FINANCIAL AND FISCAL COMMISSION COMMENTARY on the 2002 Medium Term Budget Policy Statement (for) JOINT BUDGET COMMITTEE Hearings on the MTBPS November 2002

1 INTRODUCTION Constitutional and Legislative Mandate Section 214 of the Constitution requires consultation with the FFC before the annual Division of Revenue Act is passed. This commentary is supplementary to the FFC’s analysis of the Division of Revenue Bill presented to Parliament after the Budget Speech. The analysis is therefore preliminary. Data used in this preliminary analysis will be updated and supplemented as new data is released during the annual division of revenue process. Any results indicated are therefore tentative.

2 INTRODUCTION Constitutional and Legislative Mandate Cont. Section 214 of the Constitution and Section 9 of the IGFR Act provide for the FFC to recommend on the forthcoming [financial] year’s division of revenue in April. The FFC provides an overview of its proposals for the 2003 MTEF for Government’s consideration in the annual Division of Revenue process. Government’s response is to be contained in Annex E of the Budget Review. The FFC is also mandated to comment on all money bills especially as they relate to tax and borrowing by sub-national governments.

3 INTRODUCTION Constitutional and Legislative Mandate Cont. Section 214 (2) of the Constitution provides factors (a) – (j) as a basis on which to determine, analyze and evaluate the Division of Revenue. In this preliminary comment, particular consideration is given to:  Provisions for national debt and obligations;  National government’s needs and interests;  The ability of provinces and municipalities to provide basic services;  Fiscal capacity of provinces and municipalities;  The developmental needs of provinces and municipalities;  Stability and predictability of revenue shares;

4 INTRODUCTION cont. Structure of Submission This preliminary comment is the first draft of 2 component parts of the FFC’s analysis of the Division of Revenue Bill for 2003 / 04 and consists of: Part I – Overview of the FFC’s proposals for the 2003 MTEF (presented to Parliament in May 2002). The extent to which Government has taken account of these proposals is considered where applicable. Part II – A tentative analysis of recent past and projected trends in national, provincial and, where data is available, municipal revenue sourcing and spending patterns.

6 INTRODUCTION cont. Data References & Methodology Projected budget data is derived from the MTBPS Recent past data (from 1997 / 98) is referenced to the IGFR Methodology involves comparison of recent past (‘98/99 to ‘01/02) with the current year (2002 / 03) and the 2003 M.T.E.F. period. Indicators used include: 1.Nominal and real growth rates; 2.Proportions of GDP and Government Spending;

7 PART I – OVERVIEW OF FFC PROPOSALS for the 2003 MTEF Local Government The FFC proposed widely on municipal finance. Particular note is taken here of proposals to: build creditworthiness in municipalities with little capacity to access debt through infrastructure capital grants, institutional capacity building programs and clarified accountability between the 3 spheres of government; further consider the division of functions between local and district municipalities noting existing local government policy and the primary role of national government in redistributing resources; incorporate considerations of councilor remuneration in the I-element of the LES; consider the relationship between regional and municipal electricity distributors noting the option of a levy to compensate distributing municipalities for asset transfer losses and to enable inter-municipal revenue sharing. National grants could be used to provide free basic electricity and overcome capital backlogs for the poor.

8 PART I – OVERVIEW OF FFC PROPOSALS for the 2003 MTEF Provincial Government With respect to provincial taxing powers, the FFC proposed that provinces be granted maximum flexibility in setting tax rates whilst enabling compensatory measures in equitable revenue sharing and further considering the capacity of the tax authority. Conditional grant funding mechanisms for Early Childhood Development should continue until they can be incorporated into the PES mechanism. A conditional grant was considered the most appropriate mechanism for targeting the impact of HIV-AIDS whilst a suitable information base is established.

