Public Finance Fundamentals [3 ed.] 1485129478, 9781485129479

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Public Finance Fundamentals, now in its third edition, aims to facilitate and advance learning of the fundamentals of public finance, the basic tenets that apply even as the social, political and legislative environments of organisations shift over time. The idea of the book is to equip readers with long-lasting knowledge, skills and analytical tools to successfully tackle various types of organisational, institutional and public sector dynamics, by giving them an understanding of financial management concepts, principles, theory and policy. This third edition of Public Finance Fundamentals expands the scope of the previous editions to cover contemporary concerns and debates emanating from emerging economic and financial trends in many developing countries, including South Africa. These include: • • • • • •

discussions around the appropriate mandate of the Reserve Bank proposals to unbundle or partially privatise ESKOM (the nation’s energy supplier) quantitative easing as a monetary policy strategy austerity in public financial management the role and influence of international credit ratings agencies a critically important discussion on the Standard Chart of Accounts (SCOA) as a public financial management reform in South Africa. As with the previous editions, the chapters include learning outcomes and summaries, as well as illustrations, tables and figures.

ABOUT THE EDITOR: Kabelo Moeti is currently an Associate Professor at Tshwane University of Technology (TUT) in Pretoria, specialising in Public Finance and Public Sector Economics. He holds a Bachelor’s degree (BBA) in Finance from Georgia State University, a Master of Science (MSA) in Administration from Central Michigan University, and a Doctor of Administration (DAdmin) in Public Administration from University of Pretoria.

www.juta.co.za

Editor: Kabelo Moeti

The target market of the book is South and Southern African students taking courses in Public Administration, Public Management, Public Affairs, Public Finance and Public Sector Economics.

Editor: Kabelo Moeti

Public Finance Fundamentals Third edition

Editor: Kabelo Moeti

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Public Finance Fundamentals First published 2007 Second edition 2014 Third edition 2019 Juta and Company (Pty) Ltd First floor, Sunclare Building, 21 Dreyer Street, Claremont 7708 PO Box 14373, Lansdowne 7779, Cape Town, South Africa www.juta.co.za © 2019 Juta and Company (Pty) Ltd ISBN 978 1 48512 946 2 (Print) ISBN 978 1 48512 947 9 (WebPDF) All rights reserved. No part of this publication may be reproduced or transmitted in any form or by any means, electronic or mechanical, including photocopying, recording, or any information storage or retrieval system, without prior permission in writing from the publisher. Subject to any applicable licensing terms and conditions in the case of electronically supplied publications, a person may engage in fair dealing with a copy of this publication for his or her personal or private use, or his or her research or private study. See section 12(1)(a) of the Copyright Act 98 of 1978. Project manager: Seshni Kazadi Proofreader: Jennifer Stern Cover designer: Drag and Drop Typesetter: Collaboration Corporation Indexer: Michel Cozien Typeset in Frutiger LT Std, 11pt The author and the publisher believe on the strength of due diligence exercised that this work does not contain any material that is the subject of copyright held by another person. In the alternative, they believe that any protected pre-existing material that may be comprised in it has been used with appropriate authority or has been used in circumstances that make such use permissible under the law.

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Contents Preface vii List of contributors viii

Section 1 Public money and government Chapter 1 Defining money (K Moeti) 1.1 Money defined in relation to finance 1.2 Money defined in terms of its conceptual properties 1.3 Money defined in terms of its physical properties 1.4 Key characteristic of money – acceptability 1.5 Defining money as M1, M2 or M3 1.6 Defining public money

3 3 4 5 6 6 8

Chapter 2 Monetary policy and fiscal policy (K Moeti) 2.1 Monetary policy 2.2 The South African Reserve Bank and monetary policy 2.3 Comparing traditional monetary policy instruments 2.4 Quantitative easing as a monetary policy strategy 2.5 Fiscal policy 2.6 The theoretical reality of the Phillips curve 2.7 Institutions responsible for monetary and fiscal policy

11 12 13 15 16 16 18 19

Chapter 3 Public provision of goods and services, and key sources of government revenue (S Nsingo) 3.1 The provision of goods and services by the state 3.2 The scarcity factor 3.3 Market failure 3.4 Increasing, constant and decreasing returns to scale 3.5 Externalities 3.6 Public goods 3.7 Particular goods 3.8 Quasi-collective goods and services 3.9 Market failure due to lack of market access 3.10 A classification of the services provided by government 3.11 Sources of government revenue 3.12 Classification of taxes 3.13 Types of tax 3.14 User charges 3.15 Nominal levies 3.16 Consumer tariffs

20 20 21 22 22 25 26 28 29 30 31 33 35 36 41 41 42

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Public Finance Fundamentals 3.17 Sundry charges 3.18 Bilateral and multilateral aid 3.19 Donor agencies 3.20 The influence of international credit ratings agencies

42 42 43 43

Chapter 4 Role players in public financial management (S Nsingo) 4.1 Public financial management 4.2 Key role players in financial management 4.3 The executive authority and public financial management 4.4 The administrative authority and public financial management 4.5 The reserve bank and public financial management 4.6 Reflecting on the mandate, ownership and independence of the SARB

46 46 48 54 57 59 59

Section 2 The relationship between accounting and finance Chapter 5 Accounting and finance (K Moeti) 5.1 The balance sheet 5.2 The income statement 5.3 Generally accepted accounting principles (GAAP) 5.4 Standard chart of accounts 5.5 Cash flow management

65 65 67 68 71 73

Section 3 Intergovernmental fiscal relations (IGFR) Chapter 6 Organisation and functioning of government in terms of inter-governmental fiscal relations (IGFR) (T Khalo) 6.1 Forms of government 6.2 Legislative framework for revenue collection and allocation 6.3 Factors necessitating allocation of revenue sources 6.4 Sources of revenue for spheres of government 6.5 Intergovernmental fiscal relations

81 82 86 89 91 93

Section 4 Contemporary reforms to South African public financial management Chapter 7 Budget reform and management of public money through budgeting (K Moeti) 7.1 Budgets: Definition and basic type 7.2 Historical perspective of reforms in public budgeting 7.3 Line-item budgeting 7.4 Performance budgeting 7.5 Programme budgeting and multi-year programme budgeting 7.6 Zero-based budgeting (ZBB) 7.7 Uses of budgets

101 102 103 106 107 110 114 117

iv

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Contents Chapter 8 Safeguarding ethics and accountability in the public sector (J Mafunisa and M Sebola) 8.1 Concern about unethical and unaccountable conduct 8.2 Categories of unethical conduct: Conflict of interest 8.3 Institutional bodies for combating unethical conduct in the public sector

119 121 123 128

Chapter 9 Privatisation as a major reform in public sector management (T Makondo) 9.1 Defining privatisation 9.2 History of state-owned enterprises in South Africa 9.3 Rationale for privatisation 9.4 Alternative methods or approaches to privatisation 9.5 Advantages and disadvantages of privatisation 9.6 Alternatives to privatisation 9.7 Privatisation in South Africa

135 136 137 138 139 142 144 146

Chapter 10 From procurement and tendering to supply chain management (K Moeti) 10.1 Tendering as a process 10.2 Decentralisation of tendering as a reform 10.3 Routine purchasing 10.4 Social policy goals of procurement 10.5 Supply chain management

150 151 153 155 156 158

Chapter 11 Local government financial management in South Africa (N Nkuna and M Sebola) 11.1 Background to local government challenges in South Africa 11.2 The need for financial management in local government 11.3 Democratic principles and local government finance 11.4 Legislative framework for municipal financial management in South Africa 11.5 The cycle of local government financing 11.6 Structures involved in local government finance 11.7 Budgeting process in local government 11.8 Local government financial reporting and auditing

161 162 162 163 163 168 168 172 174

Endnotes 181 Bibliography

182

Legislation included in support material

185

Index

186

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Preface Public Finance Fundamentals was conceptualised to be a book that would facilitate and advance learning of a fundamental nature in the field of public finance. Emphasis in the title is on the word fundamental, meaning learning that would not change with the social, political, and legislative vicissitudes that come with the passage of time. Thus the idea of the book is simply to equip users/ readers of the book with long-lasting knowledge, skills and analytical tools that can be used to successfully tackle various types of organisational, institutional and public sector dynamics or challenges that have financial implications.

The studious reader will gain understanding and insight of financial management concepts, principles, theory and policy that is of relevance to the public sector. The target audience of the book is therefore students and practitioners of public administration wishing to focus in on public financial management as a sub-discipline of public administration.

This third edition of Public Finance Fundamentals is not a departure from the first two editions. Instead it is a further extension of the critical topics covered in the previous editions. Key and fundamental topics remain, but to these we have added more contemporary concerns and debates emanating from emerging economic and financial trends being observed in many developing countries, including South Africa. In South Africa, for example, topics that have drawn the attention of the authors, and for which updates to the book have been crafted, include: inter alia, the discussions around the appropriate mandate of the Reserve Bank; proposals to ‘unbundle’ or partially privatise ESKOM (the nation’s energy supplier); quantitative easing as a monetary policy strategy, and the role and influence of international credit ratings agencies. We have also beefed up Chapter 5 (Accounting and Finance) by adding a critically important discussion on the Standard Chart of Accounts (SCOA) as a public financial management reform in South Africa. All of these new and emerging topics are felt to be of great significance and worthy of inclusion in the third edition of Public Finance Fundamentals.

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List of contributors ■■ ■■ ■■ ■■ ■■ ■■ ■■

K Moeti S Nsingo T Khalo J Mafunisa M Sebola T Makondo N Nkuna

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Defining money

SECTION 1

Public money and government

Introduction to the section Government exists to attend to the collective needs of society. Worded differently, governments would not be needed if all individuals (and even groups) were able to provide for all of their own needs and desires. This scenario, of a society in which members meet their own needs as well as those of their group, is plausible only to a very limited extent. Individuals, families, churches and other groups may well be able to provide for themselves in terms of food, clothing, shelter, etc, but they would probably not be able to provide adequately for every need that might arise. What about those members of society who cannot provide even basic necessities for themselves? What about the rights of weaker individuals and communities in a world where individual members and groups have to compete, and seek only to meet their own immediate needs and requirements? And what about the security of the nation? It should be noted that there exists a large array of political, social and economic problems (such as potential invasion/attack by neighbouring states, crime, infectious diseases, poverty and illiteracy) that can be minimised only through collective action. As a result, civilised societies choose to empower governments to use taxation (amongst other strategies) as a means of providing a range of collective services and products, such as national defence, police services, public health care, welfare programmes, education and waste disposal. The provision of all government goods and services requires that they have one thing in common, and that is money. Later sections of this text deal with government taxation and other sources of government income, as well as the problem of allocating scarce resources to their most efficient, effective and equitable purposes, and budgeting. Section 1 deals more generally with money and public money, for example the definition of terms and explanation of concepts; the examination of government use and management of public money, with specific reference to monetary and fiscal policy; the classification of services provided, based on revenue sources; and the identification of the responsibilities of particular governmental role players charged with managing public money. 1

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R E T P A H C

1

Defining money K Moeti

LEARNING OBJECTIVES By the end of this chapter, you should be able to: ■ explain the term ‘finance’ in relation to money ■ provide four definitions of money, based on its conceptual properties ■ define money on the basis of its physical properties ■ define, understand and use the term ‘liquidity’ ■ define money in terms of liquidity, vis-à-vis M1, M2 and M3 ■ define, understand and use the term ‘public money’ ■ discuss, briefly, the terms ‘public interest’ and ‘public benefit’.

Introduction Before proceeding with particular public finance topics, it is important to define adequately the terms ‘money’ and ‘public money’. These definitions will go some way towards helping us to grasp the magnitude and scope of the economy. In later chapters we will use these definitions in our examination of the role of government in the economy.

1.1

Money defined in relation to finance To define the term ‘finance’ as ‘anything to do with money’ would be overly simplistic, but not incorrect. As we will see in more practical applications in later chapters, finance has to do with the management of money. This may include either using money to make more money (investing) through a process of analysing the economy, financial markets and/or individual companies; or using financial data and financial management tools to manage the monetary1 affairs of a company or a public institution. In each of these descriptions, finance is equated to money.

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Public Finance Fundamentals

1.2 Money defined in terms of its conceptual properties In addition to being defined in relation to finance, money can be defined in terms of its key conceptual properties, namely as a: ■■ unit of account ■■ means of paying off debt ■■ medium of exchange ■■ store of value. We will now look at each of these properties in turn. 1.2.1 Money as a unit of account In an economy where goods and services are tradable with each other, or for money, there needs to be a way of attaching a price to such goods and services. Money serves as an abstract measure of value, in the same way as kilograms and pounds are abstract measures of mass/weight, and litres and gallons are abstract measures of volume. Whether in terms of dollars, rand, yen or whatever currency, this measurability characteristic of money is referred to as a unit of account. 1.2.2 Money as a means of paying off debt In all financial transactions, a good or service is provided and a debt created. Thereafter, this debt can be terminated only by way of the payment of money. In a simple purchase transaction at a supermarket, for example, the moment the goods that you have selected are given to you by the cashier, a debt has been created. At almost the same instant, you terminate that debt by paying for those goods. In this respect, money can therefore be defined as a means of settling debts. 1.2.3 Money as a medium of exchange In ancient times, before money came into use, goods and services were exchanged on the basis of bartering. Bartering as a system was highly inefficient as, for example, a man who specialised in making shoes could only get the other goods he needed (say, bread) by finding and trading with a person who needed shoes, and specialised in making bread. This may not have been all that problematic in small societies, but in today’s densely populated towns, cities and metropolitan areas, people could not possibly get all their needs for goods and services met through the bartering system. Simply put, without money, goods and services would have to be exchanged for other goods and services. Based on the unit of account property of money (discussed above), goods can be ‘priced’ and sold. The proceeds of such sales can then be 4

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Defining money used to purchase other goods. Thus, by putting money into the exchange equation, efficiency is created as all traders should readily accept money in exchange for the goods and services they have to offer, and in turn, all traders could use this money to buy any other good or service. The shoemaker who needs bread does not have to worry about whether the breadmaker needs a pair of shoes. By referring to money as a medium of exchange, we are saying that money is generally accepted in exchange for goods and services and/or for settling debts. 1.2.4 Money as a store of value Money not only has utility (usefulness) for today’s purchases, but can also be used for future spending. That is, people do not always want to spend all of their money in the present, and they will therefore save some for a rainy day. The setting aside of money through an investment is most commonly done to hedge against unforeseen maladies, such as the loss of a job, loss of an income-earning loved one, a sudden disability, saving/investing for children’s future university studies, or loss of a house by fire. In this respect, the money put away for future spending can be (among other things) in the form of stocks, bonds and insurance policies, all of which are considered money, even though there may be some lag time to convert them into cash. Money thus also serves as a store of value, meaning that future purchases can be made from money set aside today.

1.3 Money defined in terms of its physical properties Money may also be defined in terms of its physical properties. In ancient times, when the system of barter was the norm, money embodied any physical form that had value for someone. Thus bread, shoes, animals, and even stones were exchanged and accepted as currency. The two most common physical forms of money in contemporary society are coins and paper currency – and in the not-so-distant past (spanning the period of bimetallism through the period of the gold standard, circa 1792 until 1933)2, gold and silver were also used as physical forms of money. Interestingly, bartering – which opens up infinite possibilities in terms of physical items that could be considered to be money – is still not so uncommon in our modern times. Prison inmates, for example, may choose to exchange cigarettes for other goods. As a second example of modern-day bartering, it can be noted that cigarettes were also widely used as a medium of exchange in Europe after World War II due, in large measure, to the fact that the war had left many official European currencies practically worthless.

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Public Finance Fundamentals

1.4 Key characteristic of money – acceptability Whether speaking of money’s conceptual or physical properties, any item must meet one important characteristic in order to be defined as money. That characteristic is that it must be generally accepted, so that it maintains relative stability in value over time. Thus, for example, cigarettes may be considered to be a form of money by prison inmates, but in an environment where a large number of people are non-smokers, cigarettes cannot be thought of as ‘generally acceptable’ and a form of money. The typical non-smoker, for instance, would not accept cigarettes as payment for anything, so cigarettes could not then be considered as a form of money/currency. In terms of maintaining relative stability in value over time, using the same example, prison inmates may think twice about accepting cigarettes in exchange for other goods in the light of moves to enforce legislation that bans smoking in prisons.

1.5 Defining money as M1, M2 or M3 Another important way in which money is often defined is in terms of its liquidity. Liquidity refers to the ease or ‘speed’ with which an asset can be converted into cash (with minimal loss). Thus, on the balance sheet (to be discussed in greater detail in Chapter 5), assets are grouped in two different categories: current assets (that are relatively liquid) and long-term assets (which are relatively illiquid). Current assets are normally further broken down and ranked according to liquidity (speed of transferability into cash), so that cash will be the first item listed under current assets, followed by marketable securities, and lastly inventories. Additional categorisations of money according to liquidity are M1, M2 and M3. These classifications are important for reserve bank and national treasury officials in the performance of monetary policy (to be discussed in the next chapter), as the proper definition of money can affect how money in the economy is measured and managed. The broadest definition of money is M3, which includes the most illiquid measures of money in the economy, as well as M2 and M1 (ie M3 = the most illiquid measures of money in the economy + M2 (which includes M1)). Less inclusive a measure of money than M3 is M2, which includes relatively illiquid measures of money in the economy and M1 (ie M2 = relatively illiquid measures of money in the economy + M1).

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Defining money Lastly, M1 is the most liquid measure of money in the economy for monetary policy purposes (refer to Table 1.1). Economists often disagree as to what the exact components of each of these measures of money should be, but most generally accept that M1 should include cash, cheque deposits and travellers’ cheques which are not held at the reserve bank or national treasury. Alternatively stated: ■■ M1 is money immediately available to the general public for the purchase of goods and services or the payment of debt (Klein, 1986: 9). ■■ M2 is made up of M1 plus savings deposits below a specified amount (for example US$100 000), money market deposits and money market mutual funds/ unit trusts. ■■ M3 normally consists of M2 plus institutional savings and cheque deposits above a specified amount (for example US$100 000), and institutionally owned money market and unit trust accounts (Klein, 1986: 11). The central bank and economic analysts need to monitor trends in all three monetary aggregates, and generally pay particular attention to credit extension to the private sector as an indicator of potential spending power in the economy. There is considerable complexity in calculating or assessing the larger monetary aggregates however, as financial institutions are continuously adapting their products and services to changing economic conditions. Table 1.1 Typical components of M1, M2 and M3

M1

M2

M3

Currency outside of the reserve Currency outside of the reserve Currency outside of the reserve bank, national treasury, and vaults bank, national treasury, and vaults bank, national treasury, and vaults of commercial banks of commercial banks of commercial banks Travellers’ cheques

Travellers’ cheques

Travellers’ cheques

Other checkable deposits

Other checkable deposits

Other checkable deposits

Savings deposits

Savings deposits

Time deposits

Time deposits

Money market deposits

Money market deposits

Unit trusts

Unit trusts Institutional time deposits Institutionally held money market deposit accounts Institutional unit trusts

Source: Adapted from Klein, 1986: 9–11

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Public Finance Fundamentals

1.6 Defining public money Money can be either: ■■ privately owned, in the hands of private individuals and private institutions, and spent to advance private interests ■■ publicly owned, managed and controlled by the state on behalf of the people of the country and spent to advance the public’s interests. The key focus of public finance, and thus of this book, is public money (ie publicly owned money). It is important to stress that ‘public money’ under the control of government is held collectively by the state on behalf of the people, to be used in the public interest. In democratic countries, the public elects the government, and this government exists (and is remunerated) only to provide the goods and services that the public wants, but for which the public is unable to provide for itself on an individual basis. Through taxation (as the main instrument used by government to gather revenue), government is supposedly able to gather from the public the necessary funds to provide public goods and services. Public money must be used to provide public goods and services in the public interest and for public benefit. This is important to note, as it is easy to claim (mistakenly) that only taxpayers should benefit from public money, since taxpayers are the key contributors of that money. This is an invalid claim in any democratic country, as the principles of public interest and public benefit would apply, as discussed below. 1.6.1 Public interest Public interest is the idea that although communities/countries are made up of individual citizens (taxpayers and non-taxpayers alike) with their own peculiar needs, it is in the interest of the community as a whole that a collective effort (especially through government) be made to provide essential goods and services to all, regardless of their actual contribution to the system or their ability to pay. This is consistent with the now famous tax principles espoused by Adam Smith (1723–1790), namely benefits received and ability to pay. Adam Smith believed that the amount of tax each person should pay should take into account both the benefits received from public expenditure and an individual’s ability to pay.

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Defining money The public interest as a concept takes cognisance of the fact that a country has to take care of all of its people – not just some of its people – in order to make the country more governable and perhaps even more developed. In a country such as South Africa, where the unemployment rate was just over 40% in the early 1990s, this is an important principle; with almost half the population out of work, one could expect crime, drug abuse, infectious diseases and other social ills to affect (directly or indirectly) all citizens (rich and poor alike). In this case, government should make an effort to alleviate unemployment and poverty with the expectation that a better life for the underprivileged will translate into a better life for all. 1.6.2 Public beneft In short, public benefit is the idea that government spending of the money entrusted to it by the public must take place in the most efficient and cost-effective manner. In other words, government must spend public money in such a way that the public receives and experiences value for money. One set of definitions needs clarification at this point, these being efficiency, effectiveness and economy. These terms are often used interchangeably, but in order to understand the language of the latest and most comprehensive South African legislation in respect of public finance (the Public Finance Management Act (PFMA), and the Local Government: Municipal Finance Management Act 56 of 2003 (MFMA), the distinctiveness of these terms must be recognised: ■■ Efficiency has to do with inputs and outputs. We are said to be efficient if we can produce the maximum amount of output for a given and fixed amount of input(s). ■■ Effectiveness, on the other hand, has to do with meeting objectives. We can be very productive, efficient and economical, but all for naught if we do not meet our objectives, or if we satisfy the wrong objectives. Thus, regardless of whether we are efficient or not, we shall have to measure our effectiveness by the extent to which our objectives are met. ■■ Economy, lastly, has to do with least cost. Where all else is equal (for example quality of goods that have to be purchased by a manager), we must decide on the least costly option. Further important terminology, with respect to how public money is to be managed and spent, is the term ‘appropriateness’. According to the PFMA and MFMA, public money is considered to have been inappropriately managed or spent if instances of unauthorised expenditure, fruitless and wasteful expenditure, and/or irregular expenditure are present. Each of these terms deserves further attention:

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Public Finance Fundamentals Unauthorised expenditure, as defined by the PFMA, refers to overspending and/or spending that is not in accordance with the mandated purpose of appropriated funds. ■■ Fruitless and wasteful expenditure refers to unnecessary expenditure that could have been avoided if reasonable care had been exercised. ■■ Irregular expenditure refers to authorised (as opposed to unauthorised) expenditure that happens to be in contravention of other applicable legislation. ■■

Contrast the definition of irregular expenditure with the definition of unauthorised expenditure above, and it can be seen that irregular expenditure is actually authorised expenditure that is in violation of some or other procedural requirement. An example would be the situation in which a senior manager is authorised by legislation to make the final decision about which contractors to use to service the needs of his or her department. Any decision the manager makes in this regard is authorised, but may violate Treasury regulations (and thus be considered irregular expenditure), which exist to ensure that all eligible contractors receive an equal opportunity to do the work.

Summary and conclusion In this chapter it has been argued that the definition of money is important and fundamental to public finance for a number of reasons. First, it is important to understand that finance is essentially anything to do with money. As such, money can be defined in terms of what it includes and what it excludes. Thus, for example, there must be a differentiation between public and privately owned money. When speaking of public money, it is also critical to realise that public money belongs to the people of the country and not to those who manage and spend these funds in the public interest. It is important to note that ‘public finance’ refers to the money controlled on behalf of the public by the government, which should be managed with due regard to economy, efficiency and effectiveness in pursuit of the public interest.

Self-examination questions 1. Compare and contrast the conceptual and physical properties of money. 2. Discuss M1, M2 and M3 monetary aggregates. 3. Compare and contrast the terms ‘public interest’ and ‘public benefit’ in the context of public financial management.

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R E T P A H C

2

Monetary policy and fiscal policy K Moeti

LEARNING OBJECTIVES By the end of this chapter, you should be able to: ■ define monetary policy ■ define fiscal policy ■ differentiate between monetary and fiscal policy ■ identify the institutions that deal with monetary and fiscal policy ■ identify the goals, proximate targets and instruments of monetary policy ■ explain how monetary policy’s goals, proximate targets and instruments work together as a system.

Introduction In addition to budgeting (discussed in Chapter 7), key policy strategies used by governments to manage public funds are monetary and fiscal policies. Together, monetary and fiscal policies are referred to as stabilisation policy, as they are used to promote economic growth while avoiding excessive inflation or volatility in business conditions through the manipulation of such factors as tax rates and interest rates. Although primarily defined as government taxing and spending for the provision of public goods and services, fiscal policy also refers to government taxing and spending in order to influence economic conditions (unemployment and inflation). Monetary policy, on the other hand, attempts to influence the same economic conditions, but through different means. As the name may suggest, monetary policy is concerned primarily with the nation’s money supply. That is to say, monetary policy is that branch of economic policy that attempts to meet economic stabilisation objectives through the management of the

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Public Finance Fundamentals money supply in circulation (mostly M1 money). Interest rate manipulation by the monetary policy authorities (reserve bank and national treasury) is also considered an indirect means of affecting the nation’s money supply and thus stabilisation. It is important to note that statutorily, the South African Reserve Bank (SARB or the Bank) is mandated with the responsibility of formulating and implementing monetary policy, whilst the national treasury (Department of Finance) is tasked with fiscal policy. At least three different monetary policy instruments are available to policymakers. This chapter aims to explain the key policy instruments of monetary policy and the relationship between fiscal and monetary policy. Stabilisation policy: Policies of government that are aimed at maintaining moderate

to low levels of unemployment and inflation, whilst stimulating economic growth. The two broad categories of stabilisation policy are fiscal policy and monetary policy.

