Sustainable Financial System & Appropriate Fiscal Framework for LG

1. LG Week 31 July - 03 August Sustainable Financial System & Appropriate Fiscal Framework for LG Session 6: 02 August 2012 Cllr Subesh Pillay– NEC member & Chairperson of Municipal Finance Working Group of SALGA 1

2. Outline • Introduction • Problem Statement • Key Focus Areas • Revenue Collection • Municipal Audit Outcomes • Review of LG Fiscal Framework • Conclusion & Recommendations

3. 1. Introduction • Municipalities provide essential public services • Sustainability requires effective governance structures and efficient administrations with stable finances • Fiscal structure of LG is defined by functional competencies and the financial challenges by their varying socio-economic profiles and levels of economic activity • Municipalities face growing pressures associated with expanding populations and economic growth which increases demand for services • The rising costs of services are impacting negatively on affordability of municipal services and household disposable income • Sustainable finances and service delivery depends on successful collection of own revenue, proper planning, realistic budgeting and efficient management of expenditures

4. 2. Problem Statement • Pace of the LG reforms, particularly the financial reforms has been rapid in comparison with the growth in capacity and skills at local level • Implementation of reforms hampered by complexity thereof, inadequate municipal capacity and the high cost of compliance • achieving clean audits by 2014 is highly improbable • LG revenue generation is at risk • Various national and provincial policy and legislative developments are progressively constraining the ability of municipalities to collect revenue • The LG Fiscal Framework needs to be reviewed to address serious underlying structural challenges and to identify suitable long term funding arrangements for local government

5. 3. Key Issues The key issues covered in this presentation include: • trends, good practices and challenges in revenue collection; • financial management challenges emanating from the recent municipal audit results; and • the review of the fiscal framework for local government.

6. 3.1 Revenue Collection • Municipalities have an obligation to ensure that they have sufficient revenue to finance their expenditure • requires a proper rates policy, and tariff policy with cost reflective tariffs • Stark difference in rural and urban own revenue bases • Revenue collection rates of between 90-95% required for sustainability • Rising bulk costs, urbanisation and increasing indigents impact negatively on revenue collection

7. 3.1 Revenue Collection 3.1.1 Debtors management • Gross debtors now at R76.6 billion • Need to look at net debtors, approximately 40% of gross (R31 bn) • R1.1 billion written off across customer groups, year to 30 March 2012 • Provisions for bad debt varies • 40% in cities and about 95% for a rural municipality • identifying irrecoverable old debt remains a major challenge • Persistent increases in government and parastatal debt is against values of the Constitution • Complexity of gov billing and payment is underestimated • Need a fundamental review of how gov pay municipal tax • Stringent credit control enforcement for household and business debt

8. 3.1 Revenue Collection 3.1.2 Why are debtors increasing? • Municipal consumer debt is escalating across the different consumer groups. • Pertinent to household debt is the expansion of services to the poor • Some other key challenges include, among others: • Municipal services are becoming unaffordable for the poor; • Insufficient information and understanding of indigents; • Interest on debt is growing; • Poorly designed and ineffective implementation of revenue, indigent and debtor management policies; • Municipalities are struggling to improve the integrity of their billing data; • Minimal write-offs

9. 3.1 Revenue Collection 3.1.3 Constraints to effective revenue management and financial sustainability • Collection Impediments • Inability to enforce credit control policy in ESKOM distribution areas • Deceased estates • Deregistration of companies • Legislative/Policy constraints • MPRA rates ratios (public benefit organisations) • AARTO • Properties situated in traditional areas • Inability to access critical personal information of taxpayers/municipal councillors • Inability to issue garnishee orders

10. 3.2 Municipal Audit Outcomes • Audit outcomes for 2010/11 came at a time of a change in municipal leadership – while the outgoing councils approved budgets, the incoming leadership was responsible for signing off annual fin statements. • Substantial improvement over the past seven years: • unqualified audits increasing from 23% to 45% • adverse and disclaimers have decreased from 47% to 22%. • Leadership, governance and implementation of audit action plans remain a challenge for LG • AG concerned about leadership & appointment of appropriate management • While there is still room from improvement, we should acknowledge the 13 municipalities who have received clean audits. • Three most pertinent matters raised by the AG was in: SCM; HR; and material errors and omissions in AFS.

11. 3.2 Municipal Audit Outcomes 3.2.1 Supply Chain Management • AG has found no improvements in SCM • Increase in non-compliance laws and regulations resulting in: (i) incidents of uncompetitive or unfair procurement processes; and (ii) awarding of contracts to employees and Cllrs or other state officials. • Some of the issues relate to conflict of interest where employees in the service of the State are doing business with municipalities. • Municipalities don’t have access to a national database listing officials employed in state and other organs of state, other municipalities and Cllrs • Current verification methods are very expensive • SCM regulations require vendor to declare interest to municipality

12. 3.2 Municipal Audit Outcomes 3.2.1 Supply Chain Management • Ambiguity created by the different provisions for contracting with municipal employees ito MFMA vs. that for other govt officials in PFMA is major challenge. • Some other challenges include practicality of obtaining 3 quotes in smaller munis as a result of limited service providers • The findings on SCM might be (in some instances) responsible for the recurring irregular, fruitless and wasteful expenditure findings.