9 PART I – OVERVIEW OF FFC PROPOSALS for the 2003 MTEF Cross Cutting Equitable Share Issues The FFC offered guidelines for reviewing the Comprehensive Social Security Review and proposed the establishment of a national social security agency to administer the payment of pension and child support grants over the medium- to long-term. The FFC proposes that it, with Parliament and Government, review the inter- governmental fiscal system in the light of the Bill of Rights and Section 214 (2) a-j. Particular note is to be taken of data collection and inter-governmental fiscal capacity building requirements. A tiered system of municipal, provincial and national funding thresholds was proposed for various aspects of disaster management. Finally, the FFC proposed that a legal basis be established to enable contingency reserves to accommodate disaster management, macro-economic shocks and new policy priorities.

10 PART II – COMPARATIVE ANALYSIS OF 2002 / 03 BUDGET & 2003 M.T.E.F. Analysis of the National Budget This year’s adjusted macro-economic projections reflect the impact of the nearly 40% depreciation of the ZAR last year. These include expectations of higher [export-led] economic growth and a nearly 3% increase in expected inflation for 2003/04, which falls towards target over the medium-term. Both impacts may be countered during 2003/04 to 2004/05 with the ZAR recovering almost half last year’s loss. As a proportion of GDP, government spending is projected to rise faster than revenue. This may reflect additional spending pressures and/or the approach of capacity limitations in revenue collection. Tax room of approximately 2.5% of GDP is targeted for other “general government” bodies including provincial and municipal governments. The national deficit is projected to rise sharply next year.

11 PART II – COMPARATIVE ANALYSIS OF 2002 / 03 BUDGET & 2003 M.T.E.F. Analysis of the National Budget cont. Over the medium- to long-term, a higher national deficit impacts on debt-servicing costs. Relative debt servicing costs are expected to decline slightly over the medium-term between 16% and 15% of National Budget Expenditure. Debt servicing costs displace funds otherwise available for division between the 3 spheres to deliver services. Real growth of funds available for division is projected to be nearly 6% next year and 4% over the medium-term. This enables growth in per- capita spending on Constitutionally mandated basic services. The projected vertical division of revenue reflects a counter-shift from the national to the provincial sphere and a continued shift to the local sphere. This may reflect the demands on the social security and health systems and the consolidation of the new local government system.

12 PART II – COMPARATIVE ANALYSIS OF 2002 / 03 BUDGET & 2003 M.T.E.F. cont. Analysis of Provincial Budgets The 2002 Budget Review anticipated a reversal into provincial government deficit over the medium-term. This may reflect the demands on the social security and health systems and declining attention to provincially collected revenue. Unconditional Equitable Share funding continues to be preferred over conditional grants as a mechanism for funding provincial governments. Significant differences in the recent past and projected real growth of social security, health and education spending for the 2002 MTEF have been narrowed.

13 PART II – COMPARATIVE ANALYSIS OF 2002 / 03 BUDGET & 2003 M.T.E.F. cont. Analysis of Provincial Budgets Cont. Healthy real growth of 8.3% p.a. is projected for infrastructure capital grants over the medium-term. There may be a real decline in conditional grant allocations for institutional capacity building as national-provincial sphere relations stabilize. Both the nutrition and HIV-AIDS conditional grants have been substantially consolidated. Real growth of 10% and 62% p.a. respectively over the medium-term is indicated. This is off a low base.

14 PART II – COMPARATIVE ANALYSIS OF 2002 / 03 BUDGET & 2003 M.T.E.F. cont. Analysis of Municipal Budgets Budget projections are not yet available for municipally collected revenue or deficits. Data on local government finances is difficult to collate without standardized reporting formats. Evidence from the recent past reflects that 89% of municipal revenue is collected from own sources. Most of this is collected by Metropolitan authorities. Many rural local and district councils are heavily reliant on inter-governmental transfers. Further, municipal deficits have been rising in the recent past to an average 2.5% of municipal budgets in 2000 / 01. Real annual growth of 15% for LES allocations, 13% for infrastructure capital grants and 7% for institutional capacity building grants is projected for the short- and medium-term. This enables growth in per capita spending on basic municipal services. Consolidated data on spending trends on basic municipal services such as water, sanitation, waste disposal, electricity and transport services is difficult to compile.