2.1 Monetary policy Monetary policy is government policy that is concerned with stabilising price levels (inflation) and economic activity, mainly through the manipulation of the money supply3 in the economy. Monetary policy can be broken down into its elemental parts, consisting of goals (objectives), proximate targets (intermediate objectives) and implementing instruments, as shown in Figure 2.1. GOALS Full employment Economic growth Price stability Balance of payments equilibrium Exchange rate stability PROXIMATE TARGETS Money supply Interest rates INSTRUMENTS Open market operations Control of bank reserves Reserve bank lending to commercial banks (discount window)

Figure 2.1 Goals, proximate targets and implementing instruments of monetary policy Source: Adapted from Chick, 1977: 13

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Monetary policy and fiscal policy The goals of monetary policy cannot be directly attained with the use of monetary policy instruments; instead, monetary policy goals are met by first influencing, in the desired direction and magnitude, proximate targets. The attainment of these proximate targets is then expected to translate into the attainment of monetary policy goals after a relatively predictable lagged period. More specifically, the instruments of monetary policy are designed to directly affect the money supply in the economy and/or affect the level of interest rates (proximate target) in order to attain the goals of monetary policy, as depicted in Figure 2.1. The discussion now turns to a brief exposition of the instruments of monetary policy, which include (among other things) open market operations, reserve requirements and the discount window.

2.2 The South African Reserve Bank and monetary policy In South Africa, the main responsibility of the central bank with respect to monetary policy is to protect the value of the rand (Section 224(1) of the 1996 Constitution). This refers to the purchasing power of the rand as measured by consumer prices, which is sometimes referred to as the internal value of the currency, to distinguish it from the ‘external’ value which is measured by the rate of exchange of the rand for other currencies. The South African government has adopted an inflation targeting approach to monetary policy. This means that the reserve bank is obliged to pursue monetary policy measures aimed at maintaining inflation in the agreed target range. The present target set by the minister of finance is 3–6% a year, measured by the 12-month increase in CPIX, or consumer prices excluding mortgage interest costs. According to this rationale, in order to combat inflation, the value of the currency needs to be protected. The reverse of this is that too little money in circulation (recession) is indicative of scarcity of the currency, which results in an upward valuation of the currency and downward pressure on inflation. If the inflation rate is below a specified target range, it can safely be increased by devaluing the currency (this may occur, for example, when trade policy requires an improvement in export performance). This strategy (referred to broadly as ‘accommodation policy’) of the South African Reserve Bank is related to open market operations, as influencing the external value of the currency is done mainly through buying and selling in the currency market4.

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Public Finance Fundamentals 2.2.1 Open market operations Open market operations deal with central bank (South African Reserve Bank) sales to, or purchases from, the general public of government securities (bonds and treasury bills) in order to affect the amount of money in circulation in the economy. When the central bank purchases government securities held by pension funds, for example, the fund managers receive cash, which they can invest by lending to businesses, or by buying shares. The central bank’s open market purchase results in an increase in the amount of money in circulation thereby encouraging spending and an expansion of economic activity. Conversely, when a central bank sells securities (stocks and/or bonds) to the general public in exchange for cash, the amount of money in circulation is decreased (and the amount of securities held by the public increases concomitantly). Table 2.1 Open market operations: conditions, actions, effects

Economic conditions

Action taken by central bank

Effect on amount of money in circulation

Inflation

Sell government securities

Decreases

Recession

Buy government securities

Increases

It can further be deduced that since open market operations change the amount of money in circulation, they can also influence inflation, interest rates, investment and savings, and even employment. With respect to bringing inflation under control, open market operations change the amount of money in circulation, as indicated in Table 2.1. Inflation is characterised by unnaturally high prices, and is most often brought about by excess demand for goods and services in relation to supply. Excess demand in turn results from a situation in which there is too much money in circulation. In a situation in which inflation is unacceptably high, central bankers will quite often use open market operations to sell government securities to the public, thereby reducing the amount of money in circulation, and reducing the inflation rate. Likewise, the purchase of government securities will be considered by central bankers when economic activity is slow (i.e. recessionary) and inflation is low (refer to Table 2.1). Although open market operations are limited to the sale and purchase of government securities, they do affect the amount of money in circulation, and thus interest rates. So, with respect to interest rate levels and employment, in inflationary times, excessive amounts of money in circulation will tend to lower interest rate levels, as the cost of borrowing must naturally be reduced when there is an abundant supply of money. Lower interest rate levels in turn – according to the traditional Keynesian 14

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Monetary policy and fiscal policy view – stimulate investment, which then translates into employment creation, thus attaining yet another of the goals of monetary policy. While interest rates can be affected by open market operations, manipulation of interest rates is not one of the mechanisms of open market operations. Instead, interest rates are more directly related to discount window policy. 2.2.2 Discount window The discount window/repo rate5 refers to the interest rate at which central banks lend money to commercial banks, who in turn lend money out to the general public at a rate of interest referred to as the prime interest rate (or prime + a smaller percentage). Adjustment of the repo rate will surely have an impact on the amounts of money borrowed and put into circulation. The rationale of the discount window is that the more expensive it is for commercial banks to borrow money from the central bank, the more likely it is that commercial banks will pass on the increased costs of borrowing to the general public. This, in turn, will lead to lesser amounts of money being taken out of the banking system and put into circulation. When a situation of high inflation exists, central bankers will consider increasing the repo rate; when the economy is in a recession, central bankers will consider decreasing the repo rate. 2.2.3 Reserve requirement Cash reserve requirements refer to the amount of money all commercial banks are required to set aside (usually a percentage of cheque and savings deposits) and cannot use for transaction purposes (making loans, etc). When the reserve bank increases this reserve requirement, banks have less money available to inject into the economy by way of loans (and vice versa).

2.3 Comparing traditional monetary policy instruments Open market operations are thought to be a more effective tool for manipulating the economy than changes in reserve requirements. Reserve requirements are thought to have an extraordinarily strong effect, such that small changes in this percentage lead to a more than proportional change in a bank’s ability to loan, invest and create money. Thus, for example, an increase in an existing reserve requirement from 2,5% to just 3% of deposits translates into an astronomically large increase, and restriction on the banking sector’s ability to make loans and investments, when one looks at the total volume of money involved. In many cases, an open market operation (sale or purchase of securities) may have to be used to dampen and moderate the effects of reserve requirement changes. 15

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Public Finance Fundamentals In addition, some economists have argued that changes in reserve requirement ratios are not practical measures to use for short-term stabilisation of the economy, because banks have to be given time to adjust their financial structures, and there may be delays in the intended effect on changes in the amount of money in circulation. Table 2.2 Comparison of monetary policy instruments

Open market operations* Discount window/repo Reserve requirement Purchase government securities

Sell government securities

Increase repo rate

Decrease repo rate

Increase required ratio

Decrease required ratio

Increases money supply

Decreases money supply

Decreases money supply

Increases money supply

Decreases money supply

Increases money supply

Increases inflation

Decreases inflation

Decreases inflation

Increases inflation

Decreases inflation

Increases inflation

Decreases interest rates

Increases interest rates

Increases interest rates

Increases interest rates

Increases interest rates

Decreases interest rates

*(Not necessarily in sequential order of occurrence)

2.4 Quantitative easing as a monetary policy strategy Quantitative easing (QE) is a monetary policy strategy that aims to increase the amount of money in the economy beyond what is possible with normal open market operations. Monetary authorities (central banks) institute QE by purchasing government securities or other securities from the market in order to increase the money supply, and encourage lending and investment. QE is considered a monetary policy measure of last resort, to be used when open market operations fail to stimulate the economy (Fourie and Burger 2015:392-393). In other words, when short-term interest rates are at or approaching zero, normal open market operations, which target interest rates, are no longer effective. So, instead, a central bank can further increase the money supply by purchasing assets with newly created bank reserves in order to provide banks with more liquidity. The risk with QE is that the newly created bank reserves, in many instances, are simply a case of central banks’ printing money they do not actually have. In such cases, central banks may cause inflation through QE without economic growth, causing a period of so-called stagflation (stagflation is the simultaneous occurrence of both recession and inflation).

2.5 Fiscal policy Fiscal policy refers to changes in government taxing and/or spending6. Although the primary basis of fiscal policy is the provision of public goods and services, fiscal policy also refers to government taxing and spending in order to influence 16

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Monetary policy and fiscal policy economic conditions such as unemployment and inflation. This is so because government taxation will, at the end of the day, determine the amount of disposable income available to private individuals and businesses. In this regard, an increase in taxes will, to some extent, reduce the money supply (thus also reducing the demand for goods and services) and thereby reduce inflation. Employment can be affected by taxes in that a tax increase will cut into profit margins of private businesses, which may then choose to offset this loss of income by retrenching the workforce. The opposite can also be expected, that is, that a tax cut will provide private businesses with the extra capital needed for business expansion, which may in turn require employment creation. Alternatively, government spending can stimulate private investment, private income and private spending as private businesses are awarded government contracts for providing goods, services, projects and programmes. Such spending creates employment and increases the amount of money in circulation, which in turn puts upward pressure on inflation. A reduction of government expenditure can be expected to have the opposite effect. In contrast to monetary policy, which is the main responsibility of central banks, usually in consultation with the national treasury, fiscal policies are normally determined by Treasury and/or Parliament. In addition to being classified as tax or expenditure, fiscal policy can also be categorised as either expansionary or contractionary, depending on whether such policy aims to reduce inflation, deal with a recession, or create employment, as shown in Table 2.3. Table 2.3 Effects of expansionary and contractionary fiscal policy

Expansionary fiscal policy

Contractionary fiscal policy

Tax cuts

Increased government expenditure

Tax increases

Decreased government expenditure

Create employment

Create employment

Reduce inflation

Reduce inflation

Mitigate recessions

Mitigate recessions

Increase unemployment

Increase unemployment

Unlike government expenditure, tax rates can take effect relatively quickly and have therefore been the main focus of fiscal policy where short-run stabilisation objectives needed to be met. Government expenditure, on the other hand, has proven to be better suited to meeting long-run fiscal objectives as most government expenditure programmes (for example building roads and hospitals) take a long time to plan and complete.

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Public Finance Fundamentals A key difference between fiscal policy and monetary policy is the fact that fiscal policy is far more amenable to governments’ redistribution goals. In this regard, South Africa’s tax structure is progressive to begin with, and changes in tax rates tend to further favour the poor. Similarly, government expenditure on social and developmental programmes is strongly in favour of the poor.

2.6 The theoretical reality of the Phillips curve There is one major reality check with respect to attaining the shared goals of monetary policy and fiscal policy (vis-à-vis controlling inflation and unemployment). According to the Phillips curve, whenever unemployment is low, inflation tends to be high and whenever unemployment is high, inflation tends to be low. This inverse relationship between inflation and unemployment is depicted in what economists refer to as the Phillips curve (see Figure 2.2).

Inflation rate

This inverse relationship between inflation and unemployment presents a bit of a dilemma for policymakers as efforts to reduce inflation increase unemployment, and efforts to decrease unemployment increase inflation. Government policy must thus aim for some middle ground where the levels of both unemployment and inflation are within an acceptable range.

Unemployment rate

Figure 2.2 The Phillips curve

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Monetary policy and fiscal policy

2.7 Institutions responsible for monetary and fiscal policy One of the key differences between monetary and fiscal policies inevitably rests on which institution develops these policies. Monetary policy is typically developed and implemented by a central bank, whereas fiscal policy decisions are the responsibility of the national government. In the case of South Africa, there is a constitutional requirement that the minister of finance and the governor of the reserve bank must consult one another whilst carrying out their respective functions (Gildenhuys, 1993: 119–120; see also Section 224(2) of the 1996 Constitution). This requirement of ongoing consultation may go a long way towards ensuring that monetary and fiscal policies complement each other. As monetary and fiscal policies both strongly affect the economy of a country, they must be coordinated with each other (Klein, 1986: 257–258). Klein (1986) suggests that in all corrective instances, both monetary and fiscal policy measures must be used together, or at least coordinated (such that the left hand knows what the right hand is doing and does not get in its way) – and states that ‘... both monetary and fiscal policy must be carefully implemented in almost any type of economic maladjustment, be it recession, inflation, slow growth, or any combination of the three.’

Summary and conclusion This chapter dealt with yet another fundamental area of government economic policy, that is, the area of monetary and fiscal policies, collectively referred to as stabilisation policy. Fiscal policy refers to government taxing and spending in order to, first, provide public goods and services that society desires and, secondly, influence economic conditions such as inflation rates and unemployment. Monetary policy, on the other hand, attempts to influence inflation and unemployment through manipulation of the money supply (mostly M1 money, as discussed in Chapter 1). Three of the most commonly used monetary policy instruments, ie open market operations, discount window/repo rates and reserve requirements, were discussed in this chapter. It was also emphasised that monetary policy works in stages such that the intermediate objectives of monetary policy must first be met before main objectives can be attained.

Self-examination questions 1. Compare and contrast monetary policy and fiscal policy. 2. Compare and contrast open market operations and reserve requirement. 19

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R E T P A H C

3

Public provision of goods and services, and key sources of government revenue S Nsingo

LEARNING OBJECTIVES By the end of this chapter, you should be able to: ■ outline the fundamental rationale for the state to provide goods and services ■ describe the various categories of service provided by the state ■ describe the different sources of revenue for the state ■ define and briefly explain the terms: ■ collective goods ■ particular goods ■ quasi-collective goods.

Introduction In this chapter we focus on the ability of the state to provide goods and services based on the revenue that it raises. We begin with a brief outline of the need for the state to provide goods and services, rather than leaving this function to the private sector. We then discuss the different categories of revenue source that are available to the state, and attempt to match these to the types of service (collective, particular or quasi-particular) the state provides.

3.1

The provision of goods and services by the state In most modern economies, be they free-market systems or planned economies, decisions to provide goods and services are taken by both the private and the public sectors. This means that the state has a role to play in the economic well-being of a country. In fact, the economic role of the state has become part of our daily lives. Governments spend large sums of money to provide us with a plethora of services, such as health, education, technology, roads, railways, defence and security. These

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Public provision of goods and services, and key sources of government revenue services are not ordinarily provided by the private sector, although the state may decide to take on private sector partners to expedite the delivery of these services. It is significant to note that the untenable economic conditions during the apartheid era led to the development of a dual economic system, popularly referred to as the ‘first economy’ (a modern free-market economy) and the ‘second economy’ (basically a rural economy embedded in the peasant mode of production). It is only through state action that the two economies can be integrated, and the playing field levelled for a unified economic system geared towards fair allocation and distribution of resources throughout the country. The fact that South Africa is a developmental state means precisely that government has to manage the economy so as to offer a visionary economic transition that benefits all South Africans, particularly the marginalised societies who need expanded government services that were denied them during apartheid rule. As can be seen, the government of South Africa, just as with any post-colonial government, has several challenges to address in order to build the national economy. For it to succeed in this agenda, the government needs a large outlay of financial resources. This means that the government should be able to raise enough revenue to provide the multitude of services expected of it, thus the raising of revenue becomes the first major challenge that a developmental state faces. And this is to be done mainly – but not exclusively – through taxation, as discussed in section 3.11.

3.2 The scarcity factor According to Plato (427–347 bce), government exists to enhance social welfare and make life good for members of society. It should promote the public interest and ensure that all of society stands to benefit from the scarce resources at the disposal of the nation, thus the state is needed to manage the scarce resources and make sure these are utilised efficiently for maximum benefit. From the outset, we can see that the state’s presence in economic affairs is justified largely on the basis of the effective management of scarce factors of production (land, labour and capital). This means that the scarcity factor (together with the need for state provision of collective goods) dominates the argument of the role of the state in the economy, thus government action within the national economy is seen as a matter not only of choice, but of necessity (Visser & Erasmus, 2002: 22). The scarcity factor underlines the economic problem that resources are scarce yet the people’s wants are unlimited. South Africa has not been spared this problem as, especially under the system of apartheid, already scarce resources were centralised 21

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Public Finance Fundamentals and rationed to only a few South Africans based on ethnic factors. Democracy, in 1994, opened up the economic system to competition and increased demand on these resources. The current challenge with which the South African government is faced is to meet the demands of the majority of the people in the face of little increase in available resources to do so.

3.3 Market failure In a utopian world without government(s), private markets would provide all of the goods and services needed by the populace. In the real world, however, this is not the case, as private markets provide only those goods and services that can be produced and sold for a profit. Private producers do not invest in the production of goods and services that are unprofitable, and thus many essential goods and services desired by the public will never be produced privately. This situation, in the language of public finance and public sector economics, is referred to as market failure. Governments attempt to resolve market failure by taking on the production and/or provision of those essential goods and services desired by the public but not produced by the private sector. Market failure exists as a result not only of the unwillingness of private producers to provide publicly needed goods and services; the inability of private producers is also an issue, as are the issues of externalities and public goods. The discussion that follows addresses each of these in turn.

3.4 Increasing, constant and decreasing returns to scale The inability of private businesses to produce certain publicly demanded goods and services is captured by the concept of increasing returns to scale. The concept of increasing returns to scale can be better understood when contrasted to decreasing returns to scale and constant returns to scale. With decreasing returns to scale, the amount of production/output is limited to a certain point, after which further production begins to accrue less and less profit. The profit may even become increasingly negative (losses) if production is allowed to go too far beyond the critical point (refer to Figure 3.1). An example of a product that exhibits characteristics of decreasing returns to scale is a factory that has a fixed amount of machinery, equipment and labour. For such a factory there will be a limit (ie the maximum amount) to how much of the particular good can be produced. It may be possible to push production beyond this limit, but the cost of doing so (by, for example, paying workers for overtime) may actually make it unprofitable.

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Public provision of goods and services, and key sources of government revenue

Profit

Maximum output

Production

Figure 3.1 Decreasing returns to scale

Profit

The constant returns to scale model, on the other hand, is characterised by a production process in which output gains are always proportional to input costs (refer to Figure 3.2). Thus with constant returns to scale, there is no real limit to the amount that can be produced, and profits can be expected to grow in direct proportion to production costs.

Production

Figure 3.2 Constant returns to scale 23

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Public Finance Fundamentals

Profit

It follows then that increasing returns to scale is the situation in which it is more than proportionally profitable to increase production. The relationship is exponential and thus cannot be depicted by a straight line (refer to figures 3.3 and 3.4), thus any increase in production costs is more than offset by increases in profit. Large organisations with excess and under-utilised factory capacity may find themselves in this situation. For such organisations, it is in fact less profitable to produce too little of a good for which plant and equipment are under-utilised and for which demand exists.

Production

Price (consumers)

Figure 3.3 Increasing returns to scale

Cost of production

Figure 3.4 Increasing returns to scale on the basis of cost 24

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Public provision of goods and services, and key sources of government revenue Much of government production is based on the principle of increasing returns to scale. This is easily demonstrated in the provision of water and electricity. For the provision of electricity, for example, it is more efficient for one producer (usually government) with the necessary electricity networks and infrastructure in place to provide the service than it is for a number of small businesses to do so. Small businesses would have to invest heavily to put their extremely expensive electricity grids in place. The price that they would have to charge consumers to recover their start-up costs within a reasonable period of time would be nothing less than exorbitant. In this case, the small businesses of this example would not break even in the short to medium term, and thus would not survive in this industry (see Table 3.3). Government, mainly through its statutory taxing powers and access to tremendous resources, is in a position to enjoy increasing returns to scale on such essential and publicly demanded goods as water and electricity. The productive characteristic of increasing returns to scale makes it quite affordable for government to provide some of the goods and services that the private sector has an inability to provide. Natural monopoly: The term used to refer to industries that are characterised by increasing returns to scale. Alternatively stated, industries in which it is only possible/feasible for one large organisation to be the sole producer of a good (as smaller organisations would not be able to produce the good on a cost-effective basis) are referred to as a ‘natural monopoly’.

3.5 Externalities Market failure, as discussed above, not only has to do with the unwillingness or inability of private businesses to provide unprofitable goods and services demanded by the general public; market failure is also characterised by the intervention of government in the marketplace to provide these goods and services. In addition, externalities are yet another condition related to market failure in which government will intervene in private markets to ensure that publicly demanded goods and services are provided – on the basis of efficiency. Although defined in various different contexts, efficiency is defined here as technical/ engineering efficiency in which goods and services are provided by the private sector on the bases of least cost, and prices being reflective of their true costs. Externalities are present where technical efficiency does not exist. More specifically, externalities are external costs or external benefits that are not accounted for in calculating the cost of production or the price to be charged consumers. Externalities can be positive or negative. 25

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Public Finance Fundamentals 3.5.1 Positive externalities Positive externalities exist when people who did not pay for a certain good or service benefit from that good or service. An example of a positive externality is the situation in which farmer J detects a destructive weed that has just begun to grow amongst his crops. He invests in eradicating this weed, the spores of which are carried by the wind and spread and grow wherever they fall. The effective elimination of this weed before it has a chance to spread to other farms benefits all farmers in the area, although only farmer J had to pay to deal with the weed. In the ideal situation, all farmers in the affected area should bear some of the costs of eradicating the weed. As it may not necessarily be human nature for the other farmers to compensate farmer J, governments normally intervene in such cases by subsidising farmer J. In other words, governments normally subsidise the producer of a positive externality in order to assist him or her to deal with the costs involved in creating what is essentially a public benefit. 3.5.2 Negative externalities Negative externalities are the opposite of positive externalities, and occur when people are put in a position where they are forced to pay for the negative outcomes of the production of a good or service that they themselves would otherwise not incur. As an example of a negative externality, take the situation in which there are a number of manufacturing factories along the same river. If one of the upstream businesses severely pollutes the river water, downstream businesses may have to spend some additional amount of their resources on getting the water clean enough to use in their own production processes. In the case of negative externalities, governments normally intervene by taxing the producer of the externality and using those funds to deal with the external effect (for example restoring the water to its original condition). Governments borrow in order to finance the deficit between revenue and expenditure as well as the annual interest (debt services) costs and past debt.

3.6 Public goods Public goods are goods that must be provided to all of the people of a country, and government is responsible for producing and providing these goods. Public goods are also often referred to as collective goods, which may have one or more of the following characteristics: ■■ non-rival ■■ non-excludable 26

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Public provision of goods and services, and key sources of government revenue non-apportionable ■■ monopolistic ■■ with no direct quid pro quo linked to them. ■■

3.6.1 Non-rival This means that one person’s consumption of a good or service has no effect on the amount of that good or service that is available for others. In other words, there is no competition among consumers for acquiring the good or service in question. 3.6.2 Non-excludable Once a pure public good7 is provided for one person, it is not practically possible to exclude others from benefiting from consuming the same good. For example, once there is clean air, all within the area will benefit. Non-payers cannot be told that they are not allowed to breathe in the fresh air. This is the same with defence, street lighting and, to some extent, law and order. The consumption of non-excludable goods can easily create ‘free riders’. This means that those who do not pay for the service may still enjoy the service alongside those who have paid for it. Such goods cannot be profitably provided by the private sector, hence the need for government intervention. 3.6.3 Non-apportionable This means that it is not possible to divide up the good or service into measurable units that can be priced and sold. Although water and air are both public goods, there is an important difference with respect to public versus private provision. Water is apportionable, as it can be measured in litres, gallons or by weight, and sold per unit as is the case with bottled water. Water can thus be either privately or publicly provided. Clean air, however, cannot easily be measured, packaged, priced and sold. It is therefore non-apportionable and therefore must be publicly provided. 3.6.4 Monopolistic The term ‘monopoly’ is used to refer to an organisation that is the sole producer or supplier of a given good or service. This condition guarantees the organisation excessive control over prices and the supply of the good or service. As can be imagined, a monopoly is usually not ideal for consumers of such goods and services – however, as discussed above, natural monopoly is the situation in which it is actually more efficient (and beneficial for consumers) for a large, well-equipped organisation to operate as the sole producer. A number of publicly demanded goods and services (collective goods) are provided by government on the basis of natural monopoly. 27

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Public Finance Fundamentals 3.6.5 No direct quid pro quo Quid pro quo is the term used to signify that consumers know what (ie how much of a certain good or service) they will get for an amount spent. With collective goods there is no direct quid pro quo, as they are provided through taxes, and most taxes and fiscal spending tend to be progressive. There can be no assurance from government that the public goods and services that we will receive are proportional to the amount of tax we pay. With privately provided goods and services, on the other hand, there must be a direct quid pro quo. Public sector borrowing The fiscal deficit (or surplus) that results from the difference between government revenue and expenditure can have a significant impact on the overall macroeconomic performance of a country. Government borrowing to finance a deficit results in debt service costs, and excessive borrowing therefore leads, over time, to a reduction in revenue available for spending on public services. Interest on debt is a ‘first charge’ against revenue, and has to be provided on the annual spending budget. A budget surplus, on the other hand, allows debt to be repaid, resulting in reduced annual interest costs. The appropriate balance between revenue, spending and borrowing depends on economic circumstances. Some countries follow the so-called ‘golden rule’ that borrowing should not exceed investment in new capital assets, which should in turn contribute to economic growth and revenue to service the resulting debt. Some countries try to balance their budgets over the business cycle, which means that the excess of revenue over spending during boom years should offset deficits during years of slower growth or decline. The effects of excessive public sector borrowing include rising interest rates, lower private investment and reduced growth, and undue strain on markets and the domestic financial system as a whole. If a budget deficit cannot be financed through government borrowing, then the central bank may be obliged to ‘print money’ to meet the government’s spending commitment. If this persists, then it leads to accelerating inflation and a general loss of confidence in both the value of money and prospects for economic development.

3.7 Particular goods In direct contrast to collective/public goods, particular goods are best suited to provision by the private sector and have the following characteristics (which are exactly the opposite of the characteristics of public goods):

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Public provision of goods and services, and key sources of government revenue ■■ ■■ ■■ ■■ ■■

rival excludable apportionable direct quid pro quo no monopoly.

