Applied Fiscal Research Centre, UCT: Division of Revenue; Memorandum
1999 Budget

Submission to The Portfolio Committee on Finance on the Division of Revenue Bill and the Explanatory Memorandum

by
Conrad Barberton
Research Associate
Applied Fiscal Research Centre
School of Economics
University of Cape Town

22 February 1999

Introduction
The 1999/00 national and provincial budgets are the second to be prepared under the new Constitution, and in terms of the Intergovernmental Fiscal Relations Act 97 of 1997. As a result new precedents are being set that will impact greatly on how intergovernmental fiscal relations are organised and how the budget process is managed in the future. New precedents are also being set with regard to the kinds of information being released to Parliament and, hence, the public in relation to the budget process. In this regard we welcome the new National Expenditure Survey

The 1998/99 Budget Review set a high standard in terms of transparency, which was by and large matched by Annexure E: The Explanatory Memorandum to Accompany the Division of Revenue Bill.

Unfortunately, the current Annexure E: An Explanatory Memorandum on the Division of Revenue does not maintain this high standard with regards to its explanation as to how the criteria set out in Section 214(2) of the Constitution were taken into account in the current Division of Revenue Bill. On the other hand, the current Memorandum's explanation of the horizontal division of revenue is more comprehensive than it was last year.

As was the case last year, there is still room for greater transparency regarding the kinds of information included in the Memorandum. This submission explores what information has either not been compiled for the purposes of the budget process or has not been released for public scrutiny and debate. It also makes some specific comments regarding the current Memorandum.

The Intergovernmental Fiscal Relations Act 97 of 1997
The Intergovernmental Fiscal Relations Act 97 of 1997 (IGFR Act) specifies the formal institutions involved in the budget process (sections 2-7), the process itself (sections 8-10) and how the process is reported to Parliament (section 10). The
IGFR Act was legislated in order to give effect to section 214 of the Constitution. This section requires that:

214. (1) An Act of Parliament must provide for -
(a) the equitable division of revenue raised nationally among the national, provincial and local spheres of government;
(b) the determination of each province's equitable share of the provincial share of that revenue; and
(c) any other allocations to the provinces, local government or municipalities form the national government's share of that revenue, and any conditions on which those allocations may be made.

Section 10 (1) of the IGFR Act specifies that each year when the Annual Budget is introduced, the Minister of Finance must introduce in the National Assembly a Division of Revenue Bill for the financial year to which the Budget relates. Section 10 (2) of the IGFR Act requires that the Division of Revenue Bill must specify how nationally collected revenues have been divided between the different spheres of government and between the provinces, as well as specify any other conditional allocations made from the national government to other spheres of government. Therefore the Division of Revenue Bill, when passed by Parliament, is the "Act of Parliament" referred to in Section 214 of the Constitution. In essence the Division of Revenue Bill documents or reports on the outcomes of the intergovernmental fiscal negotiations and budgeting processes.

From the point of view of fostering greater transparency and accountability in intergovernmental fiscal relations and the budget process section 10 (5) of the IGFR Act is of even greater importance. This section reads as follows:

10 (5) When the Division of Revenue Bill is introduced it must be accompanied by a memorandum explaining -
(a) how the bill takes account of each of the matters listed in section 214(2)(a) to (j) of the Constitution;
(b) the extent to which account was taken of any recommendations of the [Financial and Fiscal] Commission submitted to the Minister in terms of section 9 or as a result of consultations with the Commission in terms of subsection (3) of this section; and
(c) any assumptions and formulae used in arriving at the respective shares mentioned in subsections 2(a) and (b).

In other words the Government is required to explain the logic, methodology, trade-offs, assumptions and formulae used to arrive at the division of national revenue detailed in the Division of Revenue Bill. The memorandum referred to in section 10(5) is included in the Budget Review, as Annexure E.

As noted there are a number of crucial areas where it is imperative that more information be given both in the interests of greater transparency and to foster greater parliamentary and public debate regarding the budget process and the actual budget outcomes. These areas are discussed below.

Additional information that should be included in the Memorandum
Section 214(2) of the Constitution
Setting out the functions of different spheres of government
Much of the additional information that should be presented in the Memorandum relates to the principle that finance follows function. At the moment it is by no means clear that this is really happening in the current division of national revenue. In the first instance, to ensure that finance does indeed follow function at each sphere of government it is imperative that the Memorandum should present comprehensive schedules of the functions and obligations of each sphere of government. The purpose of these schedules would be to set out exactly what functions and obligations are taken into consideration in the division of national revenue. They should be sufficiently detailed to show shifts in functions and obligations between the spheres of government from year to year, as well as changes in functions and obligations due to new legislation or the phasing in and out of programmes. It is proposed that the following schedules are required:

A schedule of national government functions and obligations
The Memorandum does not give sufficient information regarding what are the "national government needs and interests" that have to be taken into consideration in the division of national revenue in terms of Section 214(2)(a) of the Constitution. It is submitted that to fulfil this requirement adequately a schedule detailing all the functions and obligations of national government should be compiled, including:

- A list of institutions that national government is required to fund in terms of the Constitution, such as Parliament, the Auditor General's Office, the Financial and Fiscal Commission, the Human Rights Commission, the Public Protector etc; and
- A list of government departments detailing their major programmes (including any minimum service standards they are expected to fulfil) and the legislation they are responsible for implementing.

