental Fiscal Relations Act– Provincial Tax Regulation Process Act– Borrowing Powers of Provincial Govt Act– Public Finance Management Act (PFMA)– Municipal Finance Management Act (MFMA)

• Annual Budget Acts of Parliament– Annual Division of Revenue – explanatory

memorandum & extensive tables– National and provincial appropriation Act– Tax legislation (Taxation and Revenue Laws

Amendment Acts)

Fiscal Responsibility in SA

How do we understand fiscal responsibility in SA?

• Rules and legislation are necessary but not sufficient– Can easily get around (ex-ante or ex-post?)– Budget a plan at start of fin year, and actual may

be significantly different• Co-operation and buy-in are more important

– Budget preparatory process must be DEEPLY consultative process

• Between national and sub-national govts• Between departments in each government

• Budget is a POLICY process, driven by policy priorities and spending pressures

Transformation in first 5 years of democracy 1994-1999

• SA in a fiscal mess in 1994, with deficit close to 10% and inflation around 20%

• First priority of new Mandela govt was to get macroeconomic policy right– Achieved with stunning success but low growth

• Second priority was to make the budget process more transparent and consultative– Key budget reform was introduction of 3 year

budgeting, debt management reforms– Had to transform and modernise a bean-counting

treasury with antiquated practices into a SMART treasury with policy assessment capacity

Budget Reforms since 1994• Three-year budgeting system

– National and provinces (1998/99 Budget), Municipalities

• Budget decentralisation and CERTAINTY– Own budgets by provinces and Local Govt, grant certainty– Division of Revenue Act and schedule of all national allocations

per province, per municipality for each of three coming years

• Public Finance Mgt Act and Mun Fin Mgt Act– modernising financial management in public sector– Minister responsible for outcomes and policy,

administrative head of dept responsible for implementation and outputs

• No bail-out/guarantees for provinces/LG– Up-front allocation certainty, no ad-hoc in-year allocations

• Development of provincial/local fiscal framework

Low inflation and interest rates

0

2

4

6

8

10

12

14

16

18

20

1998 1999 2000 2001 2002 2003 2004

Per c

ent

Repurchase rateCPICPIX

Debt service costs as per cent of GDP

Debt service costs

5.6%

5.3%

4.9%

4.5%

3.9%

3.2%3.4%

3.5%3.5%3.6%

4.7%4.9%

5.2%

5.5%

3%

4%

5%

6%

1994

/9519

95/96

1996

/9719

97/98

1998

/9919

99/00

2000

/0120

01/02

2002

/0320

03/04

2004

/0520

05/06

2006

/0720

07/08

As %

of G

DP

Debt to GDP

0

100

200

300

400

500

600

700

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

R b

illio

n

0

10

20

30

40

50

60

70

Per c

ent G

DP

Foreign debt

Domestic debt

Total net loan debt as % of GDP (right axis)

Medium term outlook

-6

-4

-2

0

2

4

6

8

10

2001

2002

2003

2004

2005

2006

2007

Per c

ent

GDP growthCurrent account (% of GDP)CPIX inflation

Three year budgeting

• In 1998 shifted from one-year incremental budgets to three-year rolling budgets

• Publish 3 year budgets, but appropriate only for one year only

• Use outer 2 years as baseline for next budget, and allocate only additional funds from contingency reserve and new revenue

• We ignored nay-sayers who said not possible• Lays basis for better planning, more

consultative budget processes and better intergovernmental fiscal relations

Intergovernmental Budgeting • SA has grant certainty

– Three year allocations per province, per municipality, for EVERY grant

• Equitable share allocation main allocation to provinces (64%)– Clear formula to divide funds– Provincial formula linked to key social sectors– Local govt formula linked to poor households

• Conditional grants – Social grants (27%, previously from eq share)– Infrastructure, tertiary hospital services– Different formula for each conditional grant

• Annexure E in Division of Revenue Bill

Budget is a policy process• Budgeting is at heart of policy-making, and

needs to be consultative– Budgets require prioritising of policies, which is

essentially a POLITICAL process– Minister of Finance requested Cabinet to form-

• a Ministers Committee on the Budget (sub-com of Cab)• Budget Council and Budget Forum, for provinces and

municipalities

• Compulsory consultations for Division of Revenue process and exercise of sub-national fiscal powers

• No outside or independent agency can determine budget or allocations

Budgeting harder under decentralised system

• Need to co-ordinating policy, planning, budgeting processes– National depts responsible for policy, prov/LG for

implementation– Setting up of sectoral Ministerial forums (MinMECs)

between Ministers of national and provincial governments for education, health, welfare, housing

– Challenge of co-ordinating sectoral and budget forums, as each sector wants to maximise its funds

– Reducing sectoral collusion and allegations ofunfunded mandates

• How do we link Budgets to PERFORMANCE?

Performance and Accountability challenges

• We are still striving to get more performance accountability– Budget reforms to facilitate greater performance in

public sector as a whole– Has 3 year budgeting reached lower down to the

level of project or facility?

• How do we get better customer accountability?

• How can we get better political accountability through legislatures – Does pol failure increase risk of service delivery

failure?