3.8 Quasi-collective goods and services ‘Quasi-collective’ refers to goods and services that may have characteristics of both collective and particular goods and services. Quasi-collective goods and services can be provided exclusively by either the private or the public sector. They can also be provided by the private sector under government contract and government subsidisation. Electricity, health and education are just a few examples of quasi-collective goods. At the same time, electricity has a few characteristics of a particular good, such as the fact that it can be measured, apportioned and priced, and it is also possible to exclude non-payers from using it. Health is another example of a quasi-collective good that has most, if not all, of the characteristics of a particular (privately provided) service, but is most often provided by the public sector as it is in the public interest to do so. Education is similar to health when it comes to the issue of the public interest. For health, it is in the public interest that the prevention of infectious diseases is prioritised, regardless of the potential profits, and it is also in the public interest to ensure that a minimal level of health care is available to all, regardless of their ability to pay. With education, it is in the public interest to have a well-educated population, as the development and future prosperity of the country depend on it. Table 3.1 Summary of characteristics of collective, particular and quasi-collective goods

Collective

Particular

Quasi-collective

Excludable

No

Yes

Both

Rivalry in consumption

No

Yes

Both

Apportionable

No

Yes

Both

Direct quid pro quo

No

Yes

Both

Monopoly

Yes

No

Both

Sector responsible for provision

Public sector

Private sector

Both public and private sectors

Source: Adapted from Gildenhuys, 1997

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Public Finance Fundamentals

3.9 Market failure due to lack of market access The free-market system works on the basis of the laws of supply and demand. Consumers express a demand for a commodity and are prepared to pay a certain price for it. Suppliers respond by making this commodity available at a ‘fair’ price. However, the supply and demand equation is rather individualistic and does not cater for socially oriented products. Additionally, failure of the free-market system can be observed in the fact that members of society have unequal access to the market as a result of economic position. In some cases, consumers have no access to information on what goods and services are available to them. As a result they cannot participate in the consumption of such goods and services. This shortage of information may be deliberate (especially during the apartheid days) or may be due to technological advancement (particularly computer technology) and the unavailability of such technologies in the rural areas. Thus, most rural communities are likely to be marginalised in terms of consumption of both public and private goods and services. Poverty-prone communities are increasingly dependent on government assistance in both collective (such as defence, clean air, law and order) and quasi-collective (such as education, health and water services) goods, as well as in strictly free-marketoriented goods and services. The presence of the state becomes critical in such instances. South Africa is a case in point, where the new democratic government has to address issues of poverty, disease, malnutrition and education. This means that government is under tremendous pressure to expend incredible amounts of resources in order to mitigate market failure. The latter sections of this chapter deal with the financial resources government may secure towards this end. Table 3.2 Summary of market failure

Situation

Definition

Example

Possible intervention

Public goods/ Goods which are non-rival and non-excludable collective goods and capable of creating free riders

Defence, street lighting

Public provision

Externalities

Actions of individuals or firms capable of affecting others’ private and social costs and benefits, although the cost or benefit is not reflected in the value of the transaction

Pollution, road congestion

Taxes or subsidies to equate

Asymmetrical information

A situation where buyers and sellers have different sets of information

Health care, used vehicles

Regulation of quality, compulsory pooling of insurance Continue ➝

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Public provision of goods and services, and key sources of government revenue Situation

Definition

Example

Possible intervention

Increasing returns

Average cost decreases as output increases

Natural monopolies, eg regulation of water supply, electricity

Public ownership; private monopoly

Source: Adapted from Connolly & Munro, 1999: 3

3.10 A classification of the services provided by government It has thus far been established in this chapter that the state provides a variety of services to the public. The rationale for determining which goods and services are to be provided by government and which services are to be left to the private sector to provide was also discussed. We now focus first on classifying government services and then deal with the financial resources available to government for carrying out its mandate. Government services are classified in a number of ways. Economists choose to categorise the economic functions/services of government that are related to government expenditure as follows: ■■ Allocation: Government determines what goods and services to produce, and the quantities of these goods to produce, mainly in response to market failure (to recap briefly, the term ‘market failure’ refers to the need for government intervention when private producers are unable or unwilling to produce publicly demanded goods). ■■ Distribution: Government decides who should benefit from government expenditure. ■■ Redistribution: Government redistributes resources from the rich to the poor through, for example, progressive taxation. ■■ Stabilisation: Monetary and fiscal policy (‘fiscal policy’ refers to government taxing and spending) concerned with making the economy stable and capable of competing globally. ■■ Regulation: Government policies and structures put in place to ensure efficiency in private production. A second classification scheme, the one most commonly used in public administration, is according to the activities that the state performs. These are divided into the following categories (although they are not always mutually exclusive):

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Public Finance Fundamentals Community services: The provision of goods and services that have collective characteristics. Examples include street lighting, clean air and defence. ■■ Order and protection: The provision of goods and services in the public interest that ensure the physical and psychological well-being of the people. Examples include defence, police, justice and civil protection. ■■ Social welfare: The provision of goods and services in the public interest that seek to provide access to minimum basic social services for the people. Examples include health, pensions, education and training, housing, sport and recreation. ■■ Economic welfare: The regulation of the economy; stimulation of economic development; maintenance of economic order; provision and maintenance of economic infrastructure to support the private sector. ■■

Table 3.3 shows the different classes of service, the major characteristics of the service category, examples of the types of service in each class and, finally, the most common sources of revenue to support each class. Table 3.3 Classification of services provided by government

Service

Characteristics

Examples

Revenue most commonly used

Community services

Roads, street lighting, ■■ Pure public goods defence, law and order, ■■ Collective clean air consumption ■■ Non-excludable ■■ Non-rival ■■ Cannot be provided to individuals only

Social welfare services

Roads, health, education, Fuel levy, national ■■ Quasi-public goods income taxes, user ■■ Can be provided by water, electricity charges, nominal levies individual providers ■■ Government enters into contracts to fulfil its distribution role ■■ Costs can be apportioned to individuals ■■ Individual consumption is possible ■■ Government can provide in full or subsidise

Fuel levy, local government taxes, national income taxes

Continue ➝

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Public provision of goods and services, and key sources of government revenue Service

Characteristics

Examples

Revenue most commonly used

Economic welfare services

■■ The private sector may find provision of certain required goods non-viable ■■ Where there is an absence of entrepreneurs, government may enter the market ■■ The state may enter the market to provide these type of services through state owned enterprises

Monetary reserves of the Council for Scientific central bank; National and Industrial Research (CSIR); Human Sciences income tax Research Council (HSRC); telephone services (Telkom); road services; military equipment (Denel); railway lines and rail transport

Protection services

■■ Exclusive right of Police services; defence government given services nature of protection ■■ Large outlay of required resources makes it non-viable for private sector ■■ Joint consumption ■■ Free-ride characteristics

National income tax

As previously suggested, the provision of government services requires a large outlay of financial resources. Government can obtain these resources from several sources. In some cases (collective goods and services), there is no correlation (direct quid pro quo) between the source of revenue and the service provided, whilst in other cases (particular and quasi-collective goods and services) some degree of correlation does exist. Sources of government revenue (and their uses) are discussed in the following sections.

3.11 Sources of government revenue As indicated above, government must raise revenue first in order to provide services. The most common source of revenue is tax. The questions that we may ask here are: What is tax? What are the fundamental principles of a sound tax system? How can we classify tax? It is only once we have provided answers to these questions that we can talk meaningfully about the different types of tax. 33

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Public Finance Fundamentals 3.11.1 Taxes and taxation A tax is a due or levy paid to the state by citizens and business organisations in order to facilitate the work of government. Thus, the payment of tax is a requirement of all who get an income, be it in the form of wages, salaries, property ownership or business profits, as well as a requirement of all who are consumers of privately provided goods and services (VAT, for example). Case and Fair (1999: 429) indicate that taxes are usually imposed on transactions, property, institutions, meals, and other things. This means that taxes are effectively paid by individuals, households and companies as they are afforded the opportunity to participate in the economy (as either consumers or producers) through support and protection provided by the state. In order for the state to maintain the democratic, capitalist or socialist (or other) market systems, it is necessary for those who enjoy the benefits of whichever system to contribute towards the maintenance of the system through taxation. Thus, taxation is a process of levying tax or making sure that all eligible persons and organisations pay tax. Taxation is in line with what has come to be known as the ‘social contract’, whereby human beings establish a state to protect them and improve their welfare. 3.11.2 Fundamental principles of taxation A good tax system has to exhibit three fundamental characteristics, identified by Adam Smith (1723–1790): efficiency, equity and simplicity (including low cost). Although the universal acceptability of these principles is open to debate, they form an important basis for analysing tax systems in different parts of the world. Efficiency

A tax system must be designed to minimise cost or losses to the paying individual. It is generally agreed that tax results in a loss of efficiency, but the argument is that those affected should endure the least possible amount of loss. In the ideal situation (which is not necessarily realistic, given progressive and regressive taxation), an efficient tax should not result in a loss of Pareto efficiency. The Pareto efficiency criterion (also called Pareto optimality) states that an economic improvement is achieved when it is possible to make at least one person better off without making anyone else worse off. Tax systems must attempt to meet the Pareto efficiency criterion, but the reality is that only proportional taxation can do so. Equity

Equity is a value of fairness, both on a horizontal and on a vertical level, thus those within the same tax band (horizontal level) should endure the same tax regardless 34

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Public provision of goods and services, and key sources of government revenue of gender, ethnicity, or religious conviction. This is horizontal equity. However, it may be appropriate to have tax differentials with regard to marital status and the number of legal dependants that one has to support, thus a fair tax system should also support the family. Sometimes age is also used as a factor to create tax differentials. In this case, elderly workers receive higher tax allowances to protect them against pensioner poverty (Connolly & Munro, 1999: 160). Vertical equity results where a progressive tax system is designed to cater for different levels of income. According to the requirement of vertical equity, the more income you have, the more tax you should pay. Simplicity and low administrative cost

According to this principle, a tax system should be simple and easy to administer in order to reduce costs to both government and taxpayers. Complicated tax collection instruments lead to a lot of time being spent on the analysis of each tax return. Taxpayers may evade tax payment if they find it difficult to fill in or complete tax return forms. Tax evasion leads to a loss of revenue, thereby increasing the cost of taxation and minimising benefits.

3.12 Classification of taxes Generally, there are two main classes/types of tax. These are direct taxes and indirect taxes. 3.12.1 Direct taxes A direct tax is that which is paid by the taxpayer directly to the authorised receiver of taxes, for example a tax revenue office such as the South African Revenue Service (SARS). Examples of direct taxes are income tax, wealth tax, property tax and company tax. The concept of pay as you earn (PAYE) is consistent with direct taxation, thus direct taxes are obtained from, among other sources, individuals’ income and the net income of firms. 3.12.2 Indirect taxes These include the taxation of goods and services. They are levies on household expenditure. Households pay these to suppliers of goods and services. The latter then make payment to government. These taxes are easy to administer as companies or firms have elaborate books of accounts, making such monies easily traceable. However, the problem still arises with the parallel economy (or second economy, referred to earlier in section 3.1), where most transactions are not documented.

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Public Finance Fundamentals It is also significant to note that indirect taxes usually burden low-income groups, as these tend to allocate higher income proportions to expenditure on goods and services, thus it can be noted that indirect taxes tend to be regressive. A regressive tax is one whose burden, expressed as a percentage of income, falls as income increases (Case & Fair, 1999: 430). Alternatively stated, with regressive taxation, the more you earn the less you pay.

3.13 Types of tax There are several different types of tax. The Organisation for Economic Cooperation and Development (OECD), made up of countries in Europe, provides six different tax categories, as highlighted in Table 3.4. Table 3.4 Example of broad categories of tax

Type of tax

Direct/indirect

Examples

Taxes on income profits and capital gains

Direct

■■ Individual taxes on income, profits and capital gains ■■ Corporate taxes on profits and capital gains

Social security contributions

Direct

■■ Paid by employees ■■ Paid by the self-employed and the underemployed ■■ Employers’ payroll taxes

Taxes on property

Direct

■■ Recurrent taxes on immovable property (households and other) ■■ Recurrent taxes on net wealth (individual and corporate) ■■ Estate, inheritance and gift taxes (on wealth and other recurrent) ■■ Taxes on financial and capital transactions ■■ Non-recurrent taxes (on net wealth and other non-recurrent)

Taxes on goods and services

Indirect

■■ Taxes on production (these include general taxes such as value-added taxes, sales taxes and others) and taxes on specific goods and services

Taxes on use of specified goods

Indirect

■■ Paid solely by businesses (recurrent and nonrecurrent taxes)

Other taxes

■■ Other

Source: Adapted from OECD list.

The focus of the next section of the chapter is limited to income tax, consumption tax, property tax, user charges, nominal levies and consumer tariffs as these, to some extent, match types of taxes levied with services provided by 36

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Public provision of goods and services, and key sources of government revenue government. These taxes also give some indication of the differing responsibilities (and taxing powers) of each sphere/level of government. 3.13.1 Income tax This is the most common type of tax in most countries across the world. Worldwide, income tax is normally levied exclusively by national governments (as is the case in South Africa), but in a few rare cases, even provincial and local government institutions are entitled to derive their finances from this type of tax. According to Gildenhuys (1997: 84), the concept of income relates to the remuneration received by factors of production for their services. As indicated above, not all of an individual’s income is subjected to tax. An individual’s total income is his or her gross income. Income tax includes personal income tax, corporate tax, payroll tax and turnover tax. In its broader sense, income includes items such as wages, salaries, interest on investments, stock dividends, royalties, and income from professional services, business activities and farming activities. One’s income can thus be defined as what one gets for one’s consumption plus any net increase in wealth during a particular fiscal year. For example, if one consumes R50 000 per year, but gets R72 000 during the fiscal year, one’s net wealth for that year is R22 000. After considering several deductions, we remain with taxable net income. The question is, what are deductions? These are components of gross income that are not subjected to tax. For example, expenses incurred as costs of earning an income are allowed to be deducted from income before tax is calculated. Another important consideration in the calculation of income tax is what we call ‘exemptions’. There are two types of exemption: 1 The first are exemptions of various kinds of organisations because of the nature of their activities. In this category, we have organisations that do not operate for profit purposes. The surpluses they accumulate during their operations are not subjected to taxation. Exempt organisations include churches, sports clubs and other non-governmental organisations (NGOs) (Gildenhuys, 1997: 86). 2 The second type of income exempted from taxation includes various kinds of receipts which are treated differently from normal income. Subsidies received from government for example, or donations from one person to another, or some categories of investment income, may be exempt or partially exempt. Table 3.5 provides a summary of these exemptions.

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Public Finance Fundamentals Table 3.5 Summary of incomes exempted from taxation

Category of exempted income Specific examples Income from labour

■■ Pensions of former heads of state and war veterans ■■ Pension gratuities of public servants and political representatives ■■ Study bursaries ■■ Bonuses or gratuities to employees on resignation

Income from investment

■■ Specified interest earned on investments in specific institutions ■■ Dividends earned on specific shares held in specified corporations ■■ Interest earned on investment with government and other public institutions

Government subsidies

■■ Subsidies to farmers ■■ Subsidies to manufacturers of export products ■■ Subsidies for employers for in-service training of their employees

Source: Adapted from Gildenhuys, 1997: 87

In respect of personal income tax – as opposed to corporate income tax – a taxpayer’s tax liability is determined by: ■■ the size of the taxpayer’s income ■■ the nature and size of the exemptions and deductions for which an individual qualifies ■■ the tax rate applicable to his or her income band (Gildenhuys, 1997: 89). Once this is established, appropriate tax is calculated on taxable net income, that is, income after all statutory deductions have been made. Also, subtraction of personal rebates is required to determine the net amount of tax due to (or from) the Receiver of Revenue. 3.13.2 Consumption tax Consumption taxes are paid by consumers for privately provided goods and services. The most popular kinds of consumption tax include value-added tax, excise duty and a surcharge on imports. Value-added tax

Value-added tax, popularly known as VAT, is a tax collected at the point of sale or supply of goods or services. It forms part of the consumption expenditure of individuals when they purchase taxable commodities. The tax is calculated

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Public provision of goods and services, and key sources of government revenue proportional to the retail price of a taxable commodity or product. In simple terms, it means that a product has had value added through the production process, thus the tax is dependent on the value that has been added to the product. VAT is an output tax. We all know of this tax as it is always calculated during the transaction process. The tax is built into the price of the product. It is then deducted and shown on the receipt after the purchase so that the consumer is aware how much of what he or she has paid goes to tax. It is significant to note that the consumer pays VAT (as output tax) to the vendor who sells him or her a product. On the other hand, the vendor pays VAT (as input tax) to his or her supplier of the product, thus the difference between the amount of output tax charged by a vendor and the amount of input tax paid to his/her supplier is paid over to the government (Gildenhuys, 1997: 109). This means that: VAT collected – VAT paid = VAT payable to the government. We should note that, in South Africa, the following are exempted from paying VAT: ■■ the provision of life insurance and credit ■■ long-term residential accommodation ■■ educational services ■■ immovable property situated outside the country ■■ goods and services donated to associations not for gain. Excise duty

Excise taxes are another form of indirect tax, and are levied on specific commodities, such as cigarettes, alcoholic beverages, petroleum products, tyres, telephone services and motor vehicles. This tax is levied on the quantity of the item(s) purchased rather than on their value. There are two kinds of excises or duties – specific and ad valorem. Specific duties are levied as a fixed rand amount per unit – for example R5 for a bottle of wine or R2 for a packet of 20 cigarettes. Ad valorem excises are charged as a percentage of the price. The commodities that attract excise duty are classified differently, as follows: Luxury goods

First, we have luxury goods. These attract luxury excise taxes. The individuals paying this tax have a high capacity to pay tax. They can afford luxury goods such as jewellery made of gold, diamonds and platinum, and luxury cars. 39

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Public Finance Fundamentals Sumptuary goods

Secondly, we have sumptuary goods (‘sinful’ goods such as alcohol and tobacco). These types of goods are discriminated against by the state, since they attract a sumptuary excise tax in addition to consumption tax. The state does this mainly to discourage consumers from purchasing items in this category, as they are injurious to health. However, whether or not government meets its stated objectives for this tax is highly questionable; it is common knowledge that no matter how much tax you attach to ‘sinful’ items, consumers continue to buy them. The major objection to sumptuary taxes is the argument that consumers adjust to this tax by shifting their financial resources away from other household goods to these sumptuary products. Benefit-based taxes

Thirdly, we have benefit-based taxes, which attempt to attach the responsibility for paying for certain public goods to the appropriate users. An excellent example of a commodity that can be subjected to a benefit-based tax is petrol. The type of tax levied on petrol is a benefit-based tax and is referred to as the fuel levy. The tax on fuel is levied on all purchasers of petrol, and the revenue used to build and maintain roads. The logic of the fuel levy is that most purchasers of petrol also use roads (and put the most amount of wear and tear on them), and that non-users (for example bicyclists and pedestrians) can somehow be spared from paying for something they do not use ‘to the same extent’. Import duties

These are also known as customs duties. Import duties are levied on foreign goods brought into the country. This is done to protect domestic industries whose products may be exposed to unfair competition with producers in the international environment. The effect of the duty is to make it more expensive to purchase foreign products. When this is done, consumers tend to look into the domestic market first before they consider buying foreign products. Foreign goods that are considered to bring unfair competition to domestic products are those which are subsidised by their governments in order to make it possible to under-price local (South African) producers of the same or similar products. By dumping the exporting country effectively disposes of excess production, while at the same time raising additional income for itself and its businesses. As such, import duties are also known as customs duties, surcharges or anti-dumping duties on imports. Consequently, these are also a consumption tax and a meaningful source of revenue for government. 40

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Public provision of goods and services, and key sources of government revenue 3.13.3 Property tax Property tax is also referred to as tax on wealth. This is because property is an indicator of one’s degree of affluence. Property tax is particularly evident where the market value of real property has a tax attached to it. However, there are several types of property tax that can be enumerated. These include real property tax, capital gains tax, estate duty, donation tax and transfer duty. In this chapter we limit the discussion to real property tax, as follows. Real property tax

Real property tax provides a substantial amount of the financial resources used by local/municipal governments to provide goods and services. This is the tax levied on land owned by private individuals, and/or levied on the improvements (for example houses) built on the land. The amount of tax levied is commensurate with the capital value of the property as assessed. A comprehensive process of assessment is required in order to ensure fairness of real property taxation. Incomplete and inadequate valuation systems can undermine the objective (taxation of wealth) of the tax. Miscalculation in the valuation process can lead to (Gildenhuys, 1993: 290): ■■ loss of potential tax revenue in cases of undervaluation ■■ injustice and inequity in distributing the local tax burden. Real property taxes are normally used by local government to provide particular and, in some cases, quasi-collective services, such as garbage removal, electricity, water, sanitation, street lighting and storm-water systems.

3.14 User charges These are direct charges to individuals in communities for the use of a public facility or consumption of goods and services provided by the State or its sub-national structures, such as provinces and local governments. User charges are levied on the basis of the cost of providing a service and may amount to the total cost or, in some cases, part of the cost, thus there is a direct quid pro quo associated with them. Examples include electricity charges, water charges, health service charges, parking charges, licence taxes, or fees paid for the privilege of being involved in a specific activity such as fishing or obtaining a driver’s licence, and recreation.

3.15 Nominal levies A nominal levy is charged to consumers to recover part of the costs incurred in producing or rendering a specific service. These services may be subsidised by 41

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Public Finance Fundamentals government, and work on a benefit-received principle. Levies are imposed to try to recover some costs of providing specific services rendered for the benefit of individual taxpayers. A succinct description of these levies is provided by Gildenhuys (1997: 124), who indicates that: ... nominal levies partially compensate governments for the costs of special services rendered on request to identifiable individuals; or for special paper work, such as extracts from official records and the issuing of various certificates and documents. The services related to nominal levies are not continuous services offered for sale on a regular basis but are delivered sporadically at the request of an individual or business enterprise. Nominal levies are charged for services such as the provision of a variety of licences, for example mining licences, liquor licences, business licences and building plan fees.

3.16 Consumer tariffs These are charges for public goods that are exhaustible when consumed. The public goods amenable to consumer tariffs are also excludable and rivalrous in nature. This means that if one does not pay for the good or service, one can be excluded from consuming it, thus there is a voluntary exchange relationship between the consumer and government as the supplier of the service. In addition, the nature of the goods and services is such that a unit price can be attached. Ideally, the consumer tariff should be high enough to pay for the full cost of supplying the service – we say ideally, because some goods and services that fall under this category tend to attract government subsidies. In general, the consumer goods in this category include public transport, abattoirs and produce marketing, and the sale of erven for the construction of houses and businesses.

3.17 Sundry charges Several other revenues – besides taxes, user charges, consumer tariffs and nominal levies – are collected by government. These include rentals from the lease of government properties, registration fees of various kinds, and fines and forfeitures.

3.18 Bilateral and multilateral aid Governments may receive aid or loans from other governments (bilateral) and international financial institutions (multilateral) such as the International Monetary Fund (IMF), World Bank and African Development Bank (ADB). Most of this aid is for development purposes, particularly those intended for human resources training, infrastructure and entrepreneurial development. Government may be expected to 42

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Public provision of goods and services, and key sources of government revenue pay back this money with interest. In some cases loans are provided on concessional terms, which means that the interest cost is below market rates. Interest rates and repayment terms vary according to the nature of the agreement reached between government and the institution granting such financial assistance. Some bilateral aid may come as a free donation with very few strings attached. These may include friendship, mutual co-existence and the promotion of trade between two countries. In Africa this happens particularly where the colonising country feels it has an obligation to play a meaningful developmental role in the decolonised country; aid received is seen as a form of indirect ‘payback’ for the resources obtained from the colony during the colonial days.

3.19 Donor agencies Some governments channel their development assistance through separate agencies such as the Swedish International Development Agency (SIDA), the Canadian International Development Agency (CIDA), and the United States Agency for International Development (USAID). These agencies, though funded by their respective governments, arguably have the autonomy to determine how developing countries should be assisted in their development efforts. In addition to official development assistance, many developing countries receive aid or technical support from non-governmental organisations, such as Oxfam or the Bill and Melinda Gates Foundation.

3.20 The influence of international credit ratings agencies The ability of governments to raise funds from investors (especially from international investors) is significantly influenced by perceptions of the investment risk profile and creditworthiness of the state as a sovereign entity. Naturally, when formulating opinions on international investments or foreign government securities (for example bonds), international investors would depend on reputable international research organisations to provide information. Credit ratings agencies (CRAs) were created to fill this particular need. The work of these agencies is significant as their research findings, which are made available to investors, may affect (adversely or positively) inward investment flows. The global credit rating industry is highly concentrated, with three agencies (the “big three” – Moody’s, Standard & Poor’s (S&P) and Fitch – controlling nearly the entire market. S&P and Moody’s are based in the US, while Fitch is dual-headquartered in New York City and London. Collectively, the big three hold approximately 95% of market share in the international credit ratings industry.

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Public Finance Fundamentals Countries are issued sovereign credit ratings. This rating analyses the general creditworthiness of a country or foreign government. Sovereign credit ratings take into account the overall economic conditions of a country, including the volume of foreign, public and private investment, capital market transparency and foreign currency reserves. Sovereign ratings also assess political conditions such as overall political stability, and the level of economic stability a country will maintain during times of political transition. The riskiness of investing in these countries is determined by the likelihood that the debt issuer (the sovereign nation) will fail to make timely interest payments on the debt. Institutional investors rely on sovereign ratings to qualify and quantify the general investment atmosphere of a particular country. The sovereign rating is often the prerequisite information institutional investors use to determine whether they will further consider specific companies, industries and classes of securities issued in a specific country. Sovereign credit ratings are usually scored by way of an easy-to-interpret letter grade, the highest and safest rating being AAA, with lower grades moving to double and then single letters (AA or A) and down the alphabet from there – BBB, BB, B and so on. 3.20.1 Regulation of credit ratings agencies Since large CRAs operate on an international scale, regulation occurs at several different levels. The U.S. Congress passed the Credit Rating Agency Reform Act of 2006, allowing the United States Securities and Exchange Commission (SEC) to regulate the internal processes, record-keeping and certain business practices of CRAs. The Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 further grew the regulatory powers of the SEC, including requiring a disclosure of credit rating methodologies. The European Union, on the other hand, has never produced a specific or systematic legislation, nor has it created a single agency responsible for the regulation of CRAs. There are several EU directives, such as the Capital Requirements Directive of 2006, that affect rating agencies, their business practices and their disclosure requirements. Most directives and regulations are the responsibility of the European Securities and Markets Authority. Ever since the financial crisis and great recession of 2007 to 2009, credit rating agencies have come under increased scrutiny and regulatory pressure. It was believed that CRAs provided ratings that were too positive, leading to mal-investment. New rules in the EU have made CRAs liable for improper or negligent ratings that cause damage to an investor.

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Public provision of goods and services, and key sources of government revenue Over the past few years, South Africa’s sovereign credit rating has been steadily dropping. The continuous downgrading by the Big Three, to almost junk status, was attributed largely to political uncertainty and mismanagement of state-owned enterprises. Moody’s is the sole global rating agency to still assess SA’s sovereign debt at investment grade (i.e. rating of BBB or higher). Rivals Fitch and S&P downgraded South Africa’s credit rating to sub-investment grade (below BBB), or junk (BB or lower), in 2017 (m.fin24.com 10/06/2019 – viewed on 22/07/2019).

Summary and conclusion The involvement of the state in service provision is critical to the improvement of social welfare – and even more critical in a developmental state emerging from a colonial dispensation. In this situation, the state is in charge of addressing social imbalances and making sure that those who were denied certain services during the colonial era are now afforded the opportunity to enjoy the benefits an independent country can offer. However, in order for the state to provide services, it has to mobilise resources, the most common being taxes, bilateral and multilateral aid, and borrowing and investment in the domestic and international market systems. It is only through this effort of resource mobilisation that the state can fulfil its fundamental mission: to improve social welfare and to ensure sustainable development for the people.