A schedule of provincial functions and obligations
The Memorandum also does not give sufficient information regarding provinces' obligations "to provide basic services and perform the functions allocated to them" and "obligations of provinces in terms of national legislation" that have to be taken into consideration in terms of Section 214(2)(d) and (h) of the Constitution in the division of national revenue. As in the case of national government, the Memorandum should detail all the functions and obligations of provincial governments including:
- A list of provincial institutions that have to be funded in terms of the Constitution such as provincial legislatures;
- A list of basic services (along with the national minimum norms and standards) that provinces are expected to provide;
- A list of other functions allocated to provinces in terms of the Constitution; and
- A list of national legislation that has been delegated/assigned to provinces.

A schedule of local government functions and obligations
The current Memorandum gives virtually no information on what are the minimum functions and obligations of local governments that should be taken into account in terms of Section 214(2)(d) of the Constitution in the division of national revenue.

Ideally the Memorandum should compile a schedule that includes:
- A list of basic services (along with the associated national minimum norms and standards) that local government's are expected to supply in terms of the Constitution; and
- A list of national and provincial legislation delegated/assigned to local governments for implementation.

The fiscal capacity of each sphere of government
In terms of Section 214(2)(e) of the Constitution the fiscal capacity of provinces and municipalities has to be taken into account in the division of national revenue. However, fiscal capacity needs to be considered in relation to the functions and obligations of these respective spheres of government. The Memorandum should therefore give information on:
Own revenue sources of provinces and local governments and the amount of funding raised from these sources; and
On the cost to provinces and local governments:
- to maintain the institutions of governance as set out in the Constitution;
- to meet their obligations with regards to basic services for which national minimum norms and standards have been set, and
- to implement national legislation that has been delegated/assigned to them.

This information should be broken down by province and local government. Aggregate information would not be suitable since it would tend to hide the disparities in fiscal capacity and obligations that exist between different provinces and local governments.

This information would provide a benchmark to assess whether the division of national revenue at both the vertical and horizontal split does indeed take account of the fiscal capacity (in relation to their obligations) of the respective spheres of government. It would also set explicit input/output standards or benchmark cost levels by which to measure the efficiency of service delivery by provinces and local governments.

Financial and Fiscal Commission's recommendations
The discussion of the "extent to which account was taken of any recommendations of the [Financial and Fiscal] Commission" was undoubtedly the most satisfactory section of the 1998 Memorandum. The current Memorandum does not meet this standard. The Memorandum should contain information on:
The exact differences between the final formulae used in the division of national revenue and that proposed by the FFC. It is envisaged that this would entail putting the two formulae along side each other and highlighting the similarities and differences; and
How the final division of revenue reflected in the Division of Revenue Bill differs from the division of revenue that would have been realised if the FFC formulae were used. Where there are differences they would have to be explained and justified.

This is of course assuming that the FFC still stands by its original recommendations regarding the ideal structure of the revenue sharing formula. If this no longer applies then this information may not be appropriate. Another factor to keep in mind is that the quality of the FFC's submission to the Minister in terms of the IGFR Act, is likely to influence the quality and content of the response. If the FFC does not have the capacity to engage meaningfully in the process, then the response is likely to reflect this. The attention given to the FFC's input in the 1998 Memorandum compared to the present Memorandum certainly suggests that this might be an issue.

Assumptions and Formulae
The vertical split
The government argues that the vertical division is essentially a political decision. This is undoubtedly true, but Section 214 of the Constitution clearly states that "objective criteria" must be used to determine the needs and interests of national government. The political decision regarding the vertical split therefore needs to be informed by objective information regarding the relative roles of the different spheres of government. It is not clear from either the previous or present Memorandums exactly what information was taken into account when making the vertical split. It is therefore not possible for parliament, the provinces or the public to engage with government regarding the acceptability, equity or logic underlying the vertical split. It is simply presented as a fait accompli.

The horizontal split
Presenting the actual formulae
The Memorandum gives an interesting discussion of the assumptions and formulae used to make the horizontal division of the provincial equitable share. However instead of just describing the different components of the formula the actual formula itself should be presented. This would make the discussion of the assumptions underlying the different components, the weightings and the use of data far more real and transparent.