Budget preparation process: pre-year

• Independent FFC makes (advisory) proposals • Consultations with provinces and LG

– Budget Council of national/provincial Ministers of Finance– Budget Forum incorporates local govt

• National Cabinet makes final allocations to 3 spheres of govt in October– Equitable share formula used to divide funds between provinces

and local govt (also conditional grant formulae)

• Pre-budget in Nov, followed by Budget in Feb– Division of Revenue Bill tabled, to be passed by Parliament

• Contains memo explaining formulae• Contains or ensures up-front payment schedule for transfers

– Provinces table own three year budgets in Feb/March

• National govt publishes Intergovernmental Fiscal Review in April

Key Budget documents• Budget Review and Division of Revenue (DoR) Bill all

part of National Budget– contains memo explaining formula– contains/ensure upfront payment schedule for transfers

• Intergovernmental Fiscal Review– 1x month after national and provincial budgets tabled– discusses 9 provincial budget trends for 7 years

• in year (2002/03), three years to follow, three years past– covers LG information for current financial year

• Quarterly and monthly budget info on provinces– 30 days after end of each quarter

• Strategic plans of departments tabled with budgets• Annual reports of departments in Sept• NT website www.treasury.gov.za

Initial Lessons from SA

First Lesson from SA

• Budget reform goes with fiscal decentralisation– It is even more important for fiscally decentralised– Co-ordinating policy and sector interests across

tiers of government is really difficult but necessary– Ignore the nay-sayers and implement 3 year

budgets – Budgets should not require line-item political and

legislative approval• Reserve line-item budgets (to the extent they are even

necessary) for internal management purposes only

Budget Reforms and Fiscal Decentralisation

• Budget reforms are even more important for fiscally decentralised countries– Are budgets sustainable?– Is consolidated tax to GDP stable or declining?– Is consolidated borrowing or deficit sustainable (ie

consolidated debt to GDP stable or declining)– Are provincial budgets comparable with each

other?• Standard chart of accounts, uniform budget formats etc

– How quickly can we produce consolidated budget information?

• How much are we spending on school education?• Need to aggregate school budgets from 9 provinces

Second Lesson: Intergovernmental Grants

• Money is fungible, so unconditional grants work better than conditional grants, focusing on broad priorities related to entire budget

• Resist sectors who prefer conditional grants– Cond grants for social grants and infrastructure

• Horizontal equitable share formula is redistributive between provinces – How do we achieve equalisation?– Needs versus performance?

• Data problems– is it possible to get comparable usage and cost data for all provinces or municipalities?

Third Lesson:Transparency, Information

and Accountability • It is a continual struggle to get all levels of

government to publish information• Start with budget implementation information,

through monthly reports• Opens up possibilities for greater

accountability by Parliament, public etc– Information delayed is accountability denied!

• Culture of publishing ALL relevant info on website on same day

• How quickly do we collect and publish information?

Regular reporting

• Financial management improves dramatically if we start – Publishing of monthly in-year reports on budget

implementation– Requiring financial statements from all

departments and entities to submit for audit within 60 days of end of fin year, and audited and tabled in Parliament within 6 months

• Many benefits follow from above, including in-year accountability, better management and a further feedback mechanisms to improve budget allocation process

Fourth Lesson: Build Treasury capacity

• Third lesson is to reform all treasuries to play a leadership role in budget process

• Budgeting is too important to leave to accountants! It is positively dangerous

• National Treasury must develop its policy assessment capacity to inform budget allocation process

• National Treasury also needs to create an enabling framework for better governance, management and accountability

National Treasury capacity

• In a decentralised country, National Treasury in SA has dedicated unit for intergovernmental fiscal relations– Dedicated unit to work with provinces and municipalities– Assessing credibility of provincial budgets (informal and

perhaps to publish such assessment)– Printing Intergovt Fiscal Review (IGFR) and consolidated

budgets– Ensure each (nat, prov or mun) treasury prepares quarterly

reports for its Cabinet or Exco– Ensure that national Treasury do a consolidated quarterly

report for all provinces?

Key challenge is to ensure Budget Credibility

• National Treasury assesses provincial budgets as an advisory service to provide an independent perspective, and point out budget risk– Is tabled budget credible?– Are projections realistic? – Is the deficit fully funded? Focus on a balanced

budget rather than a deficit target?• Continual challenge is to ensure

implementation is according to planned budget

Fifth lesson:One collection agency

• Success of one national collecting revenue agency (SARS) for the major taxes

• You cannot spend or divide revenue that you fail to collect!

• We divide revenue ANTICIPATED to be collected before the start of the financial year

Last lesson: Check relevance of Conventional Assumptions• To what extent does conventional theory of

fiscal decentralisation really work in a developing country?

• Does greater tax capacity lead to better accountability? – Do developing countries have effective

accountability and auditing mechanisms?• How can we get better financial or service

accountability when we have a shortage of auditors, doctors etc?

Theory and practice• SA has clear expenditure and tax

assignment, and GRANT CERTAINTY• Why are provinces fiscally more

responsible than municipalities?– Provinces have weak tax powers,

municipalities have strong tax powers• What further taxes do we devolve?

– Why should be move away from one tax collector?– Why should we prioritise tax rate autonomy over other

taxation reforms?

• What need for borrowing if govts struggling to spend on capital?

Other factors also impact: Public Service

• Subnational govts tend to have personnel intensive functions like teachers, nurses, and personnel expenditure a high proportion of their budget (eg in education 80%)

• Bargaining system for public service –centralised or decentralised?

• Mobility and uniformity in conditions of service between states?

• Are public servants under one pension fund? Is it a benefit fund? How do you share burden of funding shortages?

Local Government

• We are still implementing our reforms with municipalities, so not as developed as with provinces

• Have undergone three major transitions (including change in boundaries) since 1993

• Provincial govt should do unto municipalities what they want central govt to do unto them!– Every govt has a propensity to be gate-keeper

over funds they control– Need three year grant certainty, predictability etc

for local govt as well, and also for projects that you control

Conclusion• Has decentralisation worked in SA?

– Don’t know, too early to tell– Reform process still not completed – Short-term assessment vs medium to long-term

• Has decentralisation led to better delivery?– Would delivery have been better if centralised?– No, if national depts with delivery responsibilities are

taken into account– Not clear if provinces or local govt would do better!

• Mixed story of early successes and failures• No easy solutions to complex problems