Self-examination questions 1. Discuss how the term ‘market failure’ is understood in the context of public financial management. 2. Compare and contrast positive and negative externalities. 3. Compare and contrast direct and indirect taxes. 4. Explain the concept of natural monopoly.

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R E T P A H C

4

Role players in public financial management S Nsingo

LEARNING OBJECTIVES By the end of this chapter, you should be able to: ■ define and discuss public financial management ■ describe the role players in public finance ■ discuss some of the pertinent legislative provisions for facilitating the actions of different role players in public finance ■ outline the basic elements of financial control in government.

Introduction Governments exist to provide a wide range of services to society in order to improve social welfare and make people happy. A government that fails in this fundamental purpose is no longer necessary and demands replacement. In order to provide services and fulfil their allocative, distributive and redistributive roles, governments need a large infusion of financial resources. These resources should be appropriately utilised and controlled to enhance service delivery. Several governmental role players are empowered to ensure such considerations are realised. This chapter examines these role players and their legally – and, to a lesser extent, ethically – recognised responsibilities. Many of these same role players are discussed in Chapter 8, where the emphasis falls on ethics.

4.1

Public financial management As this chapter seeks to identify and briefly describe roles and role players in public financial management, we begin by defining what we mean by public financial management.

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Role players in public financial management Public financial management deals with the management of the people’s money, which has been entrusted to government. Public financial management involves decision making on: ■■ what financial resources are needed to implement government programmes and projects ■■ where to obtain these resources ■■ how to collect and utilise the resources ■■ how to control all financial processes within given time frames. In order for public financial management to be effective, several key public functionaries must work in unison (but not necessarily together) toward the aforementioned common objective(s). Literally, even if a public institution had access to abundant financial resources, as well as accounting systems inclusive of the latest financial software and hardware, effective public financial management could still prove elusive in the absence of the human factor. Following this argument to its logical conclusion, one may safely state that one of the most important factors needed to ensure effective management (in any of its many manifestations) is the human resource factor. Role players (the human resource factor) can contribute to effective public financial management through, among other things, the following mechanisms: ■■ managing resource scarcity ■■ dealing with efficiency, effectiveness and economy ■■ managing the budget ■■ monitoring and controlling financial activities of public institutions. Further description of each follows. 4.1.1 Managing resource scarcity The role of government in socio-economic development has increased tremendously over the years, but this increase has not been matched by an increase in economic resources. From our knowledge of economics, we know that resources are scarce. They are insufficient to meet all human needs. We may want goods and services, but we may not have sufficient resources to purchase them. Likewise, government may wish to involve itself in the provision of a wider array of goods and services to society, but is more often than not constrained by the scarcity factor, which in turn calls for prioritisation and prudence in the management of financial resources. This means that government has to have mechanisms and appropriate role players to manage financial resources. 47

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Public Finance Fundamentals 4.1.2 Dealing with efficiency, effectiveness and economy The fact that resources are scarce means they have to be utilised in a way that minimises costs and maximises benefits (efficiency and economy) and to make sure that the goals of government are realised (effectiveness). This is the essence of financial prudence, thus all public officials and public managers should note that it is their responsibility to give assurance that public monies are spent as planned and/ or utilised efficiently, effectively and economically. This will enable senior officials (directors-general and ministers) to ensure that approved goals are attained and that the bases on which the system of financial administration is founded are honoured (Hanekom & Thornhill, 1986: 52). 4.1.3 Managing the budget This is a requirement that covers budget preparation, budget implementation and budget control. Public managers play a crucial role in the preparation of the budget and in seeing to it that budgetary rules and spending requirements are adhered to in their sections, divisions, directorates or departments. Failure to do so often leads to over-expenditure and/or poor service delivery. 4.1.4 Providing financial advice Public managers, at every level of management, should also play an advisory role in their departments. Politicians rely on financial information from these internal functionaries to enable them to formulate appropriate and implementable policies. 4.1.5 Monitoring and controlling activities All government activities need to be monitored and controlled to make sure that government resources are used properly and that waste is avoided. Internal and external audits are done to enhance financial control. Internal control may be provided by public managers, and external control is normally accomplished through legislative institutions such as the Standing Committee on Public Accounts (SCOPA) and the auditor general (AG). These external control institutions exist to further enhance financial accountability.

4.2 Key role players in financial management The Constitution of the Republic of South Africa, 1996 (in various chapters and sections), read together with the PFMA8 and MFMA9, provides for central government institutions that are expected to play a leading role in the management of public finances. The most critical institutions, as discussed in turn below, include the legislature and its committees; the auditor general; the public protector; 48

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Role players in public financial management members of the executive authority; members of the administrative authority; and the reserve bank. 4.2.1 The legislature and public financial management All democratic governments have legislatures that act as supreme institutions of social representation. This means that the legislature is made up of representatives of the people. Members of the legislature are elected to their positions through an electoral system adopted by the specific country. Through its electoral power, the legislature is in charge of making public finance laws. The legislature at the central (national) sphere of government is referred to as ‘parliament’. Most modern parliaments have either two houses (bicameral) or one house (unicameral). In South Africa the two houses are the National Assembly and the National Council of Provinces10. The fundamental purpose of the legislature is to make laws. Different government departments may use their financial allocations only after such allocations have been subjected to a process of debate, modification (if need be) and ratification by parliament. As highlighted by Cloete (1993: 151), the legislative authority is responsible for taking the leading role in financial legislation. It is its responsibility to determine which monies are to be collected; how they should be collected, banked and spent; and how financial control on transactions should be exercised. According to Section 55 of the Constitution of 1996, the powers and functions of the National Assembly of Parliament are to: ■■ consider, pass, amend or reject any legislation ■■ initiate or prepare legislation, except money bills ■■ ensure that all executive organs of the state are accountable to it ■■ ensure that legislation is implemented appropriately ■■ maintain oversight on the conduct of duty of the executive ■■ ensure that persons, institutions and all organs of the state comply with the Constitution. All these general powers apply to the management and administration of public finance. As indicated earlier, in any democracy the axis of power lies with the electorate. In a representative democracy, this power is entrusted to the people’s representatives, the legislature, thus this institution has the power to make decisions on a diversity of governance issues, including public financial matters. However, whatever decisions are made should reflect the interests of the people. This means that the people expect the legislature to be accountable, and to make decisions that lead to the promotion of the public interest in the political, social and economic sense. It is the duty of the legislature 49

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Public Finance Fundamentals to interface with various interest groups as vital stakeholders in the democratic process. In view of the above, the role of the legislature in financial matters includes: ■■ determining the sources of revenue and their collection ■■ the allocation of financial resources ■■ controlling the financial affairs of government ■■ accounting to the people, who have original authority. Each of these is briefly discussed in turn below. Collecting financial resources

The legislature operates in a political environment. As such, the decisions made reflect the political interests and overtones of the political system. This applies to all decisions to be made by the legislature, for example determining what funds are needed, and where and how these can be collected. In South Africa the Constitution sets out specific procedures for money bills that effectively protect the tax and expenditure legislation by providing that only the minister of finance introduces these bills. Taxes can only be imposed through legislation, which protects individuals and businesses from arbitrary imposition of taxation. The legislature operates on the basis of original authority allocated to it by the people through the vote. Therefore, although the ultimate power of imposing taxes is from the people, the legislature has the authority to determine the nature of the tax regime. The allocation of resources

Aside from determining the revenues to be collected, the legislature also enacts budgetary laws (budget appropriations) for the resources to be allocated to a variety of public programmes and projects that are implemented by the various government departments. In fact, this is the essence of the political process, that is, that politics is about giving effect to social values and priorities – and the allocation of resources reflects political judgements about social economic and developmental priorities. The allocation of these values begins with the legislature’s budgetary process, which includes the budget debate and enactment of the annual Budget Act. The legislature’s budgetary process is where expenditure activities are approved, the required volume of funds is determined, and expected outcomes specified. Controlling financial matters and accounting to the people who have original authority

As indicated above, funds are allocated to different programmes and projects of government under the supervision of specific departments. This means that these 50

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Role players in public financial management departments are expected to spend the allocated financial resources so as to provide specific services within their mandate. It is mandatory for the legislature to know whether the various departments are acting within budgetary prescriptions. The legislature thus plays a critical oversight role so as to ensure accountability and enhance financial responsibility in the various departments. The oversight role of the legislature on financial matters shows that a special relationship exists between this institution and the executive. Gildenhuys (1997: 45) provides a vivid summary of this relationship by indicating that: Because the legislature is responsible for taxing, collecting, safeguarding and allocating all public monies, and because the individual members of the legislature are accountable to the voters-cum-taxpayers, there must obviously be financial control over the executive [and administrative] authority. Thus, the executive authority must be subjected to the legislature in order to ensure that public accountability is maintained. By ensuring that the executive authority can be called upon to render account, the legislature, in turn, is able to render account in public to the voters-cum-taxpayers. In the South African context, in order to ensure appropriate control over the executive authority, the legislature uses its internal standing committee, called the Standing Committee on Public Accounts (SCOPA); the auditor general’s office; the Public Protector; and mandatory requirements that government departments are expected to produce financial statements that should be audited and tabled in parliament. This is a critical responsibility that is entrusted to the legislature and is carried out through the above-mentioned institutions. These institutions are often referred to as legislative institutions; they are independent of the executive authority and thus report directly to the legislature on the performance of the executive. 4.2.2 The Public Accounts Committee This is a standing committee of parliament, popularly referred to as SCOPA. It is significant to note from the outset that most of the work of parliament is carried out by committees. This means that the legislature reconstitutes itself into smaller groups, called committees. These committees are allocated different tasks, mainly in relation to the oversight of the executive authority, thus through specialisation, the committees enhance parliamentary efficiency and effectiveness. They allow for extensive research on issues, increase member participation in parliamentary issues and provide a forum for public opinion on specific issues.

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Public Finance Fundamentals SCOPA is just one of many such committees, although it stands out prominently as one of the key institutions tasked with ensuring accountability in government performance and ethical conduct. It is a watchdog of parliament (and thus also of taxpayers) on how the executive spends money allocated to it. Once the auditor general has presented his or her report on a specific department, the committee scrutinises this report to check commendations and anomalies noted by the auditor general. The committee has the power to summon heads of departments to account for the manner in which they used public funds. The committee can then recommend appropriate corrective action to parliament. 4.2.3 The auditor general This is an independent office, established to oversee the management of government finances on behalf of the legislature. Section (4)(d) of the Auditor General Act 12 of 1995 indicates that the auditor general shall reasonably satisfy himself or herself that: ■■ reasonable precautions have been taken to safeguard the proper collection of money, … and that the laws and instructions relating to [such collection] have been duly observed ■■ reasonable precautions have been taken in connection with the receipt, custody and issue of, and accounting for, property, money, stamps, securities, equipment, stores, trust money, trust property, and other assets ■■ receipts, payments and other transactions are in accordance with the applicable laws and instructions and are supported by adequate vouchers ■■ satisfactory management measures have been taken to ensure that resources are produced economically and utilised efficiently and effectively. Understandably, audit reports come after the departments have made their expenditures. This situation can be likened to the old expression: ‘shutting the stable door after the horse has bolted.’ This means that the audit cannot prevent an expense, but is there to indicate whether or not the expense was necessary and in line with budgetary expectations. While this tends to be a weakness in auditing, it is important to indicate that the process can actually determine shortcomings in the management of finances. This is particularly so in terms of whether or not the department complied with legislation, rules and regulations, and the inherent responsibility that goes along with each expenditure made. As such, the audit reports are often used as a basis for designing training programmes to enhance financial prudence in the public sector. Once a department’s finances have been audited, the auditor general prepares a report for that particular department. The report is then submitted to parliament 52

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Role players in public financial management for discussion. This enhances both the accountability of the departments and that of the legislature. It is also significant to note that the auditor general has the power to summon officials for cross-examination on any financial matters. This is important in order to enhance the report being prepared for the legislature. Lastly, it is important to note that the auditor general’s authority ends with the report and recommendations made to parliament on each audited department. The auditor general has no legal authority to prosecute or dispense disciplinary action; this is left to other public institutions, such as the Director of Public Prosecutions and the Public Protector. 4.2.4 The public protector The other name for the public protector is ‘ombudsman.’ The public protector is someone who protects citizens from administrative excesses. He or she investigates complaints from the public and may actually initiate an investigation if he or she thinks, on reasonable grounds, that there may be abuse of power in any administrative conduct. The public protector also reports directly to parliament on his or her findings. It is significant that each province has an office of the public protector to deal with provincial administrative excesses at that level. The powers of the provincial public protectors are similar to those of the national public protector. The authority and functions are provided for in Sections 182 and 183 of the Constitution of 1996, as well as in the Public Protector Act 23 of 1994. According to the Constitution, the public protector’s key functions are: ■■ to investigate any conduct in state affairs, or in the public administration in any sphere of government, that is alleged or suspected to be improper or to result in any impropriety or prejudice ■■ to report on that conduct ■■ to take appropriate remedial action. The Public Protector Act further prescribes that the public protector should investigate: ■■ abuse of or unjustifiable exercise of authority, other improper conduct or undue delay by any public official in performing a public function ■■ improper or unlawful enrichment of a person performing a public function ■■ an act or omission resulting in unlawful or improper prejudice to a member of the public.

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Public Finance Fundamentals

4.3 The executive authority and public financial management The executive authority of a state is that institution tasked with implementing the policies and decisions of the legislature as contained in laws, ordinances, by-law proclamations, regulations, white papers and minutes of meetings at all levels of government (Gildenhuys, 1997: 53). The executive authority is made up of what is generally referred to as the cabinet, with the president as its chairperson. 4.3.1 The president Thus, first under the executive authority is the president, whose duty is to assent to all bills before they become acts. This takes place once a bill has been debated and voted on in both houses of parliament, and thereafter is referred to the president for his signature of approval. The president may either sign the bill, refer it back to the legislature for reconsideration, or refer it to the Constitutional Court for a ruling on its constitutionality. This means that once public finances are voted on by the legislature, they have to be subjected to scrutiny by the president. In this regard, one may argue that the president is second only to the legislature as the supreme authority in all financial matters. 4.3.2 The cabinet In addition to the president, the executive authority also includes the cabinet, which is made up of the president, the deputy president and ministers. Cabinet ministers are highly critical role players in public financial matters, as they are members of the legislature and vote with the majority party in the National Assembly; they also have an executive role to fulfil in implementing the policies of government as ratified by the legislature. The cabinet is in charge of making both substantive and procedural decisions as contained in the Constitution and departmentally specific acts of parliament. The executive authority derives its powers and functions from the Constitution. Section 85 of the 1996 Constitution proclaims these powers and functions as: ■■ implementing national legislation, except where the Constitution or an act of parliament provides otherwise ■■ developing and implementing national policy ■■ coordinating the functions of state departments and administrations ■■ preparing and initiating legislation ■■ performing any other executive function provided for in the Constitution or in national legislation.

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Role players in public financial management Within this broad outline of functions, it is clear that the executive has a critical role to play in financial matters. It is also important to note that members of the cabinet are accountable to parliament both as individuals and as a collective. They are expected to exercise their powers and functions, including those of a financial nature, in accordance with legislative provisions and should appropriately account to parliament through regular reports. This enables parliament to know what is going on in each department. Thus, in fulfilling its financial role, the executive is expected to: ■■ provide the legislature with financial proposals in the form of bills and budget proposals as a basis for financial debates in parliament ■■ communicate with the administrative authority to ensure appropriate budget drafting and compliance with budget decisions during service provision ■■ make formal and informal contacts with interest groups and citizens in general to get a feeling of needs and priorities, and to present financial decisions after considering these preferences ■■ control administrative processes to ensure financial prudence. 4.3.3 The minister of finance Other than the president and cabinet, one other important role player within the executive is the minister of finance, who leads the national treasury. According to Gildenhuys (1997: 57), the minister of finance is responsible for functions that can be classified into four broad categories. These are: ■■ regulating the economy through monetary and fiscal policy ■■ preparing and presenting the annual budget to parliament ■■ administering public debt ■■ controlling public finance. In performing these duties, the minister is directly accountable to the president as the head of the executive authority and the one who actually appoints the former, thus the minister of finance, just like all other ministers, serves at the behest of the president. In a like manner, the minister of finance is also accountable to parliament as the institution with original authority and one in which the minister belongs as a member of parliament. The minister is in charge of his or her administrative organisation (the Department of Finance, also known as the national treasury). He or she is responsible for the department’s performance. If the Department of Finance fails to deliver services appropriately, the minister is held responsible and may be dismissed for his or her ineffective efforts. Let us briefly look at the broad category of functions of the minister of finance.

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Public Finance Fundamentals Economic regulation

It is government’s responsibility to regulate the economy and ensure economic growth. This is a fundamental challenge for government, particularly in South Africa, where there are seemingly two parallel economies (the first and the second economy) which should be integrated into one national economy to level the economic playing field, stimulate economic growth, create employment, alleviate poverty and stabilise the economy to make it competitive within the global economic order. Alongside the broad responsibilities of the minister of finance for fiscal and economic policy, the South African Reserve Bank is expected to: ■■ manage monetary policy ■■ control the interest rate and determine the bank rate ■■ exercise exchange control ■■ control the international balance of payments ■■ control credit and determine the liquidity of commercial banks and other financial institutions (Gildenhuys, 1997: 57). Presenting the annual budget

The minister of finance is responsible for tabling the budget in parliament (Budget Speech). This is an august occasion that is given a high profile in South Africa as well as in other countries. On this day the minister of finance is also expected to make a speech on the status of the state’s finances and the economy in general at that moment and what is expected in the future, particularly in terms of the developmental focus of the state, economic policy, managing the assets of the state, medium-term expenditure estimates and issues of revenue collection. Dealing with public debt

The minister of finance has authority to borrow internally and externally on behalf of government. This is necessary to finance budget deficits, obtain foreign currency, and manipulate the domestic monetary situation to create economic stability (Visser & Erasmus, 2002: 38). The minister of finance works in collaboration with the reserve bank, which acts as a major government advisor on monetary issues. Control of public finance

While it is generally accepted that the national treasury is in charge of the general control of public finances, it is important to indicate that the minister of finance has specific public finance control functions. As such, the minister may: ■■ approve the transfer of savings on one budget vote to another budget vote to defray a deficit on the latter 56

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Role players in public financial management approve expenditure of an exceptional nature which has not been provided for in the budget ■■ impose or change the rate of certain taxes, such as value-added tax and excise duties ■■ determine the interest rate and conditions for government loans to individuals and other borrowers (Gildenhuys, 1997: 59). ■■

The many powers of the minister of finance do not suggest, however, that he or she is superior to all in the executive and even the legislature, but underscores the importance of the ministry in dealing with dynamic economic issues that require urgent responses. Remember, if he or she makes wrong decisions in the conduct of his or her duties, these may undermine the success of his or her ministry. If such decisions become prevalent, he or she is increasing his or her chances of being dismissed by the president. Thus, although he or she has diverse powers, accountability still remains key.

4.4 The administrative authority and public financial management Although it is generally acceptable to cluster the administrative authority within the executive authority, in this text the executive and administrative authorities are considered separately11. The administrative authority, known also as the bureaucracy, refers to line function departments that provide services directly to the people. The bureaucracy is made up of appointed administrative officials who are expected to assume their positions due to their competence in government service. The bureaucracy performs an administrative function and makes sure, among other functions, that specific departmental policies are implemented appropriately. The director general (DG) is referred to as the accounting officer of his or her department. He or she is legally recognised as the administrative head of a government department. In the hierarchy of government, the DG reports directly to the minister (executive) in charge of the department. In state-owned enterprises and constitutional institutions, the accounting officer is known as a chief executive officer (CEO) and not as a DG. The DG/CEO is in charge of strategy formulation, managing internal components and, where appropriate, managing the external environment of the department. Thus, to be an accounting officer requires very advanced skills in decision making, communication, managing diversity and change, as well as conflict resolution. The accounting officer has to understand the mission of the department and be able to formulate a vision that would enhance institutional performance and ensure excellence in service provision. 57

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Public Finance Fundamentals Section 38(1) of the Public Finance Management 1 of 1999 (as amended by Act 29 of 1999), states that an accounting officer for a department must ensure that: ■■ the department maintains effective, efficient and transparent systems of financial and risk management and internal control ■■ there is a system of internal audit under the control and direction of an audit committee ■■ an appropriate procurement and provisioning system – which is fair equitable, transparent, competitive and cost effective – is put in place ■■ there is a system for properly evaluating all major capital projects prior to a final decision on each project. Further, the director general/accounting officer (among other responsibilities): ■■ is responsible for the effective, efficient, economical and transparent use of the resources of the department ■■ must take effective and appropriate steps to collect all monies due to the department ■■ must prevent unauthorised, irregular, fruitless and wasteful expenditure and losses resulting from criminal conduct, and manage working capital efficiently and economically ■■ must manage, safeguard and maintain the assets and the liabilities of the department ■■ must comply with any tax, levy, duty, pension and audit commitments as may be required by legislation ■■ must settle all contractual obligations and pay all monies owing, including intergovernmental claims, within the prescribed or agreed period. With respect to matters relating to budgetary control, the accounting officer’s function is to: ■■ ensure that the expenditure of that department is in accordance with the vote of the department and the main divisions within the vote, and that effective and appropriate steps are taken to prevent unauthorised expenditure ■■ take effective and appropriate steps to prevent any overspending of the vote of the department or a main division within the vote; and report to the executive authority and the national treasury any impending (i) under-collection of revenue; (ii) shortfalls in budget revenue; and (iii) overspending of the department’s vote or a main division within the vote.

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Role players in public financial management In addition, the accounting officer has reporting responsibilities to ensure financial accountability and must therefore: ■■ keep full and proper records of the financial affairs of the department, in accordance with any prescribed norms and standards ■■ prepare financial statements for each financial year, in accordance with generally recognised accounting practices ■■ submit those financial statements within two months after the end of the financial year to the auditor general for auditing and to the national treasury to enable that organ to prepare consolidated financial statements ■■ submit to the national treasury, within five months of the end of a financial year, an annual report on the activities of that department after the statements have been audited. The auditor general’s report on this should also be submitted. In his or her conduct of financial duties, the accounting officer is assisted by the financial managers and departmental accountants.

4.5 The reserve bank and public financial management The South African Reserve Bank (SARB) is what is referred to as the ‘central banker’ of the Republic. Worldwide, central banks exist to regulate banking and financial systems (ie commercial banks and stock exchanges) and maintain sound economic conditions in a country. In South Africa’s case however, the stock exchange is not regulated by the reserve bank. The reserve bank oversees the banking sector and the monetary system. The Financial Services Board regulates other financial industries, such as the insurance sector and the stock exchange. Central banks operate mainly through the use of monetary policy in which the supply of money in circulation in the economy is controlled in order to influence inflation and interest rates positively. Although indirectly, the influence of the SARB is experienced by government through the economy, which in turn affects the tax base and availability of financial resources for government. The central bank is constitutionally required to cooperate with and advise the minister of finance on matters of monetary and fiscal policy.

4.6 Reflecting on the mandate, ownership and independence of the SARB At the time of writing this 3rd edition of the book, a heated public debate is gaining traction and placing pressure on Government to re-consider or even amend the functioning of the SARB. These pressures and debates are considered 59

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Public Finance Fundamentals by some commentators and pundits to be driven more by political agendas than by pragmatism and justifiable reforms. Regardless of the views one may hold, it is worthwhile for us to attempt to look as objectively (and factually) as possible into concerns over the mandate, independence and ownership of the reserve bank. 4.6.1 Mandate and independence of the reserve bank With regards to its mandate, the South African Reserve Bank, states on it’s official website and documents: The primary purpose of the Bank is to achieve and maintain price stability in the interest of balanced and sustainable economic growth in South Africa. Together with other institutions, it also plays a pivotal role in ensuring financial stability. (http://www.resbank.co.za viewed on 07/19/2019) (see also section 2.3 in Chapter 2 of this book). This stated objective is derived directly from Section 224 of the 1996 Constitution and Section 3 of the South African Reserve Bank Act 90 of 1989. ‘Price stability’ referred to in the South African Reserve Bank Act 90 of 1989 is synonymous with ‘protecting the value of the currency,’ which is the terminology used in the 1996 Constitution. It is notable, however, that both the Constitution and the act, mention economic growth as the key objective of the Bank, but fall short of mentioning ‘financial stability’. In essence the Bank assigned for itself a second mandate. As Fourie and Burger (2015:373) point out, the SARB had a single mandate up until October 2010, when the then minister of finance announced that the reserve bank ‘now has a revised mandate that includes particular responsibility for financial stability.’ Thus, according to the finance minister’s 2010 pronouncement, the Bank would pursue a dual mandate going forward. This announcement was a response/reaction, by the reserve bank and Finance Ministry, to the global financial crisis of 2007–2008. The global crisis brought with it the realisation of the importance of maintaining stable financial systems (in addition to price stability) for economic growth. The Bank’s mandate is not static. It is not inconceivable that the Bank’s mandate may change, or be amended, from time to time, as was the case in 2010. However, it must also be noted that formal changes to the reserve bank mandate are a constitutional matter. Meaning that the mandate/goal can only be changed by a constitutional amendment approved by a two-thirds majority in Parliament. Neither the Bank, nor the minister of finance, can therefore determine the reserve bank 60

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Role players in public financial management mandate. Alternatively stated, the Bank has operational independence, but not goal independence (http://www.resbank.co.za), (Fourie and Burger 2015:373). A natural question then arises as to whether or not the Bank has a legitimate dual mandate. The answer to this question is that the Financial Sector Regulation Act 9 of 2017 formally brought into effect the dual mandate that the minister of finance had announced seven years previously. A further note on the independence of the Bank can be garnered from the 1996 Constitution and the South African Reserve Bank Act 90 and 1989, both of which state the following: The South African Reserve Bank, in pursuit of its primary objective, must perform its functions independently and without fear, favour or prejudice, but there must be regular consultation between the Bank and the cabinet minister responsible for national financial matters. 4.6.2 Ownership Since its establishment in 1912, the Bank has been privately owned, and at time of writing has more than 600 shareholders. Except for the provision of the Bank that no individual shareholder may hold more than 10 000 shares of the total number of 2 000 000 issued shares, there is no limitation on shareholding. The Bank’s shares are traded on an over-the-counter (as opposed to a stock exchange) share trading facility managed by the Bank (http://www.resbank.co.za viewed on 19/07/2019). After allowing for certain provisions, payment of company tax on profits, transfers to reserves and dividend payments of not more than 10 cents per share per annum to shareholders, the surplus of the Bank’s earnings is paid to the government. The Bank’s operations are therefore not driven by a profit motive on the part of the Bank or it’s shareholders. Instead bank operations raise funds that are largely paid into public coffers in the public interest and for public benefit (http://www.resbank.co.za viewed on 19/07/2019).