Presenting full information
In the 1998 Memorandum not sufficient information was given to allow independent researchers to replicate the calculation that was made to divide the national revenue between the different spheres of government. The current Memorandum gives far more information, but there are still some gaps. For instance how was the ICS deduction calculated? The result is that anyone wishing to engage government regarding the division of revenue can not do so with complete information. This undermines the scope for meaningful debate on the equity of the current division of national revenue.

The weightings used in the formulae
Many of the components in the formula use weightings and the logic underlying these weightings are adequately explained in most places. However, the crucial set of weightings relating to the how the different components themselves are weighted is not explained nearly adequately enough. Why does education get 40% versus the 18% for health etc. (see table E.6)? If this is a political decision then, as with the vertical split, the information that informed this decision should be presented so that parliament, the provinces and the public can engage government regarding the equity and logic of these weightings.

Comparing the effect of changes to the formulae
The fact that the formulae used to divide national revenue for the 1998/99 fiscal year was not given means that it is not possible to explore the exact impacts of the changes that were made to the formulae this year. This effectively stifles meaningful debate about the equity of the changes or possible ways of improving on the division in future years. Keeping the actual formulae out of the public arena does not foster transparency in the budget process. Ideally the Memorandum should present both the previous and the current formulae and show how the division of revenue differs according to the changes that have been made and why these changes are presumed to be more equitable. This is not done, and cannot be done by independent researchers.

Deviations from the Medium Term Budget Policy Statement
As noted above the IGFR Act only requires that the Memorandum cover the criteria in Section 214(2) of the Constitution, the FFC's recommendations and the assumptions and formulae to divide the national revenue. However, given that the rationale for the Memorandum is to promote transparency in the budget process a strong case can be made for it covering one other important body of information namely: providing an explanation of deviations in the final division of national revenue as set out in the Division of Revenue Bill from the division of revenue set out in the Medium Term Budget Policy Statement for that particular budget year.

The Medium Term Budget Policy Statement presents the broad parameters within which the current budget is being drawn up. As such it commits the government to dividing the national revenue along certain lines in the forthcoming budget.

Since the Medium Term Budget Policy Statement commits the government to certain broad parameters and creates expectations regarding the forthcoming division of national revenue, the Memorandum should explain any deviations from it in the final division of national revenue. It is expected that reasons for deviations would fall into four categories, namely:
changes in the division due to changes in the underlying data (such as the census data),
changes in the medium term macroeconomic assumptions and hence the expected flow of revenues;
changes in the actual formulae, such as those relating to the weighting of different functions; and
changes resulting from changes in government policy and the resultant allocation of obligations and responsibilities of the different spheres of government.

Ideally the division of national revenue presented in the Division of Revenue Bill should not deviate much (if at all) from that set out in Medium Term Budget Policy Statement. Indeed any deviations should be interpreted as reflecting poorly on the discipline and accuracy of the budget process, especially the work underlying the Medium Term Expenditure Framework on which the information in the Medium Term Budget Policy Statement is based

Specific comments on the 1999 Memorandum
1. The discussion of how the Division of Revenue Bill takes account of the criteria set out in Section 214(2) of the Constitution does not cover all criteria adequately, especially when compared to the discussion in the 1998 Memorandum. It is thin and we would argue misleading in certain respects.
2. Page 251: "In addition the national government is responsible for policy co-ordination and establishing national norms and standards. These are met through conditional grants and agency payments to other spheres"
This does not reflect the real situation even remotely, especially with regards to social security, where norms and standards are set at the national level, but have to be financed by the provinces out of their equitable share.
3. Page 251: "Sub-national governments have a significant degree of autonomy in the allocating of resources to meet basic needs and respond to local priorities."
This is largely true for local government, but is not true of provincial governments. The latter are constrained in their choices by the fact that expenditure on personnel and welfare transfers account for at least 70% of their budgets. Most of this goes into health, education and welfare which together account for about 80-85% of total provincial spending leaving very little scope for provinces to exercise much "autonomy in the allocation of resources".
4. The discussion of output-based budgeting does not reflect the enormity and complexity of the proposed change. It does not simply amount to an add-on onto the current system as seems to be suggested, but is a fundamentally different way of doing things requiring new management structures and systems, new incentive structures, new policies regarding accountability etc. The entire strategic planning, budgeting and financial management system needs to be re-engineered to take performance into account. The R191 million allocation to fund special initiatives to improve efficiency in the current system is not the way to go. It does not address the fundamental weaknesses in the current system.
5. Page 260: "A conditional grant is voted in both the budgets of the national and provincial department". This is a most undesirable position as it does not put in place clear lines of accountability and responsibility. It allows national departments to shift responsibility onto provincial departments, and provincial governments could argue that they should be allowed to decide how they are going to allocate funds that they vote for and so renege on the conditions applied to the grants. Ideally the grants should only be voted on the national department's budgets and the national department should be solely accountable for ensuring compliance with the conditions attached to the grants. The provinces would merely spend the funds on an agency basis in accordance with an agreement signed between the national and provincial governments, and not between the national and provincial departments.