13. 3.2 Municipal Audit Outcomes 3.2.2 Human Resource Management • Key positions were left vacant for a prolonged period in 30% of municipalities while 23% had prolonged acting positions. • SALGA found high turnover of CFOs in low capacity municipalities, while secondary cities have the longest serving CFOs (average of 4.5 years). • Competency regulations needs to be reviewed • Extremely costly process for municipalities and LGSETA don’t fund all municipalities • Cost approximately R100 000 to train one employee • Quality of training provided by accredited trainers is questionable

14. 3.2 Municipal Audit Outcomes 3.2.3. Material errors and omissions in Fin Statements • The quality of annual financial statements and use of consultants indicates that munis are battling to produce annual fin statements. • The preparation of annual financial statements according to GRAP is onerous and complex, costly and municipalities have limited capacity. • AG assists municipalities to improve quality of AFS, but at the same time make findings on areas clarified in process • AG audit procedures changes every year and municipalities always playing catch up Predetermined Objectives • From next financial year organisational performance will be audited • AG should rather split Audit Report on fin man from Performance Audit

15. 3.2 Municipal Audit Outcomes 3.2.4 Achieving a Clean Audit • The number of municipalities that obtained clean audit outcomes was noted to have improved from 7 to 13. • The AG, in his report on the 2009/10 audit outcomes, addressed the important question of determining what factors led to such improvement. • good municipal leadership, the appointment of experts to assist with specifically identified deficiencies; and improved management of record keeping. • LG has a considerable amount of ever changing legislation, accounting and other requirements to consider while embarking on their business and compliance to all of these requirements is an overwhelming exercise. • LG operates in an environment with vast dynamics and at times, the real difficulties of complying with all the requirements are often overlooked.

16. 3.3 Review of LG Fiscal Framework • The LG fiscal framework (LGFF) has been reformed over the last 5 yrs to address key challenges in national transfers and own revenue sources of municipalities. • There were reforms made to the LG Equitable Share formula to allocate more resources to support institutional capacity in smaller municipalities. • In 2010, SALGA recommended to the Budget Forum that an independent commission be appointed to undertake the review of the fiscal framework. •  National Treasury and the Department of Cooperative Governance (DCoG) have started a process for a review of the LGFF. • The Financial and Fiscal Commission (FFC) has also launched its own initiative to understand the symptoms and drivers of problems in munis and conducted public hearings in 2011 which was followed up in June 2012 by another set of public hearings on proposals for improving the LGFF.

17. Provision for growth Economic Cost of infrastructure & services required to adequately fulfil legal mandate GAP Expenditure efficiencies Maintenance & refurbishment backlog Development charges Tax & tariff increases Minimum standards backlog Improved revenue effort Residential Ongoing costs of services Existing revenue capacity Constitutional Mandate

18. 2012 MTEFDivision of Revenue (1) • increasing from a low base • response to high electricity prices • municipal revenue collection affected

19. 3.3 Review of LG Fiscal Framework 3.3.1 Vertical Division of Revenue • LG’s share of the division of nationally raised revenue has increased steadily from 1.3 per cent in 1998/99 to 8.8 per cent in 2012/13. • The comprehensive review of LGFF should systematically re-assess the appropriateness of the baselines which underpin the vertical division of revenue to examine whether LG is receiving revenue for the broader development mandate, not just free basic services. 3.3.2 Unfunded Mandates • Unfunded mandates continue to exist across many services, including libraries, museums, primary health care etc. • FFC has conducted an analysis of the extent of unfunded mandates in municipalities for their submission on the Division of Revenue for 2012/13 & found that six metros spent an additional amount of R3.8 billion in 2008/09 and R4.2 billion in 2009/10 in the provision of existing unfunded mandates.

20. 3.3 Review of LG Fiscal Framework 3.3.3 LG Equitable Share • There is a need to properly quantify the costs of the provision of municipal services, governance and administration costs and to provide commensurate financial resources to those municipalities with low fiscal capacity - would begin to address the issue of funding of repairs and maintenance in municipalities. 3.3.4 Conditional Grants • Conditional grants should be re-assessed as part of the comprehensive review of the LGFF, with a view to analysing past performance and improving their operational effectiveness. • Currently there is no reporting on the non-financial achievements of conditional grants. • A major concern remains the proliferation of conditional grants and the reporting burden associated with it.

21. 3.3 Review of LG Fiscal Framework 3.3.5 Funding model of District Municipalities • Since the abolishment of RSC levies as a revenue source for district municipalities, the erstwhile levies have been replaced by government grants – this has in essence undercut the redistributive function of district municipalities. • C1 district municipalities are increasingly dependent on government grants from an operational perspective. C2 district municipalities are less dependent on grants, but grants are still a significant source of revenue. • High costs of maintaining a Disaster Management Centre and the communications system required to be connected to the National Disaster Management Centre is a major challenge. • A major challenge with the RSC Levy Replacement Grant is that its calculation is based on the average collection over the last three years when it was in place - means that the base includes the deficiencies associated with the payment of the establishment levies where the head offices of institutions were.

22. 3.3 Review of LG Fiscal Framework It is recommended that: • Empirical studies into the cost of providing municipal services, governance and administration functions should be conducted and inform the review of the LGFF including the LGES formula; • Unfunded mandates be resolved and that nat & prov govt should properly cost and budget for agency functions; improve management of service delivery contracts; and that powers / functions arrangements be reviewed; • A comprehensive analysis be conducted on the non-financial performance of conditional grants; and • Appropriate funding arrangements be investigated for district municipalities to resolve immediate funding constraints while long term solutions are investigated for functional arrangements for district municipalities under the LGFF review.

23. 5. Recommendations • With much of the transition of govt having been completed and with the policy, legislative and fiscal framework in place for LG, it is timely to reflect and draw on experiences and lessons learnt. • While we only highlight some of the key issues for debate, the focus must be on ensuring that LG has a sustainable financial system and appropriate fiscal framework in place which is conducive to accelerating service delivery. South African Local Government Association invites delegates to: • Debate the issues and proposals for discussion; and • Assist in the formulation of recommendations which will address the challenges and facilitate a sustainable financial system and conducive fiscal framework for the acceleration of service delivery.