Summary and conclusion The provision of services in any country depends very much on the manner in which the state manages its financial resources. Apart from being able to collect these resources from a diversity of sources, there is thus a need for the state to determine its expenditure patterns in a rational manner and to put in place systems for monitoring and controlling the utilisation of funds. As indicated in the chapter, a 61

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Public Finance Fundamentals plethora of role players exists for this purpose. However, it is important to note that these systems can work appropriately for community benefit only if there is political commitment from the legislature and the executive authority to see to it that all role players act in accordance with legislative stipulations and with a community focus.

Self-examination questions 1. Discuss the role of the minister of finance as a key role player in public financial management in South Africa. 2. Briefly discuss the role of the South African Reserve Bank (SARB) in the country’s economy. 3. Compare and contrast the responsibilities of the auditor general and public protector in South Africa.

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Accounting and finance

SECTION 2

The relationship between accounting and finance Introduction to the section Finance and accounting are integrally related. Managing the finances of an organisation can only take place if the finances in question are properly recorded, organised and categorised for easy referencing, control and reporting. Record keeping, control and reporting are all facilitated by the art and practice of accounting. Conversely, accounting as a profession and academic discipline exists to provide managers with the best possible advice on running their organisations. As such, accounting information is put to its best possible use when combined with financial management tools as discussed in this section of the book. Note that there is only one chapter in this section of the book, as the authors do not wish to belabour the topic under study, but instead choose to introduce and highlight the fundamentals of both accounting and finance, and emphasise their interrelatedness. Also, the importance of both disciplines (accounting and finance) for the subject matter of the text dictates separate treatment from all of the other topical issues covered in the various sections of the book. It is also of critical importance to note that the Constitution of the Republic of South Africa, 1996, section, 216 (1) states that national legislation must establish a national treasury and prescribe measures to ensure both transparency and expenditure control in each sphere of government, by introducing: (a) generally recognised accounting practice (b) uniform expenditure classifications (c) uniform treasury norms and standards. To give effect to section 216 (1) of the constitution of the Republic of South Africa, The Public Finance Management Act, section 6(2), mandates that the national treasury: (a) must prescribe uniform treasury norms and standards (b) must enforce this Act and any prescribed norms and standards, including any prescribed standards of generally recognised accounting practice and uniform classification systems, in national departments. This section of the book also aligns with this constitutional and legislative imperative as prescribed for public sector financial management.

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R E T P A H C

5

Accounting and finance K Moeti

LEARNING OBJECTIVES By the end of this chapter, you should be able to: ■ define and understand the preparation and use of balance sheets ■ define and understand the preparation and use of income statements ■ define and understand the preparation and use of cash flow budgets ■ define and understand the preparation and use of statements of sources and uses of funds ■ define and understand the preparation and use of financial ratios.

Introduction Although most public sector managers are experienced in a specific area of accounting, referred to as fund accounting, as well as being involved in public budgeting, it is not possible to do much of the analytical work of financial management with these limited skills and competencies. What is needed for effective public financial management to take place is a basic understanding of some of the analytical tools of finance, which can only be used in conjunction with the two most fundamental documents used in the field of accounting: the balance sheet and the income statement. As a foundation for the discussion of financial management tools, a brief introduction to the balance sheet and income statement follows. This discussion takes place within the broader context of what is known as generally accepted accounting principles (GAAP), which is also examined in the chapter.

5.1

The balance sheet The balance sheet shows the financial standing of an organisation at a particular point in time, specified by the date on that balance sheet. The balance sheet date

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Public Finance Fundamentals is normally the end of the accounting period (which can be monthly, quarterly or yearly). (Refer to Figure 5.1 for an example of a more comprehensive balance sheet.) In written notation, the balance sheet appears as follows: assets = liabilities + equity BALANCE SHEET Fiscal year 20XX (R millions) Assets Current assets: Cash and securities 66 Accounts receivable 115 Inventories 163 Prepaid expenses 13 Total current assets 357 Long-term assets: Plant and equipment 198 Accumulated depreciation 85 Net plant and equipment 113 Land 7 Other long-term assets 14 Total long-term assets 134 Total assets 491 Liabilities and equity Current liabilities: Short-term debt 11 Accounts payable 33 Income taxes due 18 Incentives and retirement 23 Payroll due 23 Total current liabilities 108 Long-term liabilities: Long-term debts 37 Deferred tax liability 16 Other long-term liabilities 4 Total long-term liabilities 57 Total liabilities 165 Fund equity 326 Total liabilities and equity 491

Figure 5.1 Example of a balance sheet

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Accounting and finance Assets represent what the organisation owns. Cash is a defining asset, as all other assets are categorised according to how quickly they can be converted into cash. The asset side of the balance sheet is thus normally divided into current assets and long-term assets. Current assets are relatively easily transferable into cash and include, first, the cash account, marketable securities, accounts receivables and inventories. Long-term assets include land, buildings and machinery. Long-term assets are not intended to be converted into cash, but instead are used in the process of generating cash. They are long term, as they are normally possessed by organisations for a year or longer. As can be ascertained from the list of items in the long-term category, these items are also quite expensive and are therefore also referred to as capital assets. Liabilities and owner’s equity (called ‘fund equity’ in the case of public institutions) represent the sources of income used to support the asset side of the balance sheet. It is therefore necessary that both sides of the assets must equal the liabilities and owner’s or fund equity. Similar to assets, liabilities are also divided into current and long-term categories. Included among current liabilities are accounts payable and current loans outstanding. Long-term liabilities include long-term loans and other financial obligations that will come due in a period of a year or longer. Owner’s equity refers to the money invested to start the business and also represents the current ownership of the organisation. In the public sector, where there are no specifically identifiable individuals who are owners of a public institution, the term ‘owner’s equity’ is not used – instead, the term ‘fund equity’ is used as a convention that recognises that most public organisations are organisationally set up as a series of funds (or budget votes and budget items, programmes and activities).

5.2 The income statement Whereas the balance statement shows the financial standing of the organisation at a specific point in time, the income statement depicts the income earned by the organisation over a period of time. The balance sheet and income statement are related, as the balance sheet shows how much income-generating potential the organisation has, while the income statement shows what income was generated, with the assets and debts shown on the books of the organisation.

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Public Finance Fundamentals In short, the income statement shows revenues less expenses and the net result (or net income) of that calculation. Most public organisations will use one of the budgeting approaches in lieu of an income statement. Figure 5.2 shows a highly summarised income statement for a private company. INCOME STATEMENT Fiscal Year



20XX

(R millions) Income: Net sales 599 Cost of goods sold −266 Gross profit 333 Operating expenses: Engineering expense 50 Selling expenses 87 Administrative expense 53 Earnings 143

Figure 5.2 Income statement

5.3 Generally accepted accounting principles (GAAP) In many countries, the public sector prepares accounting statements as prescribed by International Public Sector Accounting Standards (IPSAS). In the South African context, public sector accountants follow the prescripts of generally recognised accounting practice (GRAP), whilst their private sector counterparts observe generally accepted accounting principles (GAAP) (Scott 2008). GAAP is internationally prescribed, and although initially intended for use in the private sector, formed the basis of much of accounting practice in the public sector. The discussion that follows begins by exploring GAAP, and then briefly discussing public sector and local government accounting conventions that closely mirror GAAP. GAAP is a set of standardised conventions, developed by professionals in the accounting field, that specify how financial information and financial transactions are to be captured for internal data collection and external reporting purposes. GAAP developed out of a need to ensure meaningful comparisons between accounting information collected from two different periods for the same organisation, as well as between accounting information from two or more organisations.

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Accounting and finance In South Africa, GAAP is used to refer to generally accepted accounting practice, as opposed to generally accepted accounting principles. The slight variation in wording used by South African and international accountants may be attributable to legislation in the form of the 1973 Companies Act, which states in Section 286(3): annual financial statements of a company shall, in conformity with generally accepted accounting practice, fairly present the state of affairs of the company and its business as at the end of the financial year concerned and the profit or loss of that company for that financial year … 5.3.1 GAAP’s disclosure criteria GAAP provides guidelines on the types of information to be reflected in accounting statements in order for them to be considered comprehensive. In this regard an organisation’s full set of accounting statements must incorporate the following: ■■ the financial position at the end of the period ■■ earnings for the period ■■ comprehensive income for the period ■■ cash flows during the period ■■ investments by and distributions to owners during the period. Inclusion of all (ie not just some) of the above information in the accounting statements should provide the manager/decision maker with a fairly holistic picture of the organisation’s financial standing during an accounting period. It would be most misleading to rely solely on, for example, earnings or cash balances at the end of a period to assess how the organisation is performing. 5.3.2 GAAP’s qualitative criteria In order to give further relevance to accounting information, GAAP recommends that the accountant attempts to ensure that the accounting data contain the following qualitative characteristics: ■■ understandability ■■ relevance ■■ timeliness ■■ representational faithfulness ■■ predictive value ■■ comparability (including consistency) ■■ benefits exceeding costs ■■ decision usefulness ■■ reliability 69

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Public Finance Fundamentals verifiability ■■ neutrality ■■ feedback value ■■ materiality. ■■

These qualitative criteria may be somewhat subjective, but are nonetheless important guidelines for financial statement preparation. 5.3.3 GAAP’s recommended methodology for accounting The conventional methodology (endorsed and prescribed by GAAP) for recording financial transactions takes account of all the following fundamental concepts: the going concern; the matching concept; the consistency concept; and the prudence concept. Let us briefly examine each of these in turn. The going concern concept

The term ‘going concern’ refers to the expectation, on the part of the accountant, of the organisation’s fitness to continue its operations into the foreseeable future. If the accountant has information to the contrary, assets of the organisation may not be recorded at book value or market value; instead, these asset values must be adjusted to reflect liquidation prices. The going concern concept promotes the ideal of accurate disclosure to management, as well as to the organisation’s stakeholders (creditors and bondholders). The matching concept

The matching concept is based on the accrual basis of accounting. Accrual accounting is in direct contrast to cash-basis accounting. Under cash-basis accounting, revenues are recorded only when they are received, and expenditures are recorded when payments are made. With accrual accounting, revenues are recorded when earned rather than when cash is received, and expenses are recorded when incurred rather than when paid. Accrual accounting provides a more accurate picture of the productivity of an organisation within a specified accounting period than does cashbasis accounting. This is because cash amounts paid out or received during a certain period are often incurred or earned in previous periods, and these in no way reflect the activities of the organisation in the current period.

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Accounting and finance The matching concept seeks to match revenues that were earned with the expenses that were incurred in producing that revenue, to the extent that a relationship between the two can be established. The matching concept also aims to record, within the same accounting period, revenues and expenses that were incurred during that period. The consistency concept

The consistency concept requires that within any given accounting period there must be consistency in the way in which financial transactions are recorded. The accountant may change to a different method of accounting at the start of a new accounting period, but these changes and the anticipated effects of them must be disclosed. The prudence concept

The prudence concept is based on the doctrine of conservatism, thus especially with accrued revenues and expenses, some degree of estimation has to take place with regard to the actual amounts to be received or paid out. When uncertainty exists, the accountant is encouraged to err on the side of underestimation of expected revenue receipts; and, conversely, it is better for the accountant to overestimate rather than underestimate expenses to be paid. 5.3.4 GAMAP for local government in South Africa It can be argued that different and greater challenges exist in the local/municipal sphere of government than in national and subnational/provincial spheres. In South Africa, these challenges are usually quite evident and include, inter alia, lack of effective governance and poor financial management. The accounting convention for local government thus differs to take account of the unique nature and character of this sphere of government. Local governments in South Africa are expected to make use of the convention referred to as Generally Accepted Municipal Accounting Practice or GAMAP (Pauw et al, 2002: 183; see also Scott, 2008).

5.4 Standard chart of accounts Standard Chart of Accounts (SCOA) comprises of coding of items used for classification, budgeting, recording and reporting of receipts and payments within financial systems. (National Treasury, 2009:3). On 1 April 2004, SCOA replaced the old standard item, which is outdated. The following were the reasons for changing from the old standard item classification to SCOA (National Treasury and IPFA (2004:8): 71

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Public Finance Fundamentals ■■ ■■ ■■ ■■ ■■

The old standard item structure of classification was characterised by outdated accounts for examples, Stores and Livestock. As result, government reports were not reliable source of accurate and timely information needed for decision making. In the old system a vast number of line items existed including several which were no longer in use. The old system allows for duplication of items. The old system was fragmented.

The Standard Chart of Accounts came into effect on 1 of April 2004 with five segment types (see Figure 5.3) (National Treasury & IPFA (2004:12). The segment types introduced include: fund, objective, responsibility, project and item as part of budget reform. The SCOA is to be implemented in the national and provincial departments. STANDARD CHART OF ACCOUNTS Fund Segment

Objective Segment

Responsibility Segment

Project Segment

Item Segment

The purpose of this segment: What was the source of money? The purpose of this segment: What was the purpose of the expenditure?

The purpose of this segment: Who spent the money?

The purpose of this segment: On what project was the money spent

The purpose of this segment: On what items was money spent?

Figure 5.3: The standard chart of accounts segment types and description for each segment type Source: National Treasury and IPFA (2004:4-6)

According to National Treasury (2009:135-136), the SCOA was revised on 1 April 2008. This revision is known as SCOA toning. The two additional segments were introduced to improve quality of information and data. The segment types were increased from five to seven. The following additional segment types were introduced on 1 April 2008: 72

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Accounting and finance Asset segment: the purpose of asset segment relates to transaction of an asset or the use of an asset and, if so, which asset class. ■■ Regional segment: the purpose of this segment is to identify which region benefits from the government spending. The expenditure is posted to individual municipalities, for example, to public hospitals located in different municipalities. The segment type applies to the beneficiary of amount spent. ■■

According to National Treasury (2013:11), the SCOA (standard chart of accounts V4 re-implementation was introduced on 1 April 2013. The segment types were increased from seven to eight. The following is the additional segment type: ■■ Infrastructure segment: the purpose of this segment is to identity whether or not the spending item relates to infrastructure and to show the type of infrastructure. The aim is to improve infrastructure reporting on the chart of accounts. SCOA makes it easier for budget analysis, reporting, and monitoring & evaluation on financial management and programmes. All institutions to which the PFMA applies are mandated to implement SCOA.

5.5 Cash flow management Most organisations need to keep a minimum amount of cash available for operating purposes. This cash amount is normally referred to as working capital. It is not a straightforward matter to determine the amount of cash (working capital) an organisation ought to maintain to meet all of its current financial obligations. If the organisation does not have enough cash on hand, it will fail to meet all of its current obligations, some of which may prove costly to the organisation. Examples of this type of loss include loss of discounts for early payments to creditors and failure to meet client demand. If, on the other hand, the organisation holds far more cash than is needed, this is also a financial loss to the organisation, since this idle cash could have been put to use to generate additional funds. The latter type of working capital inefficiency is referred to as the opportunity cost of capital. The process of working capital management is facilitated by the use of a number of financial management instruments, such as the cash flow budget, the statement of sources and uses of funds, and financial ratios. A brief description of these three capital instruments follows.

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Public Finance Fundamentals 5.5.1 The cash flow budget The cash flow budget is a forecast of current and future inflows and outflows of cash set up within a calendar framework (or schedule). The schedule breakdown for the cash flow budget is normally monthly and covers a 12-month time span. With the cash flow budget, monthly subtotals and yearly totals are given for the following categories of cash flows (see Table 5.1): ■■ cash receipts ■■ cash payments ■■ net cash receipts (the difference between cash receipts and cash disbursements) for each month ■■ net cash receipts for the year. Table 5.1 Cash flow budget (in 1 000s)

January February March xxxx December Cash receipts

500

700

Cash payments

300

400

Net cash receipts

200

300 Net cash receipts for the year

The cash flow budget, then, gives an indication of the anticipated amount of cash that will be available at the beginning and end of each month, and at the end of the year. 5.5.2 Statement of sources and uses of funds The statement of sources and uses of funds, in contrast, is much broader in scope than the cash flow budget, as it does not focus exclusively on the cash account for evidence of cash flows, but seeks instead to examine all the balance sheet accounts to determine when, where and/or on what the organisation’s resources have been spent. The starting point for preparing a statement of sources and uses of funds begins by listing, side by side, two balance sheets of the organisation. The change in each balance sheet item is either a source or a use of funds, therefore the second step in preparing the statement of sources and uses of funds is to indicate, in a separate column, the direction of change of the balance sheet accounts (see figures 5.3 and 5.4). Aside from intergovernmental grants and other income sources of public sector organisations, income is generated in one of two ways: 1. by reducing an asset (for example sale of assets for cash or by making payment on accounts receivable)

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Accounting and finance 2. by increasing a liability (for example increases in bank loans or by issuing of municipal bonds). Conversely, aside from payments to the public or to other public sector organisations, cash is used in two standard ways: 1. to increase an asset account (for example purchasing inventories or building a new plant on account) 2. to reduce a liability account (for example repayment of loans and accounts payable). This information is summarised in Figure 5.4. Sources of funds

Uses of funds

Any decrease (–) in an asset item

Any increase (+) in an asset item

Any increase (+) in a claim item

Any decrease (–) in a claim item

(that is, a liability or shareholders’ equity item) (that is, a liability or shareholders’ equity item)

Figure 5.4 Sources and uses of funds (increasing or decreasing asset or liability accounts) Source: Adapted from Van Horne & Wachowicz, 1995: 166

Lastly, the statement of sources and uses of funds can be constructed with the information as compiled and arranged in the first two stages, as shown in Figure 5.4. As an important check for efficient working capital management, total uses of cash over an accounting period must equal total sources of cash. If this equality does not occur between sources and uses, then the organisation is either at risk of cash flow shortfalls as a result of overspending, or at risk of experiencing opportunity losses as a result of idle cash balances. Assets Cash and cash equivalents Accounts receivable

20X2

20X1

247

175

Direction of change sources

Changes Uses

+

72

678

740

-

62

1,329

1,235

+

94

21

17

+

4

Bank loans

448

356

+

92

Accounts payable

148

136

+

12

Long term debt

631

627

+

4

Inventories Prepaid expenditures Liabilities and owners equity

Figure 5.5 Statement of sources and uses of funds Source: Adapted from Van Horne & Wachowicz, 1995: 166

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Public Finance Fundamentals 5.5.3 Financial ratios Of the many analytical applications of financial ratios, one is that they can also be used to assist with cash flow management. At least two categories of financial ratios, referred to as liquidity ratios and coverage ratios, are highly relevant for this purpose. Liquidity ratios

The importance of liquidity ratios lies in their ability to inform management of the organisation’s prospects for remaining solvent in the face of adversity. The term ‘liquidity’ refers to the degree of availability of cash, or the ease with which other assets can be turned into cash to meet immediate financial needs. Therefore, it can be correctly concluded that from the asset side of the balance sheet, current assets are considered to be more liquid than long-term (or fixed) assets. Liquidity ratios are subdivided into current ratios and acid-test ratios. Current ratios

The current ratio aims to determine the extent to which cash and other current assets are available to cover short-term obligations (current liabilities). Alternatively stated, the current ratio is calculated as follows: Current assets Current ratio = Current liabilities As with all other financial ratios, the organisation’s current ratio becomes much more meaningful when compared to the current ratios for other organisations in the same industry or providing a similar service. These types of comparison are not always possible for government departments and parastatals. Generally, however, a current ratio of 1 would mean that the organisation’s liquidity and level of solvency are dangerously low. On the other hand, it is also advisable for the organisation to not be too liquid (ie have too high a current ratio), as this would be an indication of opportunity losses associated with having too much idle cash and too many inactive current assets on the books. Acid-test ratio

To all intents and purposes, the acid-test ratio is the same as the current ratio, the distinction being that the acid-test ratio takes account of the liquidity of the individual components of the current assets that appear in the numerator of the current ratio. In contrast to the current ratio, the acid-test ratio considers the organisation’s ability to cover its short-term obligations without first having to sell its inventories, thus the acid-test ratio appears as follows: Acid-test ratio =

Current assets − inventories Current liabilities

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Accounting and finance The acid-test ratio is considered a far better test of liquidity and solvency than the current ratio. This is because the current ratio may rate as equally liquid the organisation whose current assets consist mostly of cash and accounts receivables and the organisation whose current assets consist mostly of inventories. Inventory liquidation is in many cases a lengthy process that also often requires fire-sale or bargain basement prices, as well as conversion of inventories to accounts receivables and then to cash. The approach recommended is to use the acid-test ratio as a supplement to the current ratio in order to get both a holistic view and a more detailed breakdown of the current asset composition of the organisation being analysed. Coverage ratios

A second group of ratios known as ‘coverage ratios’ (or alternatively ‘leverage ratios’) can also be used in cash flow management. Whereas liquidity ratios assess the organisation’s solvency prospects by examining balance sheet information, coverage ratios seek to do the same, but from the vantage point of information from the income statement. Whereas the balance sheet focuses on short-term assets (such as cash and inventories) and short-term liabilities (such as accounts payable and outstanding loans payable), the income statement is concerned with revenue generation and the difference between total revenues and total expenses. Ratios based on the balance sheet are concerned with the total amounts of borrowing (capital amounts, as opposed to interest and principal) that are classified as current (one year or less), while, alternatively, ratios based on the income statement deal with the fixed charges (interest and principal) associated with that same amount of borrowing. One of the most commonly used coverage ratios is referred to as the debt service coverage ratio, which is defined by the following relationship: Earnings before interest and taxes (EBIT) Debt service coverage = Interest expense + Principle payments 1 – tax rate Earnings before interest and taxes is an income statement account that is usually used in coverage ratios as a rough measure of the cash flow available to cover fixed financial charges. Interest expenses, principal payments and the tax rate all also appear on the income statement. For the debt service coverage ratio, principal payments are adjusted to take account of the fact that principal payments are not deductible for tax purposes, as in the case of interest expense. As can be expected, this ratio is used with great frequency in private sector organisations that pay business taxes. However, public organisations also have debt in the form of loans that require principal and interest payments, for which 77

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Public Finance Fundamentals the organisation must be financially able and ready to pay. However, most, if not all, public sector organisations are classified as tax exempt, as they do not operate on a for-profit basis. This tax-exempt status is not a deterrent to public sector organisations using the debt service coverage ratio, as using a tax rate of 0% in the equation does not affect the usefulness of the information communicated in the ratio.

Summary and conclusion In this chapter it was argued that the work of the financial manager begins where the work of the accountant ends. In turn, the foundation of accounting consists of two key instruments/documents, ie the balance sheet and the income statement. The balance sheet indicates the financial standing (or health) of the organisation at a given point in time, and the income statement shows profitability (or income flows) over a specified period of time. The tools of financial management (cash flow budget, statement of sources and uses of funds, financial ratios and the like) subject the information found on the balance sheet and income statement to further analysis, with the expectation of assisting managers to make all the right decisions, and especially those with financial implications.

Self-examination questions 1. Compare and contrast the balance sheet and income statement. 2. Briefly summarise the key aspects of GAAP, GRAP and GAMAP as accounting standards.

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Organisation and functioning of government in terms of IGFR

SECTION 3

Intergovernmental fiscal relations (IGFR)

Introduction to the section Intergovernmental relations (IGR) has gained prominence in recent years as government has come to realise that it cannot operate in isolation from other government institutions, either in the same sphere of government (horizontal IGR) or from institutions at different spheres of government (vertical IGR). Such cooperation is important as it reduces the chances of wasteful government where duplication of functions or services may take place, or where synergies can easily be created and exploited but are not even acknowledged. The importance of IGR for the performance of government is also evidenced by the fact that an entire chapter (and several sections of other chapters) of the South African Constitution Act 108 of 1996 is dedicated to spelling out government’s expectations in respect of IGR. In this regard, the Constitution specifies the functional areas in which national, provincial and local government have exclusive legislative competences, and those in which they have concurrent powers. It provides for cooperative governance in areas of joint responsibility and defines the circumstances in which national or provincial government should intervene and supervise a non-performing institution in a province or municipality, respectively. Last, but by no means least, the Constitution dictates that institutions at all spheres of government must exhaust all avenues of dispute resolution before turning to the courts for assistance and a ruling. If we focus just on the financial implications of IGR, we are by default speaking the language of intergovernmental fiscal relations (IGFR). As this textbook deals with public finance and its fundamentals, the importance of IGR is recognised, but the locus of the section is on IGFR. More specifically, and similarly to the previous section, this section contains only one chapter in which types of government are first discussed. Thereafter, the South African government is considered in its elemental parts (national, provincial and local spheres; and judicial, legislative, executive and administrative branches). The Constitution speaks most directly to IGR and IGFR with respect to cooperation amongst spheres of government as opposed to cooperation amongst branches. Branches of government are also important, but are considered to balance out each other’s powers (vis-à-vis the concept of separation of powers) in order to prevent any one branch of government from being so powerful as to suppress the democracy that we enjoy. 79

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R E T P A H C

6

Organisation and functioning of government in terms of intergovernmental fiscal relations (IGFR) T Khalo

LEARNING OBJECTIVES By the end of this chapter, you should be able to: ■ describe the legislative framework governing revenue generation and allocation ■ explain the factors necessitating allocation of revenue sources ■ describe revenue sharing in government and intergovernmental fiscal relations.

Introduction In order to reflect its distinctive character, and to replace the term ‘levels of government’ (with its implication of hierarchy), the South African government adopted the terminology ‘spheres of government.’ The distinction is important, because each sphere of government can be thought of as being relatively autonomous from any other sphere, yet at the same time having a cooperative and interdependent relationship with the other spheres. The three spheres of government in South Africa are municipal, provincial and national. Consistent with the concept of distinctiveness or interdependent autonomy, each sphere of government should be equally capable of carrying out its own affairs and raising its own revenues within the boundaries set by the Constitution. This chapter explains the reason for existence (raison d’être) of each of the spheres of government and how the spheres cooperate to meet the shared goal of promoting the public interest. The three spheres work within parameters that recognise their

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Public Finance Fundamentals interdependence, especially with respect to revenue sharing and financial control – that is, intergovernmental fiscal relations (IGFR). The chapter discusses the various forms of government and the types of services delivered by each of the governments. Thereafter, legislative framework governing revenue collection and revenue allocation is examined, with attention being given to the vertical and horizontal financial relations between the spheres of government. Finally, the chapter explores particular recommendations regarding balanced financial relations between the different spheres of government.

6.1 Forms of government A form of government, or form of state governance, refers to the set of political institutions by which a government of a state is organised in order to exert its powers over a house in the congress body politic. The most common forms of government or systems of governance within the state include the following: ■■ Presidential/separated republics: These are systems in which a president is the active head of the executive branch of government and is elected and remains in office independently of the legislature. These include democratic and nondemocratic states. ■■ Full presidential: In full presidential systems, the president is both head of state and head of government. There is generally no prime minister, although if one exists he or she serves purely at the pleasure of the president. ■■ Monarchy: An undivided rule or absolute sovereignty by a single person. A state can have a monarchical government if the absolute power vested in one person is passed on from generation to generation. Monarchies are divided into ‘constitutional’ and ‘absolute’. Constitutional monarchies are systems in which the head of state is a constitutional monarch; the existence of their office and their ability to exercise their authority is established and constrained by constitutional law. On the other hand, absolute monarchies are monarchies in which the monarch’s exercise of power is unconstrained by any substantive constitutional law. ■■ Aristocracy and oligarchy: Aristocracy refers to the ideology of government by what are considered to be the ‘best possible persons.’ It is a government of individuals with high morals, ethics and intellectual capacity, which make them the ‘best’ in the society. Similarly, oligarchy is government or rule by a few, such as (but not limited to) in the case of aristocracy. ■■ Democracy: Democracy as a form of government entails the rule of the state by the majority of the population. ■■ Dictatorship: Dictatorship as a form of government entails a rule by one person with dictatorial powers. Dictatorships may evolve from democracies where 82

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Organisation and functioning of government in terms of IGFR dictatorial powers are vested in a military commander in an emergency in the hope that such power would be surrendered after the state of emergency has ended. It is useful to distinguish also between federal and unitary states in contemporary times: ■■ Federal state: According to Van Niekerk (in Venter, 2001: 53), a federal state is one in which a number of provinces (also called ‘states’ in the USA and ‘cantons’ in Switzerland) unite for certain common purposes. They are states in which the federal government shares power with semi-independent regional governments. In many cases, the central government is (in theory) a creation of the regional governments. ■■ Unitary state: A political system in which all the powers of government are vested in the central or national government (as is the case with the Republic of South Africa) and the central or national government may delegate some powers to the sub-units (the provinces and municipalities) and may revoke such delegation through due process. Many states in the world have a unitary system of government. ■■ Confederation: An association of states or regional governments under an encapsulating body, which makes decisions on behalf of the member states. Irrespective of the form of government a particular state may take, such governments must provide the citizens with goods and services that will satisfy their material wellbeing. In order to do so, such governments must have adequate funds, and these are obtained from different sources in society. In the case of the Government of the Republic of South Africa, a unitary state with some federal aspirations, there are three spheres of government that must provide these goods and services to society at large. These are national/central, provincial and local/municipal. Each of these is discussed briefly in the sections that follow. 6.1.1 National government The national government consists of: ■■ A legislature at central/national government level, normally referred to as parliament. By definition, a legislature (and thus parliament) has the power to make laws for the country in terms of that country’s constitution. In South Africa, there are two houses of parliament, namely the National Assembly and the National Council of Provinces. The National Assembly has no fewer than 350 and no more than 400 members, elected for a term of five years; the National Council of Provinces consists of 54 permanent members and 36 special delegates who aim to represent provincial interests in the national sphere of government. ■■ The president, who is the head of state and the leader of the executive branch of government. The powers of the president are great, but are also limited by 83

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Public Finance Fundamentals

■■ ■■ ■■ ■■

the notion of separation of powers, where no branch of government (executive, legislature or judiciary) has more powers than any other branch. As head of the executive, the president is also the leader of the cabinet and its ministers. The deputy president, who is appointed by the president from among the members of the National Assembly in parliament. The cabinet, which consists of the president, deputy president and ministers in charge of portfolios/national government departments. Deputy ministers, whom the president may appoint from among the members of the National Assembly. Traditional leaders, who play an important role in the governance process. The institution, status and the role of traditional leaders are recognised according to customary law and subject to the Constitution.

According to South Africa’s Constitution, in Schedule 4 (Parts A and B), the national government (in cooperation with provincial and local government) has legislative and executive powers over, among other areas: ■■ agriculture ■■ cultural affairs communication ■■ economics and finance ■■ education ■■ environment ■■ health services ■■ housing ■■ language policy ■■ nature conservation ■■ police services ■■ public transport ■■ planning and development ■■ tourism ■■ trade and industrial development ■■ urban and rural development ■■ welfare services. 6.1.2 Provincial government In terms of the Constitution, each of the nine provinces has its own legislature, consisting of between 30 and 80 members. A provincial government consists of the executive council, made up of a premier and a number of members. The premier is elected by the provincial legislature.

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Organisation and functioning of government in terms of IGFR Schedule 4 (dealing with functional responsibilities that are concurrently provided for by both national and provincial government) and Schedule 5 (dealing with functional responsibilities that are exclusive to provinces) of the Constitution require provincial governments to cooperate with the national government (Part A of Schedule 4) and also to cooperate with local government (Part B of both Schedule 4 and Schedule 5) to provide and regulate, among other areas: ■■ agriculture ■■ casinos, racing, gambling and wagering ■■ cultural affairs ■■ education at primary and secondary levels ■■ environment ■■ health services ■■ housing ■■ language policy ■■ nature conservation ■■ police services ■■ provincial public media ■■ public transport ■■ regional planning and development ■■ road traffic regulation ■■ tourism ■■ trade and industrial promotion ■■ traditional authorities ■■ urban and rural development ■■ vehicle licensing ■■ welfare services. 6.1.3 Local government Local government is an important sphere of government in that it delivers, according to the Constitution, basic goods and services to members of society on behalf of the two other spheres of government. Local government responsibilities, with regard to service provision, are specified in Part B of Schedule 4, and Part B of Schedule 5 of the Constitution (see also Section 156 of the Constitution). These goods and services are to be provided in cooperation with the national government (according to Part B of Schedule 4) and also in cooperation with provincial government (as per Part B of Schedule 5), and include: ■■ the provision of clean water ■■ the provision of electricity ■■ refuse and garbage removals 85

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Public Finance Fundamentals the provision of land for housing purposes ■■ local economic development ■■ road infrastructure. ■■

It is a fact that the government of the Republic of South Africa requires substantial amounts of money in order to sustain the myriad services that must be delivered to society. In the next section, the legislative dynamics of revenue collection and allocation are explored.

6.2 Legislative framework for revenue collection and allocation The legislative framework for revenue collection and allocation includes a vast amount of legislation and public policies that have a direct bearing on who may collect revenue, and how, where and when it may be collected and allocated/ distributed to the different spheres and structures of government in order to deliver efficient and effective services. Some of the more prominent pieces of legislation and policy in this regard in South Africa are the Constitution; the Public Finance Management Act (PFMA); the Financial and Fiscal Commission Act; the Division of Revenue Act (DORA); the Medium Term Budget Policy Statement (MTBPS); the Intergovernmental Fiscal Relations Act; the Borrowing Powers of Provincial Governments Act; and the South African Revenue Service Act. Each of these is briefly discussed in the sections that follow. 6.2.1 Constitution of the Republic of South Africa Act 108 of 1996 The Constitution makes provision for the collection and allocation of revenue in the following sections: ■■ Principles of public financial management and administration – Section 195(1) ■■ National Revenue Fund – Section 213 ■■ Equitable shares and allocation of revenue – Section 214 ■■ National, provincial and municipal budgets – Section 215 ■■ Treasury control – Section 216 ■■ Government guarantees – Section 218 ■■ Provincial Revenue Fund – Section 226 ■■ National sources of provincial and local government funding – Section 227 ■■ Provincial taxes – Section 228 ■■ Municipal fiscal powers and functions – Section 229 ■■ Provincial and municipal loans – Section 230.

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Organisation and functioning of government in terms of IGFR Key features of the Constitution include the following: ■■ There is one National Revenue Fund into which all monies received by government must be paid, except if excluded by an act of parliament. ■■ Money may be withdrawn from the fund only in terms of an appropriation act or as a direct charge if provided for in the Constitution. ■■ Provincial equitable shares are direct charges against the National Revenue Fund. ■■ National legislation must establish a national treasury to ensure uniform accounting and financial practices, standards and norms. ■■ National treasury may stop the transfer of funds to any organ of the state. ■■ National legislation must set conditions for the guarantee of loans. ■■ The Financial and Fiscal Commission (FFC) must make recommendations to parliament on the equitable shares of the three spheres of government. ■■ There are provincial revenue funds, equivalent to the National Revenue Fund and managed on the same principles. ■■ Provincial and local governments are entitled to an equitable share of revenue from the National Revenue Fund. ■■ Provincial and local governments may receive other allocations from national government, either conditionally or unconditionally. ■■ Additional revenue may be raised by provinces and municipalities, but the national government has no obligation to compensate for such revenue if it is not collected as envisaged. ■■ Provincial and local taxes may be enacted only after recommendation by the FFC and must be regulated in terms of an act of parliament. 6.2.2 Public Finance Management Act 1 of 1999 (as amended by Act 29 of 1999) and the Treasury Regulations The Public Finance Management (PFMA) Act 1 of 1999 (as amended by Act 29 of 1999) focuses mainly on the national and provincial spheres of government. According to Visser (2002: 4–5), the act replaces and supersedes the various national and provincial exchequer acts and the Reporting by Public Entities Act 93 of 1992. The purpose of the act is: ■■ to regulate financial management in the national and provincial governments ■■ to ensure that all revenue, expenditure, assets and liabilities of government are managed efficiently and effectively ■■ to provide for the responsibilities of persons entrusted with financial management in government.

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Public Finance Fundamentals Based on the purpose of the act, the aim of the act is to secure transparency and accountability and sound management of the revenue, expenditure, assets and liabilities of the institutions of government to which the act applies. 6.2.3 Financial and Fiscal Commission Act 99 of 1997 The Financial and Fiscal Commission Act 99 of 1997 was promulgated to give effect to constitutional requirements with regard to the establishment of the FFC and related matters. In terms of the act, the Fiscal and Financial Commission (FFC) acts as a consultative body on financial and fiscal matters for organs of the state in national, provincial and local spheres of government. The FFC must also make recommendations and give advice on financial and fiscal matters to organs of state in all three spheres of government. With regard to provincial taxes, for example, Section 228(2) of the Constitution determines that the power of the provincial legislature to impose taxes must be regulated in terms of an act of parliament, which may be enacted only after recommendations by the FFC have been considered. Similarly, a province may raise loans for capital or current expenditure in accordance with reasonable conditions determined by national legislation after any recommendations by the FFC have been considered. 6.2.4 Division of Revenue Act (DORA) In terms of Section 10 of the Intergovernmental Fiscal Relations Act 97 of 1997, the minister of finance must introduce a division of revenue bill each year, for the next financial year, in the National Assembly when the annual main budget is introduced and is to be voted upon. Such division of revenue bill must specify the following: ■■ the share of revenue raised nationally that each sphere of government will receive ■■ each province’s equitable share of the provincial share of that revenue ■■ any other allocations to provinces or local government from the national government’s share of that revenue, as well as any conditions on which those allocations are or must be made. After the recommendations of the FFC are received and before the Division of Revenue Bill is introduced in the National Assembly, the minister must first consult with the provincial governments, through the Budget Council or in another way, as well as with the FFC. 88

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Organisation and functioning of government in terms of IGFR 6.2.5 (Annual) Medium term budget policy statement The medium term budget policy statement (MTBPS) is issued by the national treasury in October of each year. It outlines the government’s fiscal framework, as well as expenditure plans and policies, by including the proposed division of revenue between the national, provincial and local governments over a three-year period. All three spheres of government benefit greatly from this statement of the proposed division of revenue in advance of the new financial year and estimated for a period of two years thereafter. The result of this is increased certainty with regard to medium- to long-term planning. Further, the MTBPS not only sets out the equitable division of nationally raised revenue between the three spheres of government, but also explains the rationale behind it. 6.2.6 Intergovernmental Fiscal Relations Act 97 of 1997 The Intergovernmental Fiscal Relations Act 97 of 1997 was promulgated: ■■ to promote cooperation between the national, provincial and local spheres of government on fiscal, budgetary and financial matters ■■ to prescribe a process for determining the equitable sharing and allocation of revenue raised nationally. This act strengthens the provisions of the Financial and Fiscal Relations Act. 6.2.7 South African Revenue Service Act 34 of 1997 The purpose of the Revenue Service Act 34 of 1997 is to provide for the efficient and effective administration of the revenue-collecting system of the Republic of South Africa and, for this purpose, to reorganise the South African Revenue Service and to establish an advisory board. 6.2.8 Organised Local Government Act 52 of 1997 The purpose of the act in financial matters is to determine procedures by which local government may nominate persons to the FFC.

6.3 Factors necessitating allocation of revenue sources In South Africa, substantial power to collect revenue from society rests with the national government. National government collects the bulk of the revenue from society mainly in the form of income and sales taxes, the provincial government collects revenue in the form of licence fees and other charges, while the municipalities collect revenue in the form of property taxes, municipal levies and service charges. Although the South African Constitution does allow the provinces to collect revenue through provincial taxation, this has not happened. 89

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Public Finance Fundamentals What are the factors that determine how each of the three spheres of government will be allocated revenue raised nationally? According to Gildenhuys (1993: 189–194), the following two factors necessitate allocation of revenue sources to the different spheres of government: the determination of financial needs and financial capacity. 6.3.1 Determining financial needs The three spheres of government have different types of financial needs as a result of the functions performed or services delivered by each sphere. The difference in the unit cost of services is in turn the result of factors such as geography, demography, prices of input resources and the extent of urbanisation. The division of revenue between provinces and municipalities in South Africa takes into account demographic factors, such as the number of children of school-going age, and socioeconomic considerations, such as the proportion of people with access to private medical insurance, the number of people with incomes below the poverty line and the backlog in housing provision. Relative financial needs can be determined by these indicators of demand for public services, taking into account also the costs and affordability of progressive improvements in service delivery. 6.3.2 Determining financial capacity The other factor, besides financial need, which necessitates the allocation of revenue sources to the different spheres of government is financial capacity. Before sources of revenue can be allocated to the different spheres of government, the financial capacity of such governments must be determined. This means that the capacity of a specific government to generate income, relative to other governments subjected to the same tax effort and tax base, must be determined. Gildenhuys (1993: 193) put forward three criteria for determining the financial capacity of government. These are: 1. per capita income of a community 2. revenue potential of an ideal tax system 3. representative revenue system, in which the financial capacity of a government may be regarded as the potential revenue which may be collected within a demarcated area, as compared to the national average per capita rate for each of various revenue sources applied to similar areas. In simple terms, this means that the economic prosperity of a community determines the tax-paying ability of such a community and therefore its financial capacity. In summary, Visser and Erasmus (2002: 194) argue for the allocation of sources of revenue to a government or government institution in line with the specific public 90

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Organisation and functioning of government in terms of IGFR service or function provided, therefore the rational allocation of functions must go hand in hand with the rational allocation of revenue sources. The status quo in South Africa is that the national government collects revenue from society and equitably shares it with the other two spheres of government. Monies collected from society by the national government are paid into the National Revenue Fund. The Government of the Republic of South Africa depends on these monies to pay for goods and services so that the collective needs of society may be satisfied. Sources of revenue for the different spheres are dealt with below.

6.4 Sources of revenue for spheres of government 6.4.1 Sources of revenue for the national government The national government collects revenue from society, mainly in the following forms: ■■ Income tax on natural persons/individuals: All income that accrues to persons, or to trusts on behalf of individuals, is subject to income tax. Personal income tax is paid by employees through the pay as you earn (PAYE) system, which includes a standard income tax on employees (SITE) for earnings up to a prescribed threshold. (Note that SITE is no longer used. It was repealed by Government proclamation with effect from 1st March 2011,and thereafter systematically phased out and eventually abolished from 1st of March 2013 (SARB 2015:3)). Self-employed people, directors of companies or those in receipt of irregular income from investments are required to pay provisional tax during the course of the year, with the final amount determined by assessment once all information has been submitted to the South African Revenue Service. Personal income tax is payable according to prescribed tax rates and thresholds, which are announced by the minister of finance at the beginning of each tax year as part of the budget speech. Those who earn low incomes pay no tax, and the rate of tax payable increases up to a maximum rate of 40% (in 2006). ■■ Tax on corporate income: Business enterprises are required to pay company tax, which is levied on their profits made each year – that is, revenue minus the costs of production, including depreciation of capital assets. The standard rate of tax on companies was 28% in 2019-2020, with lower rates applicable to qualifying small enterprises. A secondary tax on companies (STC) is also payable by companies, levied on the amount of profits distributed to shareholders as dividends during the tax year. The minister of finance announced in 2007 that STC would be replaced with a tax on dividends in the future, and also announced that the tax on retirement funds would be abolished. 91

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Public Finance Fundamentals ■■

Interest and penalties: The South African Revenue Service charges interest and penalties on overdue tax or when individuals or companies fail to declare all income received.

National government also generates revenue through the levy of taxes on goods bought and sold, as well as services rendered domestically. These include, among others: ■■ value-added tax: levied at the rate of 15% on goods sold ■■ specific excise duties: including, for example, duty levied on: ❏❏ beer, sorghum beer and sorghum flour ❏❏ wine and other fermented beverages, mineral water, spirits ❏❏ cigarettes and cigarette tobacco, pipe tobacco and cigars ❏❏ petroleum products ■■ ad valorem excise duties: motorcars and some luxury goods are subject to excise duties as a percentage of their production or input value ■■ levies on fuel. 6.4.2 Sources of revenue for provincial government Provincial government has two main sources of revenue: 1. National-source revenue: These are monies received from the national government as the province’s equitable share of revenue raised nationally, and grants (conditional and unconditional). 2. Own-source revenue: These are provincial taxes and fees, licences and fines. A provincial government may impose taxes, levies and duties other than income tax, value-added tax, general sales tax, rates on property or customs duties. It may also impose flat-rate surcharges on any tax, levy or duty that is imposed by national legislation, other than corporate income tax, value-added tax, rates on property or customs duties. 6.4.3 Sources of revenue for local government The local sphere of government has three main sources of revenue, other than equitable share, as follows: ■■ municipal rates ■■ fees and service charges ■■ grants and subsidies. Municipal rates levied on property values are the main source of tax revenue for municipalities, and depend in part on local residential development for expansion of the tax base. Charges for municipal services, such as electricity, water and refuse 92

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Organisation and functioning of government in terms of IGFR removal, are intended to recover the costs of these services, but also yield an important secondary source of income for municipalities. Grants and subsidies from the other spheres of government are the third source of revenue for local government, especially for the rural and remote municipalities where own-source revenue-raising capacity is limited. Other sources of revenue for local government include the following: ■■ interest on income ■■ dividends ■■ interest on grants and subsidies ■■ fines.

6.5 Intergovernmental fiscal relations According to Section 40 of the Constitution, government in South Africa is divided into three spheres, namely national, provincial and local. These spheres of government are distinctive, interdependent and interrelated with respect to administration and legislation. With regard to fiscal administration, however, the system of government may seem very unitary, as revenue collection offices are centralised in the national sphere of government. Simultaneously, the system also has federal characteristics – for example, the local sphere of government is autonomous and has the right to selfgovernment, subject to corrective intervention and supervision by the provincial sphere. The national government may raise the bulk of tax revenue from society, whilst provinces may raise only an insignificant portion of their required revenue from society. Remember that Section 228 of the Constitution permits provinces to impose taxes, levies and duties other than income tax, value-added tax, general sales tax, rates on property or custom duties. Provinces also generate revenue from sources such as motor vehicle licences, gambling proceeds and hospital fees. This means that productive taxes are left to the national sphere of government, and the provincial government must necessarily rely heavily on intergovernmental transfers. The situation is not much better for municipalities, especially those located in impoverished areas, where there is little scope for generating income from local businesses or households. Such municipalities rely largely on transfers from national government.

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Public Finance Fundamentals The above situation creates fiscal imbalance – that is, there is a mismatch in terms of revenue generation and service provision in the three spheres of government. Fiscal imbalance, in turn, is evidenced by serious revenue shortfalls for the provincial and municipal spheres of government, and this situation can be rectified only by an effective fiscal system that makes adequate provision for intergovernmental financial transfers and an equitable, transparent division of revenue raised nationally between the three spheres of government. The legislative measures mentioned earlier in this chapter are key in this regard. This legislation essentially attempts to bring about fiscal equalisation, as discussed below. 6.5.1 Fiscal equalisation To address fiscal imbalance, the Constitution, the Intergovernmental Fiscal Relations Act 97 of 1997, the Financial and Fiscal Commission Act 99 of 1997, and the relevant Division of Revenue Act have collectively created a mechanism of revenue sharing, so that taxes collected nationally can be distributed across all spheres of government in an equitable manner. Revenue sharing

Revenue raised nationally must be shared by the three spheres of government in an equitable manner, both vertically and horizontally. In terms of Section 214(1) of the Constitution Act 108 of 1996, an act of parliament must provide for equitable division of revenue, raised nationally, among all three spheres of government, as well as for the determination of each province’s equitable share of the total provincial allocation. ■■ Vertical revenue sharing: The Constitution makes provision for revenue collected nationally to be shared equitably among the three spheres of government in the form of revenue less debt service costs, contingency reserves and standing appropriations. The aim of vertical revenue sharing is to address the vertical imbalance that exists in terms of revenue capacity between the three spheres of government. The vertical division of revenue allocates funds to the national, provincial and local spheres of government in line with their responsibilities. Further aspects taken into account are the financial efficiency of provinces and local governments, the developmental needs of provinces, obligations of provinces and local governments, and the need for stable allocations of money and for flexibility to tend to emergencies. ■■ Horizontal revenue sharing: According to Levy and Tapscott (2001: 132), the horizontal division of revenue entails the distribution of the total provincial pool of revenue across the provinces. Each year, the Budget Council, the FFC and the 94

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Organisation and functioning of government in terms of IGFR national treasury draw up the formula for revenue sharing by the nine provinces. The formula used is explicitly known as the ‘provincial grants formula’ as it divides nationally raised revenue equitably between the nine provinces. The provincial grants formula does not allocate funds to provinces equally, but rather on an equitable basis that takes into account demographics, infrastructural backlogs and economic profiles of provinces, as these indicate the demand for education, health, welfare and other services in a province. It should be noted, however, that these distributions are made in the context of the three-year rolling medium term expenditure framework (MTEF) and that additional revenue raised by provinces may not be deducted from their share of the allocation, in order to encourage provinces to raise their tax effort. Intergovernmental transfers

Intergovernmental transfers mark the second step of fiscal equalisation. They exist as grants (conditional and unconditional) to cover special needs or purposes, as follows: ■■ transfers to equalise the average revenue of provinces and municipalities (with a horizontal effect) ■■ transfers for special programmes, such as for housing development, environmental purposes and infrastructure ■■ transfers from the contingency fund. Unconditional grants to provinces

According to Gildenhuys (1993: 198), ‘… unconditional grants are made without any conditions being imposed by the donor government on how they should be spent. The fiscal autonomy of the receiving government is not affected in any way.’ Gildenhuys (1993: 198–199) sees the purpose of these grants as creating horizontal equality between governments at the same level, meaning to benefit those governments with extensive financial needs and relatively low financial capacity. Conditional grants (see Annexure E of Annual Budget Review)

Conditional grants have specific conditions imposed by the donor government and are in addition to the provinces’ equitable share (unconditional grants). These grants are used for the specific purpose they are appropriated for and are also aimed at compensating for cross-border services (spillover grants), or meeting the costs of national functions administered by provinces or municipalities. Conditional grants in the South African fiscal system contribute to meeting the costs of tertiary health services, professional health training, rehabilitation of 95

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Public Finance Fundamentals hospitals, provision of low-income housing, municipal and provincial infrastructure investment, recapitalisation of higher education and further education institutions, implementation of HIV and AIDS programmes and development of local community library services, amongst other functions. Gildenhuys (1997: 199) lists the following types of conditional grants: ■■ Variable conditional grants: The purpose of these grants is to reduce the costs of service subjected to externalities in order to increase the scope and quality of service. The amount to be allocated will vary from year to year in terms of benefits and costs. ■■ Fixed or limited conditional grants: Limits are placed on the amounts of grants in the case of limited conditional grants, which are used in circumstances where the objective is to supply collective services countrywide on a uniform basis.

Summary and conclusion Intergovernmental relations (IGR) simply refers to the way in which different government institutions cooperate with each other in order to deliver on their individual as well as their collective mandate. Intergovernmental fiscal relations (IGFR), on the other hand, deals with the financial aspects and implications inherent in IGR. The importance of both IGR and IGFR were demonstrated in this chapter. Throughout the Constitution, and especially so in Chapter 3, IGR is stressed as an important requisite for effective governance to take place. This chapter introduced several aspects of the form and structure of government, and highlighted the main intergovernmental features of the South African financial system, as these are significant determinants of how this income is shared in order to achieve a balanced allocation of resources between government’s social, economic and developmental policy priorities. Thereafter, the legislative framework that supports the Constitution on the issue of IGR was discussed. The sources of income available for each sphere of government were also described, and this was followed up with a discussion on how this income is shared (ie IGFR).

Self-examination questions 1. Briefly discuss any two legislative acts governing the collection and allocation of revenue. 2. Compare and contrast conditional and unconditional grants.

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Organisation and functioning of government in terms of IGFR 3. Discuss the sources of revenue for national government. 4. Give a brief exposition of factors necessitating allocation of revenue sources. 5. Briefly explain any five forms of government.

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Budget reform and management of public money through budgeting

SECTION 4

Contemporary reforms to South African public financial management

Introduction to the section Public finance is a subject that, by its very nature, must be sensitive to environmental changes and international trends geared towards best practices. Thus, for example, where there was room for improvement in the way budgeting was done, innovation was welcomed in the United States, France and thereafter in various other parts of the world. In some cases the new approaches/innovation in budgeting did not work, whereas in others there was considerable improvement. What needs to be stressed for budgeting and all other public finance reform efforts is that reforms can never be a panacea, but rather ought to be considered, and then modified and adapted to specific circumstances. The chapters grouped into Section 4 of the text deal with those aspects of public finance that have experienced the greatest degree of change and innovation. The section includes, amongst other things, discussions of budgeting and budget reform (Chapter 7); ethics and accountability (Chapter 8); privatisation and restructuring of public enterprises (Chapter 9); procurement and supply chain management (Chapter 10); and local government financial management in South Africa (Chapter 11). The section deals not only with the timeless, fundamental principles connected to each of these subjects, but also strives to underscore development as an ongoing process, and new knowledge generated as a direct result of wide-ranging reforms.

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R E T P A H C

7

Budget reform and management of public money through budgeting K Moeti

LEARNING OBJECTIVES By the end of this chapter, you should be able to: ■ define budgeting ■ explain annuality, annuality, unity, unity,appropriation appropriationand andauditing auditingininpublic publicbudgeting budgeting ■ describe the historical perspectives of budgeting and budget reform ■ explain traditional line-item budgeting ■ explain the the processes processes ofofperformance performance budgeting, budgeting, programme programme budgeting budgeting and zero-based budgeting. zero-based budgeting.

Introduction The format for budgeting is inflexible. This inflexibility seemingly arises from the fact that all budgets must have certain basic components, such as cells formed by the intersection of rows and columns, subtotals, and grand total figures. To the extent that budgets can be flexible, however, their flexibility lies not in the format, but rather in the philosophical approach to the placement of information into budgets. This chapter is more concerned with innovations and reforms in the art and science of budgeting than in the standard format requirements of formal budgets. Line-item incremental budgeting has been the norm for budgeting since time immemorial. Recent reforms sought to improve decision-making capabilities in line-item budgeting. A word of caution, however: line-item budgeting has not been dispensed with in favour of more ‘sophisticated’ budgeting approaches. Modern budgetary reforms simply contribute to the ongoing improvement of the historically tried-and-tested principles of line-item budgeting. For each of the reforms covered

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Public Finance Fundamentals in this chapter, it will be clear that line-item budgeting remains an important core component. It is still a basic part of any expenditure item and therefore its associated cost must still be clearly communicated. This chapter begins at the beginning, so to speak, by defining the term ‘budgeting.’ Discussions of historical approaches to budgeting and budget reform follow. The traditional line-item method of budgeting is contrasted with more contemporary budgeting methods, ie performance budgeting, programme budgeting and zerobased budgeting, alongside discussions of reforms that have led to these new or improved methods.

7.1 Budgets: Definition and basic types A budget, properly considered, comprises two parts – a revenue budget and an expenditure budget. Revenue budgets indicate the source of funds for planned activities, whereas expenditure budgets convey information about carefully considered estimated costs of future activities. Although revenues and expenditure have to be prepared and considered jointly in order to ensure that spending plans can be afforded, the main national and provincial budgets are typically presented as separate and distinct revenue proposals and spending estimates. 7.1.1 Defining the term ‘budget’ First and foremost: A budget is a plan expressed in monetary terms. A budget can be called a plan because, in effect, it is designed to communicate ‘what it is we plan to do in the future.’ However, although budgets are plans, not all plans are budgets. A plan is a budget only if quantitative and/or monetary information is provided about the planned activities. Furthermore: A budget is a documented source of information on anticipated income and expenditure over a specified period.

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Budget reform and management of public money through budgeting And, viewed over time or on an ongoing basis: A budget is also a report to interested parties, such as the public, which makes it possible to check that expenditures have been made and revenues collected as planned or mandated. By comparing the information a budget contained at the start (ie the plan) of a particular process with what has really taken place (ie the actual outcome), a budget also becomes a management instrument to monitor an individual’s or department’s activities (ie performance, including time and cost) and to determine whether these are in line with the objectives to be reached.

7.2 Historical perspective of reforms in public budgeting According to Caiden (in Savoie, 1996: 51), the historical chronology of public budgeting can be divided into three relatively distinct phases. These phases, to be discussed in turn below, are the pre-budgetary period, the budgetary era and, finally, the post-budgetary era in which we currently find ourselves, also called the ‘modern budgeting period’. Although distinct, the phases are connected in the sense that each phase evolved naturally from the previous phase. In fact, incongruity experienced in any phase was the key basis of reforms during, or leading ever closer to, the next phase. 7.2.1 The pre-budgetary period Rabin (1992: 3–4) argues that systems of governance to a great extent determine how public budgeting will be conducted. Thus: … It matters whether the public budgeting is being carried out in a capitalist, democratic, federal society, or in a socialist, authoritarian, nation state. It matters whether the form of government is parliamentary or presidential … In essence, then, changes in governance systems and political ideology led to – and continue to lead to – changes in approaches to budgeting. It can be noted that formal governmental budgeting has been traced back, in the academic literature, to the period spanning from the feudal system to the early 19th century. The pre-budgetary period is that period in history that is characterised by monarchical rule and, as such, public budgeting of this particular era was designed to satisfy the needs of kings, queens and aristocrats.

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Public Finance Fundamentals Public financial management of the pre-budgetary period embodied the following general features: continuousness, decentralisation, privatisation, expediency and corruption. These are explained below. Continuousness

In the pre-budgetary period, budgeting was considered a continuous process, with no scheduled starting and ending dates to define the budgeting period, and with no deadlines for submission and consideration of budgets. Essentially, there were no annual budgets, and finance ministers budgeted on the basis of available cash flows. Budgeting was extremely simplistic, mainly because the demands/expenditures that needed to be met were dictated by the wishes and whims of the ruler, and the resources acquired for this purpose depended upon the creativity of the rulers’ tax collectors. Decentralisation

The second key feature of public financial management in the pre-budgeting period, decentralisation, refers to the fact that there were no central treasuries to regulate and control public expenditure. Instead, treasury functions were devolved to various sub-national (provincial, local and district) authorities. Communications and transportation systems of the time necessitated this type of decentralised control, as it was an arduous task, and extremely dangerous, to transfer large holdings of currency in the form of gold and silver. Privatisation

Since there was no centralised treasury in existence, European governments in the pre-budgetary era relied on private businesses for assistance with a number of financial and fiscal matters. These included, among other things, the collection and transfer of tax payments. Expediency

Pre-budgetary financial management was expedient and flexible, since governments were free to devise whatever means necessary to extract additional funding from their already heavily taxed citizens. Corruption

Not surprisingly, public corruption was widespread, the natural outcome of a system nurturing each of the features above, ie continuousness, decentralisation, privatisation and expediency. 104

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Budget reform and management of public money through budgeting Although fraught with problems, the pre-budgetary era was not a complete failure. The system’s effectiveness in mobilising resources was quite remarkable, as evidenced by the fact that the Napoleonic Wars were financed by it. 7.2.2 The budgetary era The flaws and challenges of the pre-budgetary era ushered in the first wave of budget reforms associated with the budgetary era. France is known to be the first European country to have instituted a national centralised budget. The French national budget came about with the restoration of the monarchy in the aftermath of the French Revolution and the Napoleonic Wars. Around this time, reforms in the form of fund accounting were observed in parts of Europe, and the British treasury was formed and given the responsibility of presenting draft budgets to parliament. In France, Louis XVIII’s finance minister, Baron Louis, proclaimed the end of continuous budgeting, making France one of the first countries to introduce annuality (annual budgets). With annuality came increased control over and accountability for public funds. The four main characteristics of public finance management in the budgetary era were: annuality, unity, appropriation and auditing, as discussed below. Annuality

This refers to budgeting on an annual basis such that budget preparation, submission of draft budgets to the legislature, legislative votes on draft budgets and the spending cycles of government agencies would revolve around a government’s fiscal year. Budgeting decisions would be routinely revisited on an annual basis. Unity

The concept of unity in public budgeting interprets a public budget as a single pool of financial resources, such that all claims upon the budget are considered in relation to all other claims on that same budget. In other words, with limited public money, all proposed expenditures must compete with one another for funding. Appropriation

The concept of appropriation specifically calls accountability into play. ‘Appropriation’ is the term used to describe the legislature’s approval of government’s spending proposals. As the legislature exists to discharge the wishes of citizens and voters, the legislature can move to approve spending only where such proposed spending is in 105

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Public Finance Fundamentals the public interest and occurs in such a way that the public can demand and receive account of how their money will be (or was) spent. Auditing

Auditing (or alternatively control) was the final link in the continuous and repeating chain of public budgeting in the budgetary era. Auditing was done to ensure that funds were spent as appropriated, both in terms of the approved amount and for the good or service specified. Each of the key features of the pre-budgetary phase was challenged by prescriptions of the budgetary phase, thus annuality in budgeting opposed continuity; unity went against decentralisation and privatisation; appropriation (approved spending) contrasted with expediency; and auditing mitigated corruption. 7.2.3 Modern budget reforms/the post-budgetary era Budgetary era reforms (annuality, unity, appropriation and auditing) remained as principles of public budgeting and, over time, were buttressed by further reforms, so that elements of the system were able to survive right up to the present. Budgetary reforms of the 20th century coincided with a new thinking on management issues and the general acceptance of management as an academic discipline. In this modern era of reform, scientific management and line-item budgeting evolved to the point where relatively less consideration was given to control and more to lower-level managerial autonomy and decision making. Line-item budgeting (as discussed below) was thus infused with performance budgeting, with programme budgeting and zero-based budgeting subsequently coming into the mix as well.

7.3 Line-item budgeting The simplest and perhaps oldest way to budget is on the basis of line-item budgeting, in which every good or service produced, purchased or sold is specifically accounted for as a single entry in the budget. The only information of significance in line-item budgeting is the good or service itself and its related amount (vis-à-vis quantity and cost/price). As the information provided in line-item budgets is scant, this type of budget is often presented alongside other more detailed budgets (for example capital budgets, operating budgets, performance budgets, programme budgets).

7.3.1 Advantages of line-item budgeting The main advantage of line-item budgeting is the fact that the key management processes of tracking and controlling costs are simplified. If every item of revenue 106

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Budget reform and management of public money through budgeting and every item of expense were to be put on a line-item budget, a manager would be able to account for all monies received, as well as all monies spent. In fact, the simplicity of line-item budgets makes them quite amenable to incremental analysis and incremental decision making. That is, if line items on the budget are unchanged from year to year, the only consideration needed is in relation to the amount spent on each item. Incremental budgeting assumes increasing costs due to inflation, and thus the coming year’s budget is normally equal to the current budget adjusted for inflation.



7.3.2 Disadvantages of line-item budgeting The main disadvantages of line-item budgeting relate directly to its incrementalism. First, line-item budgeting (as applied incrementally) raises no questions about the relevance of the items on the budget, as presented year after year. The reality may be that expenditure items on the budget need to be reviewed on an ongoing basis to determine whether they are still needed. Incremental line-item budgeting does not allow for such considerations. Secondly, line-item budgeting is input oriented. Successful line-item budgeting is considered to have occurred where expenditure/line-item amounts are acquired and spent as budgeted. Regrettably little, if any, consideration is given to the outcome of that spending, thus, it is often unimportant in line-item budgeting whether or not objectives were met. Instead, the emphasis is on overspending, underspending and spending in line with budgetary appropriations.

7.4 Performance budgeting Performance budgeting, a conceptualisation from the early 1900s, was the first real attempt at addressing key shortcomings of traditional line-item budgeting. Whereas line-item budgeting operated on the basis of classifying expenditure by type, performance budgeting sought instead to classify expenditure by the activities for which it was needed. By classifying expenditures according to activities, performance budgeting provided a means with which to measure efficiency. Efficiency: The maximum output attained from a given amount of input (or unit cost). Whilst line-item budgets focus on the things to be acquired (inputs), performance budgets emphasise the work to be done (activities). Performance budgeting is thus supported by the concept of management by objectives (MBO), of which the main premise is that organisational objectives can be met only by breaking these 107

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Public Finance Fundamentals objectives down into departmental objectives (actually sub-objectives), which in turn can be met only when the work-related objectives (ie sub-sub-objectives) of all individuals in the organisation are met. The work of individuals in the organisation thus represents the activities that must be carried out in order to meet organisational objectives. In this regard, performance budgets specify what the organisation’s activities are (for example water meters to be read, or kilometres of road to be paved), and they also prescribe standards for how much work must be done in the allotted time (ie the number of water meters to be read per day/week/month; kilometres of road to be paved per month). Performance budgeting therefore entails clarifying and quantifying different levels of activities that must be completed in order to meet objectives for which the institution exists. The amount of money needed to carry out these activities then provides the basis for budgeting. Using one of the examples cited above, an activity can be the number of water meters to be read per month by a municipal service department (which is based, of course, on the number of houses that receive municipal water). From this we can predict the amount of money needed to fund this monthly activity, for instance by multiplying the number of meter readers in the department by the number of hours they must work to complete the activity each month. As a second example of activity budgeting, a drivers’ licensing department has a key objective of administering a specified (standard) number of driving examinations per month. The number of driving exams is the activity that defines how the budget will be drawn up and how much will be spent. As a process, performance budgeting has three distinct steps, namely: ■■ activity classification ■■ the establishment of a performance indicator/measurement ■■ feedback. So, for example, each activity or function that contributes to the attainment of organisational objectives is assigned its own ‘mini-budget’. Secondly, performance measures that indicate a benchmark or standard in terms of time and cost per unit are articulated. And, lastly, there must be a mechanism that provides a useful comparison between planned and actual performance so that deviations can be identified and corrected. Continuing with our last example, meter readers can be prescribed a certain number of meters to read per month as a performance standard. The actual number of meters read by a given meter reader can be compared to the standard to find out whether it was met and, if not, why not. 108

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Budget reform and management of public money through budgeting



7.4.1 Advantages of performance budgeting The main advantage of performance budgeting is the fact that activities of the organisation are judged on the basis of their efficiency and effectiveness, as activities can be measured and compared to planned results.



7.4.2 Disadvantages of performance budgeting There are several disadvantages to using performance budgeting. The main disadvantage is that objectives, which are the precipitating factors of organisational activities, are taken for granted. That is, performance budgeting assesses how well we are achieving our objectives through our activities, but never questions whether those objectives are still worth pursuing. A second disadvantage of performance budgeting is the fact that activities differ and thus some are easier to measure/evaluate than others. It therefore becomes impossible to compare one organisation’s performance to another’s or, for that matter, to compare the performance of different sections/departments within the same institution. Thirdly, performance standards set for performance budgeting are normally based on quantity only and do not consider quality. Fourthly, it is possible for performance standards to hold managers responsible for outcomes that are beyond their control. Performance can be affected by external events or circumstances, but these are not normally taken into consideration in the standards set for performance budgeting. For example, a fire department’s performance in a certain fiscal year may look dismal if during that year arsonist activity was higher than normal, or if electrical inspectors allowed many unsafe dwellings to be built, or if citizens were non-responsive to calling in fires, etc. In truth, perhaps, these fire fighters heroically and very efficiently saved many buildings and lives over the year, and without the sporadic incidents of arson (over which they had no control) their performance would have been rated as very good indeed. However, in performance budgeting no provision is made for the influence of external factors, and the manager/fire chief will be called to book, since his or her department’s fire-fighting activities would be rated ‘inefficient’ and/or ‘ineffective’ and therefore not contributing to meeting the organisation’s objectives.

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Public Finance Fundamentals

7.5 Programme budgeting and multi-year programme budgeting By the 1960s, budgeting reforms had moved the discipline away from performance budgeting’s somewhat short-sighted focus on activities, and turned towards programme budgeting, which in essence focused on entire programmes and their objectives. As with performance budgeting, programme budgeting is also consistent with the concept of management by objectives (MBO). In fact, in the language of public sector budgeting, an organisation’s mission is synonymous with its goals, goals are broken down into specific objectives, and each of these objectives has a budget of its own. Objectives are synonymous with programmes, and the budgets set up to accomplish objectives are referred to as ‘programme budgets.’ 7.5.1 Aims, objectives, programmes and directorates For public institutions in South Africa, the first piece of information communicated in a budget is the aim of the organisation. The aim of the National Department of Agriculture, for example, is stated in the budget as follows: The Department of Agriculture strives to lead agricultural development for economic growth and social development in South Africa and play a constructive role in agricultural development in Africa, providing national-level leadership, national regulatory and coordination services, agricultural risk management, and support to targeted services. This aim is to be accomplished through the specification and attainment of the following strategic objective: The strategic role of the Department of Agriculture is to facilitate the transformation objectives for agricultural development, food security, the growth of the sector and the sustainable use of natural resources. This objective is aligned with, and to be achieved through, the following eight programmes of the Department of Agriculture: ■■ Administration ■■ Farmer Support and Development ■■ Agricultural Trade and Business Development ■■ Agricultural Research and Economic Analysis ■■ Agricultural Production ■■ Sustainable Resources Management and Use ■■ National Agricultural Regulatory Services ■■ Agricultural Communication, Planning and Evaluation. 110

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Budget reform and management of public money through budgeting For the Department of Agriculture, the key strategic objective is translated into programmes, and each programme has its own budget, which is consolidated from the sub-programmes that make up the programme. The sub-programmes are referred to as directorates, each of which also has a budget of its own. To illustrate: The Department of Agriculture has a programme called ‘Agricultural Research’, which has a sub-programme/directorate for statistics as well as one for economic analysis. Each of these sub-programmes in turn has a budget of its own (refer to tables 7.1 and 7.2). The concept of programme budgeting can be clarified by comparing it to the other types of budget discussed above, thus contrasted with one another, one can correctly say that: ■■ line-item budgeting is focused on inputs and their costs ■■ performance budgeting is focused on activities and their costs ■■ programme budgeting is focused on outputs (ie objectives). As can be deduced, therefore, programme budgeting is aimed at effectiveness. Effectiveness: The extent to which objectives are met. Advantages of programme budgeting

The main advantage of programme budgeting relates to its association with management by objectives (MBO). Attainment of objectives is more likely to take place under programme budgeting than under line-item or performance budgeting. A second advantage of programme budgeting relates to the fact that it can be relatively effective when money is in short supply. Given that the financial resources at the disposal of the state are limited, government departments must inevitably compete with one another for funds. Likewise, programmes within each government department must compete for funding with other programmes in the same department. With programme budgeting, those programmes that best contribute to the objectives of the organisation will garner financial support away from less-effective programmes. As Gildenhuys (1993) states: ‘In a programme budget, similar approaches for handling a public problem will compete with each other, not with dissimilar programmes housed in the same department’.

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Public Finance Fundamentals Table 7.1 Expenditure estimates Programme

R thousand

Medium-term expenditure estimate

Expenditure outcome Prelimi- Adjusted Revised appro- estimate nary outcome priation

Audited

Audited

1998/99

1999/00

2000/01

2001/02

2002/03

2003/04 2004/05

1. Administration

91 313

99 374

91 282

121 439

115 237

126 815

132 413 142 000

2. F armer Support and Development

10 717

10 803

12 473

116 680

110 394

126 850

135 337

43 283

 gricultural Trade and 3. A Business Development

11 011

10 827

11 858

18 165

18 165

24 750

34 378

36 373

 gricultural Research and 4. A Economic Analysis

5 950

9 526

11 483

16 013

20 586

19 571

30 310

33 362

5. Agricultural Production

8 593

6 480

–

–

–

1 669

1 728

1 816

6. S ustainable Resources Management and Use

455 243

395 778

399 875

394 920

388 925

394 966

424 168 410 078

 ational Agricultural 7. N Regulatory Services

106 255

100 629

134 857

158 249

146 061

140 023

161 806 171 917

47 930

42 280

61 500

73 896

69 764

82 075

8. A  gricultural Communication, Planning and Evaluation Total

737 012

675 697 723 328

Change to 2001 Budget Estimate

90 655

97 301

899 362 869 152 916 719 1 010 795 936 132 124 185

93 975

98 026

92 845

Economic classification Current Personnel

677 051

623 892

672 186

734 000

706 271

741 508

860 854 866 697

167 937

184 587

202 413

239 260

219 160

252 785

286 605 304 136

Transfer payments

372 596

319 105

294 066

316 507

316 507

289 764

314 754 294 119

Other current

136 518

120 200

175 707

178 233

170 604

198 959

259 495 268 442

59 961

51 805

51 142

165 362

162 661

175 211

149 941

Capital

69 435

Transfer payments

14 150

14 500

14 500

102 000

102 000

102 000

102 000

18 020

Acquisition of capital assets

45 811

37 305

36 642

63 362

60 881

73 211

47 941

51 415

Total

737 012

675 697 723 328

899 362 869 152 916 719 1 010 795 936 132

167 937

184 587

202 413

248 775

228 675

263 009

286 605 304 136

39 969

44 778

60 600

69 460

52 618

93 291

101 535 109 357

Standard items of expenditure Personnel Administrative Inventories

22 787

20 449

31 350

27 979

27 118

33 116

34 917

37 406

Equipment

40 037

34 965

36 130

28 980

26 499

36 820

32 601

35 155

5 774

2 340

512

14 114

14 114

14 679

15 340

16 260

Land and buildings Professional and special services Transfer payments Miscellaneous Total

64 345

50 953

67 486

91 547

91 550

84 040

123 043 121 679

386 746

333 605

308 566

418 507

418 507

391 764

416 754 312 139

4 020

16 271

–

71

–

9 417 737 012

675 697 723 328

–

–

899 362 869 152 916 719 1 010 795 936 132

Source: National Treasury, 2002 Standard items have since been replaced with a more detailed breakdown of the (internationally standardised) economic classification.

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Budget reform and management of public money through budgeting Table 7.2 Expenditure estimates Sub-programme

Audited Audited R thousand

Medium-term expenditure estimate

Expenditure outcome Preliminary outcome

Adjusted appropriation

1998/99

1999/00

2000/01

2001/02

2002/03

2003/04

2004/05

371

445

970

872

937

967

1 020

Economic Analysis

1 793

1 598

1 627

4 639

5 659

8 369

8 879

Statistics

3 786

7 483

8 886

10 502

12 975

20 974

23 463

Total

5 950

9 526

11 483

16 013

19 571

30 310

33 362

–

–

–

Management

Change to 2001 Budget Estimate Economic classification Current Personnel Transfer payments Other current Capital Transfer payments

5 335

9 151

11 217

15 727

18 867

29 677

32 691

4 536

4 519

5 130

7 760

7 918

8 309

8 821

–

–

–

–

–

–

–

799

4 632

6 087

7 967

10 949

21 368

23 870

615

375

266

286

704

633

671

–

–

–

–

–

–

–

615

375

266

286

704

633

671

5 950

9 526

11 483

16 013

19 571

30 310

33 362

4 536

4 519

5 130

7 760

7 918

8 309

8 821

Administrative

576

706

775

2 199

2 120

4 095

5 560

Inventories

100

418

120

290

415

678

720

Equipment

615

375

266

286

704

633

671

–

–

–

–

–

–

–

60

3 433

5 146

5 478

8 414

16 595

17 590

–

–

–

–

–

–

–

Acquisition of capital assets Total Standard items of expenditure Personnel

Land and buildings Professional and special services Transfer payments Miscellaneous Total

63

73

46

–

–

–

–

5 950

9 526

11 483

16 013

19 571

30 310

33 362

Source: National Treasury, 2002 Standard items have since been replaced with a more detailed breakdown of the (internationally standardised) economic classification. (See support material.)

A third advantage of programme budgeting is the fact that programmes can be continuously assessed to ensure that they are still directed at attaining the objectives for which they exist. Disadvantages of programme budgeting

There is no substantive literature with regard to the disadvantages of programme budgeting. Gildenhuys (1993) writes at length about budget reform, but does not 113

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Public Finance Fundamentals mention disadvantages of programme budgeting per se. Instead, he speaks of ‘obstacles in the way of programme budgeting.’ There is a major difference between a disadvantage and an obstacle. The most recent budget reform in the South African public sector is known as multi-year programme budgeting (ie programme budgeting for more than one year at a time, in three-year rolling cycles). The only conclusion to be drawn from the fact that multi-year programme budgeting is now being introduced is that programme budgeting in itself has no major drawbacks. Flowing from Gildenhuys’s (1993) discussion of obstacles that stand in the way of budgeting, however, it may be noted that funding choices are complicated by the fact that parts of certain programmes may be effective with respect to organisational objectives, whereas other parts of the same programme may not. When a decision has to be made whether to fund or abandon such a programme on the basis of its (or parts of its) failing to contribute significantly to organisational objectives, managers may be forced to ‘throw the baby out with the bath water’. A solution might be to reduce funding such that only those activities of the programme that contribute to organisational goals are funded.

7.6 Zero-based budgeting (ZBB) The zero-based budgeting (ZBB) approach was developed by an American, Peter Phyrr, in the early 1970s, in his capacity as manager at Texas Instruments Inc. Although there is mixed opinion concerning its efficacy, ZBB did enjoy some measure of success in the private sector and, albeit to a lesser degree, the public sector, particularly as applied in the US state of Georgia under the governorship of the then president-to-be, Jimmy Carter. In government the results were mixed. ZBB failures in some jurisdictions were blamed on the excessive amounts of work required to develop and implement the system. Elsewhere, in other jurisdictions sufficiently refined to adapt to changing circumstances, ZBB was hailed as a success. 7.6.1 Zero-based budgeting as a process As the name may suggest, ZBB justifies from scratch (ie zero) all expenditure on the budget, as opposed to budgeting on the basis of prior approved amounts and incremental adjustments of such amounts. In practice, however, ZBB is actually not intended to ‘start from scratch’, as its name implies. Instead, ZBB calls for a matching of available budget revenue against all of the proposed expenditure items of the budget. As money is scarce, it is the norm that the monetary amount of proposed expenditures 114

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Budget reform and management of public money through budgeting will exceed the amount of money available, and thus there must be some competition among anticipated expenditures such that the least important expenditures are excluded from funding. ZBB allows managers to increase funding for some programmes, whilst simultaneously decreasing funding for less effective programmes, given a fixed amount of revenue. In the language of ZBB, the precise tools used to accomplish this feat are ‘decision packages’ and ‘decision units’ (Phyrr, 1973: 5; Gildenhuys, 1993: 528–529), as discussed below. Decision units

With ZBB, competition (and thus comparison) takes place not just between programmes, but also between the activities that make up the programmes. Activities within a particular programme are evaluated and ranked against each other in order to compete for funding. Activities in this context are referred to as ‘decision units.’ Furthermore, activities of a given programme must also compete for funding against the activities of other programmes. This ranking and comparison across programmes is accomplished through the use of ‘decision packages’, as described below. Decision packages

Decision packages can be equated to programmes. When it comes to ranking programmes by the extent to which they contribute to the organisation’s objectives, one can position these programmes on a list of first, second, third, fourth, etc. A manager with sufficient funds to cover the first three programmes, for example, will know that he or she has to drop the fourth, fifth and any other programmes, as these should not receive funding ahead of programmes that have a higher position on the list and therefore more closely contribute to the organisation’s objectives and success. Decision package 1

Decision package 2

Decision package 3

Unit 1

Unit 5

Unit 9

Unit 2

Unit 6

Unit 10

Unit 3

Unit 7

Unit 11

Unit 4

Unit 8

Unit 12

Figure 7.1 Decision packages and units 115

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Public Finance Fundamentals 7.6.2 Advantages of ZBB From the above description of the process of ZBB, it is clear that it has a number of advantages: ■■ A main advantage is that limited resources can be put to their most effective uses in programmes and activities that best meet the organisation’s objectives. ■■ Ineffective programmes and activities can be identified and phased out, if necessary. ■■ Effective programmes can be identified and further supported by increased funding, which is taken away from ineffective programmes. ■■ One of the end results of the ZBB process is the accumulation of a substantial quantity of operational data about programmes and activities, and such data can be made available for use in other management applications. ■■ Not only does ZBB require managers to review programmes and activities regularly, it compels them to consider the relevance of organisational objectives. ■■ In general, tax increases could be limited if all government departments were required to budget on the basis of ZBB, as public managers would not apply for ever-increasing amounts of funding each year. Instead, available funds would be more effectively spent by cutting spending on ineffective programmes whilst increasing spending on more effective ones. The advantages of using ZBB must be considered alongside its possible disadvantages, as addressed below. 7.6.3 Disadvantages of ZBB As noted, ZBB has succeeded in some institutions and jurisdictions, and failed in others. Failures of ZBB may be explained in part by some of the following disadvantages associated with its use: ■■ Some government activities may not be suitable for ZBB. ■■ To illustrate: A municipal government is mandated by national government to carry out a certain programme, which then has to compete with prioritised programmes of the municipality. If the mandated programme is funded by national government, it can simply be left out of the ZBB process of the municipality, as it will have its own funding. However, an unfunded mandate added to the municipality’s ZBB process will have the effect of further limiting the municipality’s ability to carry out all of its prioritised programmes. ■■ Ranking decision units and decision packages can prove to be a complicated matter. ■■ To illustrate: A manager may be unsure as to how much data will be needed before a sound decision can be made, leading to premature or late decisions, or lengthy delays in decision making. 116

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Budget reform and management of public money through budgeting The ranking process may also be complicated by the fact that while some programmes and activities contribute to the same objectives, they may at times do so in very different ways, making comparison, and ranking, difficult. ■■ In order to be executed effectively, ZBB requires an advanced level of expertise and experience, which may not be available. ■■

7.7 Uses of budgets A manager would be hard pressed to find a more useful tool than budgets, perhaps particularly in the public sector. The following are all important applications of budgets (Caiden in Savoie, 1996: 56; Gildenhuys, 1993: 395–412): ■■ Budgets enforce honesty in financial transactions through accountability. ■■ Budgets facilitate the maintenance of control. ■■ Budgets facilitate planning and the management of resources. ■■ Budgets balance income with expenditures. ■■ Budgets are a source of information that inform the public of what government intends to do (ie a plan). ■■ Budgets are also reports that convey information on how efficiently and effectively government has done what it said it intended to do (ie performance). ■■ Budgets are policy statements informing the public of government priorities.

Summary and conclusion This chapter focused on reforms in public budgeting. Perhaps the oldest form of budgeting is line-item budgeting, which works well when control over expenditure amounts is the only objective. This is because line-item budgets are simplistic in their detail, and only specify the items that must be funded and a corresponding amount. Whether or not the items on the budget meet organisational objectives is inconsequential. Budget reforms of the 1960s, 1970s and 1980s, such as performance budgeting, programme budgeting and zero-based budgeting, all attempted to expand upon line-item budgeting shortcomings. None of the reforms dealt with in this chapter offers a perfect solution for budgeting, but each has its advantages and disadvantages – the opinion as to the success of reforms varies according to different government jurisdictions. Using the National Department of Agriculture as an example, it was seen that expenditure plans can be presented in various ways: summarising the main programmes or functions of a department, breaking down current and capital spending into more detailed economic categories, and setting out more specific clusters of activities and transfers to organisations or projects. 117

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Public Finance Fundamentals

Self-examination questions 1. Compare and contrast traditional line-item budgeting with zero-based budgeting. 2. Briefly discuss the processes involved in performance budgeting, as well as its advantages and disadvantages.

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R E T P A H C

8

Safeguarding ethics and accountability in the public sector J Mafunisa M Sebola

LEARNING OBJECTIVES By the end of this chapter, you should be able to: ■ define unethical and ethical conduct ■ list categories of unethical conduct, and define corruption ■ define accountability ■ name role players in the fight against corruption and conflict of interest ■ describe the powers of these institutional bodies.

Introduction For many years in South Africa, there has been a steady public outcry about corruption and financial misconduct in the form of fraud, theft of state assets and abuse of positions to obtain financial favour from private businesses. These practices are nothing short of a societal cancer that threatens progress towards economic and social development in the country. Left unchecked, this growing and deteriorating state of affairs can also be expected to lead to a threat to our democratic way of life and to political instability. Accordingly, one major challenge facing nations all over the world today is the lack of trust in government. In some countries, trust in government is challenged by the simple fact that citizens’ access to information and public debate is firmly in the hands of government; in other countries, such access is shifting away from the domestic arena and into the hands of the global market.

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Public Finance Fundamentals A case in point is the United States and Britain, where the ‘pre-emptive’ invasion of Iraq to locate what the two governments proclaimed to be weapons of mass destruction turned out to be blatant falsehoods and, although individuals and businesses continued to benefit financially from the war in Iraq, both governments lost much trust among their own citizens and goodwill the world over. A second example on the global economic front is the US government’s refusal (regardless of opposition to this stance from the American public) to sign world agreements such as the Kyoto Protocol. The Kyoto Protocol calls for hugely expensive policies and projects to ‘clean up’ polluter nations, and the US has been shown to be the prime polluter of the planet. A third example closer to home is that of South Africa during the apartheid era, when access to information was strictly controlled to the point where newspapers were banned and reporters imprisoned. Perhaps a bit more insidious but an equally dangerous threat to democracy is the inability of private citizens to find out how much money government is spending and what it is spending it on. Fortunately, to deal with the latter, most democratic countries have enacted laws requiring government to be open and transparent. In South Africa the relevant law is the Promotion of Access to Information Act 2 of 2000. The demand for accountability is a powerful tool for change. As a result, established notions of the procedures and institutions of accountability are being challenged. In this regard, South Africa’s Truth and Reconciliation Commission, in which the perpetrators of apartheid crimes against fellow citizens of the country were very publicly confronted, is regarded as groundbreaking. Although it dealt with what are internationally defined as crimes against humanity as opposed to petty corruption in government departments, it did show accountability to be an important factor in the eyes of citizens. The possibility exists that a person entrusted with privileged information and/or official funds may, at some time, wonder about using these for their own benefit. If it is one’s work to deal with valuable information or large sums of money, perhaps after a while complacency might set in. It could be that otherwise upstanding individuals might be persuaded, by the very ease of the act, to do some small illicit thing, even if they know it is strictly against the regulations, and because, really, who will know? It is not difficult to imagine these thought processes at work when, say, an off-duty police officer drives home in an official police vehicle, or a clerk in this or that department uses a departmental computer to type the story of his or her life, or a member of parliament chooses to stay overnight in a luxury hotel instead 120

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Safeguarding ethics and accountability in the public sector of the relatively inexpensive one in the same block. It is not difficult to imagine that these same thought processes are at work when an elected representative first starts accepting inappropriate gifts or bribes in the belief, no doubt, that no one will ever know. In this chapter we examine ethics and accountability as these pertain to our elected representatives and appointed public officials. As mentioned in earlier chapters, government exists to provide services, improve social welfare and satisfy the needs of the people. The people expect that all of this will be done in such a way that financial resources entrusted to government are appropriately managed, optimally utilised and, it almost goes without saying, safe in the hands of government role players. The identification and establishment of measures to combat corruption are meant to ensure that public functionaries serve members of the public in an equitable and impartial manner. Taxpayers require assurance that there are measures and checks in place to make public functionaries on the payroll less likely to use their positions for personal gain. The chapter looks at categories of unethical conduct, at the authorities charged with combating it, and at legal and other consequences if an individual were to be found to be in transgression of the various codes of conduct and/or regulations.

8.1 Concern about unethical and unaccountable conduct Historically the concept ethics comes from the Greek word ethos, and it implies a character or custom of a people (United Nations Economic Commission for Africa, 2003: 34). It has to do with right or wrong, or appropriate and inappropriate conduct or behaviour. It is the case, however, that this question of what is considered moral or immoral conduct is relative in the sense that it is ultimately determined within social and cultural contexts. The reality of globalisation adds further complexity to our understanding of ethics, as the existence of a myriad cultures and the ease with which those cultures transcend borders has a great bearing on the way in which the behaviour and conduct of people will be judged. Culture is, by definition, shared values and norms passed down from one generation to the next, and Raga and Taylor (2000) further point out that our interpretation of what is ethical is shaped not only by culture, but also by historical circumstances and events. Ultimately, however, and within prescribed limits or boundaries, appropriate or moral conduct must be evaluated against some absolute criteria to which negative or 121

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Public Finance Fundamentals positive values are attached (Hanekom, 1984: 58). Thus, although it can be argued that cultural nuances and differences among societies determine the yardstick for measuring what is ethical (for example, private business enterprises and citizens giving gifts to politicians and government officials may be acceptable and ethical in one country, yet this is deemed unethical in another), what is actually required for pragmatism and social equality is that governments should allow little or no space for the interpretation of what is ethical, acceptable and allowable conduct for public officials and elected representatives. On this point, Hanekom (1987) argues that the challenge for government is to ensure that a code of ethics is formalised and legislated or prescribed by a higher authority to apply to all workers as a homogeneous group, with a view to eliciting specific behaviours under specific conditions. Unethical conduct reduces public trust and confidence in the integrity and impartiality of elected representatives. In this respect, the appearance of unethical conduct can be as damaging as an actual act of unethical conduct. Once, in discussing his code of conduct, US President John F Kennedy (in Frier, 1969: 3–4) remarked that, even though technically a conflict of interest may not exist, it would be desirable to avoid the appearance of such a conflict from a public confidence point of view. By the same token, even though a particular act might involve no actual wrongdoing or abuse of office, the possible perception that it does should be avoided from a public trust point of view. This view is also supported by Williams (1985: 6), who remarks that even if no financial gain accrues to the elected representative involved, other aspects of the conflict-of-interest dilemma do create problems and attract criticism – for example, the problem of competition for an elected representative’s time has been recognised. There is also sometimes the criticism that too many outside interests take up time and energy that an elected representative should otherwise be spending in the performance of his or her duties. Media coverage has stimulated public concerns about unethical conduct, which in turn has prompted some politicians to seek out cases of, for example, apparent conflicts of interest involving their political opponents, with a view to using the adverse media coverage to their own political advantage. Increased concern in contemporary society about unethical conduct has come about in large part from the realisation that public functionaries, such as elected representatives, have various opportunities to put private benefit before public duty. These opportunities arise from the increased scale and complexity of government 122

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Safeguarding ethics and accountability in the public sector and the expansion of bureaucratic power in the policy process. Furthermore, the slow growth in government functions means that public functionaries have fewer opportunities for promotion and that many of their jobs are less likely to be permanent. The detrimental effect of these developments on morale is aggravated by the relatively negative public image of public institutions. It may also be that the less committed to their job, the more likely some officials and elected representatives would be to engage in activities for remuneration outside of government, possibly as a hedge against losing their job or in preparation of resigning from their position. In some cases, elected representatives may experience the financial and psychological rewards that come from serving the public as being so inadequate that they feel justified in using their public office for private gain (Kernaghan & Langford, 1990: 139–140). From the above discussion, if accountability means to answer for the ‘fulfillment of assigned and accepted duties within the framework of the authority and resources provided’ (Kernaghan & Langford, 1990: 160), then unaccountability means not being called to book for neglecting, or failing to fulfil, assigned and accepted duties. The public demands accountability, however, and much time and effort have gone into the development of government policies and measures to ensure greater degrees of accountability. In this next section we first examine different categories of unethical conduct (specifically in the area of conflicts of interest) that might arise in public office, and thereafter consider the different institutions charged with combating unethical conduct and ensuring accountability in the public sector.

8.2 Categories of unethical conduct: Conflict of interest According to Williams (1985: 6), conflict of interest denotes a situation in which an elected representative or an official has a personal or private financial interest sufficient to influence, or appearing subjectively to influence, the exercise of his or her public duties and responsibilities. The concept is applicable not only to situations where a conflict of interest actually exists, but also to where it may appear to exist. Let us examine different categories of conflict of interest, as identified and explained in the sections that follow. 8.2.1 Using inside knowledge and influence Section 2(2)(b) of the Executive Members’ Ethics Act 82 of 1998 does not allow elected representatives (cabinet members, deputy ministers and members of executive councils (MECs)) to use any information entrusted to them to enrich themselves or improperly benefit any other person. In many situations an elected 123

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Public Finance Fundamentals representative who has access to inside information may face opportunities to use it as a source of potential profit. At the local sphere of government, for example, a mayor colluding with the director of city planning could potentially profit from knowing where new sewer facilities are to be constructed, or what land is likely to be rezoned. This information has significant financial implications for land purchasers, and would be particularly helpful to the profit margins of a variety of land-development role players, if known well in advance. Moreover, there may be a temptation to provide friends or relatives with information before it is made public. Elected representatives or officials sometimes become silent partners and profit from transactions, either in exchange for the information they provide or as a gratuity for their tacit manipulation of events to make such transactions possible. According to Murphy (1981: 496), some elected representatives argue that it would be foolish of them not to take advantage of any privileged knowledge they may gain by virtue of their position as elected officials, ignoring the fact that it is illegal actively to influence decisions that could favourably affect their own financial positions. Elected representatives can avoid conflicts of interest by disqualifying themselves from situations in which personal interests are involved. In judicial circles, for example, a judge may disqualify him- or herself because he or she was the prosecuting attorney on a case now before him or her on appeal. Similarly, an executive director may disqualify him- or herself when called upon to make decisions affecting a department for which he or she formerly worked or where he or she is a director. 8.2.2 Self-dealing ‘Self-dealing’ refers to a situation in which one takes an action in an official capacity that involves dealing with oneself in a private capacity and which confers a benefit on oneself. Furthermore, the notion of self is expanded to include one’s spouse, family members and business partners. It also refers to an elected official who finds himor herself in a position to do favours for a relative or friend. This form of unethical conduct is also called ‘nepotism’, which is a special class of influence peddling. It involves using influence to gain preferential treatment in hiring, promotion, the awarding of contracts, or other business practices from which a relative or close friend will benefit. An elected representative who engages in such practices gains not directly but indirectly by reinforcing family bonds and mutual support (Cooper, 1990: 117).

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Safeguarding ethics and accountability in the public sector An obvious example of self-dealing is a public functionary who awards a contract to a company which he or she owns, or in which he or she has shares (Kernaghan & Langford, 1990: 142). A good example is the so-called Travelgate scandal, involving the misuse of travel vouchers by members of parliament, which defrauded parliament of as much as R17 million. The vouchers were intended to cover the costs of travel between parliament in Cape Town and the members’ constituencies. Up to 40 MPs allegedly colluded with several travel agents to make false travel claims and inflate the price of air tickets to cover the costs of luxury car rentals and hotel accommodation. One MP went as far as to form his own travel agency to better further his own aims. 8.2.3 Using government property Elected representatives should not use or permit the use of government property of any kind for activities not associated with the performance of their official duties unless they are authorised to do so. The private use of government property takes different forms, ranging from relatively minor offences – such as taking pencils home or using a government office for non-governmental purposes – to major offences, such as using a fleet vehicle for personal use such as traveling to far away holiday destinations whilst on official leave. The Code of Conduct for Councillors contained as Schedule 1 of the Local Government: Municipal Systems Act 32 of 2000 prohibits municipal councillors from using, taking, acquiring or benefiting from any property or asset owned, controlled or managed by the municipality and to which that councillor has no right. 8.2.4 Outside employment ‘Outside employment’ refers to work or any activity in which a person engages outside of normal working hours for additional remuneration. While such activity may be conducted on a full-time basis, it usually involves part-time work and includes a wide variety of activities, such as working for a non-governmental organisation, running a business, or doing consulting work for a fee. The problem of conflict of interest arises when outside employment (or moonlighting) of elected representatives clashes with the performance of their official duties. Cooper (1990: 116) argues that conflict situations include: ■■ the use of public employment status to enhance a private employee (or oneself) ■■ the draining away of efforts and energy required for official duties ■■ the use of government services and equipment in outside work.

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Public Finance Fundamentals It should be mentioned here that different regulations apply in the case of councillors who are not full-time employees of a council. More specifically, moonlighting may need to be restricted (Kernaghan & Langford, 1990: 147): ■■ if the activity is in direct competition with the council or parliament or provincial legislature ■■ if an elected official’s work performance is affected ■■ if the employer’s property is being used to engage in the activity ■■ if confidential information from the elected representative’s public work environment is being used in the performance of the outside work ■■ if an elected official is using his or her official position to solicit business ■■ if an elected official’s activity could be perceived by members of the public to constitute a conflict of interest. Section 2(b)(i) and (ii) of the Executive Members’ Ethics Act 82 of 1998 prohibits elected office bearers from undertaking any other paid work and from exposing themselves to any situation involving the risk of a conflict of interest arising between their official responsibilities and their private interests. 8.2.5 Post-employment The scope of private interests considered relevant to the conflict-of-interest debate varies, extending from the fundamental level of interest an elected representative possesses while holding office – including existing interests when taking office, and the interests of family members – to interests acquired on leaving office. Economic interests for elected officials are likely to arise on retirement or resignation, where there are potential opportunities for using confidential information or expertise obtained in public office, or influencing policy either for their own benefit or for that of their prospective employer (Williams, 1985: 8–9). Kernaghan and Langford (1990: 149) describe post-employment as ‘subsequent employment’ or ‘future employment’. It constitutes conflict of interest when elected officials use, or appear to use, information and contacts acquired while in government to benefit themselves or others after they leave office. Among other variations of conflict of interest, the post-employment problem is one of the most difficult to regulate. The difficulty arises in large part from the fact that the persons being regulated are former elected representatives; once elected representatives have left government, the range of penalties that government may apply to them is limited. In the Canadian federal government, ministers and public employees are responsible for ensuring that former elected representatives 126

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Safeguarding ethics and accountability in the public sector do not take advantage of a prior position in public office (Kernaghan & Langford, 1990: 150). In some countries a cooling-off period is required before a former political office bearer may take up employment in the private sector. Reaffirming their political commitment to enhancing professionalism and ethical conduct in the public service, African public service elected representatives (ministers) (‘Charter for the Public Service in Africa’, 2001) argue that upon leaving office – and for such period of time as may be stipulated by law or by the relevant regulations – public employees appointed to positions of responsibility and trust shall not take undue advantage of positions previously held by accepting remunerated employment that is related to their previous functions. What applies to public service employees should apply equally to elected representatives, as both are serving the public. Some years ago, while addressing a media briefing in Pretoria, then President Thabo Mbeki (The Star, July 27, 2001: 1) reported that government was in the process of developing new regulations to clarify the role of employees involved in the negotiation of large contracts as a measure to limit corruption. He cited, as an example, a cabinet minister who could leave the government to join the private sector in a field covered by that particular minister during his or her term. Such a move from the public to the private sector, President Mbeki said, could be viewed as a case of corruption, since the minister would have participated in the awarding of tenders to a firm that he or she later joined. The applicable legislation is aimed at making it impossible, for instance, for a former minister of defence to join the arms industry after leaving government. 8.2.6 Gift-giving traditions and entertainment ‘Gifts and entertainment’ refers to the seeking or accepting of gifts and hospitality that may influence an elected official’s impartial discharge of his or her duties. This category simply amounts to a broadening of one’s understanding of bribery. It includes such things as discounts on purchases, theatre tickets, sex, vacation trips, use of vehicles, lavish meals, recreational equipment and liquor. Typically, gifts of this kind are given with no specific favours requested, as would be the case with bribery, but are intended to create a generally positive predisposition towards the donor (Cooper, 1990: 116). In an actual case, an MP was convicted of defrauding parliament by failing to disclose a near 50% discount received on a new luxury 4x4 vehicle. This was an excellent car deal by anyone’s standards, but it had been arranged by a representative of a bidder in the government’s arms acquisition process at a time when the MP involved 127

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Public Finance Fundamentals was chairman of parliament’s Joint Standing Committee on Defence, which oversaw the arms deal – and the MP’s acceptance of the discount was therefore illegal (http://news24.com/News24/South Africa/News/0,,2-7-1442_1832874,00.html). Section 2(2)(c) of the Executive Members’ Ethics Act, 1998 requires elected representatives to disclose to an official in the office of the president (and/or the premier concerned) all their financial interests when assuming office. They also have to declare any financial interests acquired after their assumption of office, including gifts, sponsored travel and hospitality received by them or by persons who are family or have other ties with them. Bozkurt and Moniz (1999: 89) remark that the continuing tradition of gift giving prepares a fertile ground for corruption. For example, before the onset of colonialism in many Southeast Asian countries, instead of a regular salary, employees used to receive a given fee for a given job. In the Ottoman Empire, too, the kady (judge of Islamic law) would receive a fee for the resolution of disputes between parties. A gift of a basket of fruit or a few chickens for public employees in Indonesia was very common (Heidenhammer, 1970: 205). In Burma, too, gifts to judges were accepted custom. In societies where these gift-giving traditions continue, individuals do not regard it as at all against the rules to present gifts to the latter, and public employees are not averse to receiving these. In African countries such as Kenya, Uganda, Tanzania, Nigeria and Ghana, the tradition of presenting gifts, consistent with tribal customs, continues (Bozkurt & Moniz, 1999: 90). Wraith and Simpkins (1964: 36–37) also support the argument that tolerance stemming from traditions creates a possible ground for corruption and bribery. In addition, they report that in Africa traditional gifts are being replaced with money.

8.3 Institutional bodies for combating unethical conduct in the public sector Institutional bodies combating unethical conduct in the public sector are the: ■■ Public Service Commission ■■ Auditor General ■■ Public Protector ■■ Special Investigating Unit ■■ National Prosecuting Authority. Each is discussed briefly in the sections that follow.

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Safeguarding ethics and accountability in the public sector 8.3.1 Public Service Commission The Public Service Commission was established in terms of Section 196(1) of the Constitution of the Republic of South Africa Act 108 of 1996. Its independence and impartiality are provided for and safeguarded by Section 196(2) of the Constitution, in the interests of the promotion of effective public finance and administration, and a high standard of professionalism and ethics in the public service. The Public Service Commission is competent to: ■■ investigate, monitor and evaluate the organisation, administration and personnel practices of the public service ■■ propose measures to ensure the promotion of efficiency and effectiveness in the departments of the public service ■■ give directions aimed at ensuring that personnel procedures relating to recruitment, transfers, promotions and dismissals comply with the values and principles of public administration ■■ investigate grievances of officials in the public service, and to advise national and provincial governments regarding personnel practices in the public service, including those relating to recruitment, appointment, transfer, discharge and other aspects of the careers of officials in the public service (Section 196(4) of the Constitution, Act 108 of 1996). According to Vil-Nkomo (1996: 21), the Public Service Commission ensures effectiveness, and contributes to conformity in the total system of governance. A unified system of governance suggests efficient and effective delivery of services, a responsive public service, recognisable adherence to ethical behaviour by public officials, and a focus on productivity and accountability. The powers of the Public Service Commission include the promotion of democratic values and principles applicable in public administration, for example that: ■■ a high standard of professional ethics must be promoted and maintained ■■ efficient, economic and effective use of resources must be promoted ■■ services must be provided impartially, fairly, equitably and without bias ■■ people’s needs must be responded to ■■ public administration must be accountable and transparency must be fostered by providing members of the public with timely, accessible and accurate information (Section 195(1) of the Constitution). The Public Service Commission promotes the development of ethics and accountability in that it ensures that public officials follow sound principles of public administration 129

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Public Finance Fundamentals for the efficient, economic and effective use of resources, and that people’s needs are responded to. 8.3.2 Auditor General The post of the Auditor General, as it currently operates, was created in terms of Section 188(1) of the Constitution of the Republic of South Africa Act 108 of 1996. The functions of the auditor general are to ascertain, investigate and audit all the accounts and financial statements of: ■■ all departments of the central, provincial and local spheres of government ■■ any statutory body or any other institution which is financed wholly or partly by public funds. The legislatures appoint some of their members to public accounts or finance committees, which can summon accounting officers to account for financial transactions involving their specific institutions. The word ‘accounting’ in the title ‘accounting officers’, argues Cloete (1998: 197), refers to the rendering of account and answerability, not to accounting in the sense of bookkeeping. A forensic auditing capacity was established in 1997, based on the increasing level and negative effect of economic crimes on the public accountability process, which obliges the office of the Auditor General to report on such crimes within the public sector. The objectives of the office of the Auditor General with respect to forensic auditing are to (PSC, 2001: 13): ■■ determine the nature and extent of the perpetration of economic crime, and the adequacy and effectiveness of measures that should have either prevented or detected them ■■ facilitate the investigation of economic crime in general by providing support to the relevant investigating and/or prosecuting institutions (by handing over cases and providing accounting and auditing skills). To address corruption, preventive and reactive strategies have been developed by the forensic auditing division. The proactive strategy is aimed at preventing economic crime by promoting an overall fraud awareness culture in the public sector through, amongst other things, publications, workshops and participation in relevant national and international initiatives. The following aspects have been identified as having the potential to reduce the risk of economic crime: ■■ strong financial management systems ■■ effective internal controls ■■ adequate awareness (and acceptable standards of conduct). 130

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Safeguarding ethics and accountability in the public sector The reactive strategy is aimed at investigating allegations of economic crime. Allegations submitted to the auditor general’s office are confirmed, or refuted, by collecting and submitting substantive evidence and findings, and are reported through the normal audit process or, when applicable, handed over to bodies with investigating and prosecuting powers (PSC, 2001: 13). 8.3.3 Public Protector The Public Protector has the power to investigate any conduct in state affairs, or in the public administration in any sphere of government, that is alleged or suspected to be improper or to result in any impropriety or prejudice. In terms of Section 112(1) of the Constitution of the Republic of South Africa Act 200 of 1993, the public protector shall, on his or her own initiative or on receipt of a complaint: investigate any alleged maladministration, abuse or unjustifiable exercise of power, improper or dishonest act, corruption, unlawful enrichment, or receipt, or any improper disadvantage, or promise of such enrichment or advantage, by a person as a result of an act or omission in the public administration of public institutions, or omission by a person in the employ of any sphere of government, or a person performing a public function, which result[s] in unlawful or improper prejudice to any person. The office of the Public Protector measures its effectiveness in respect of whether recommendations in a particular case are followed. It has been found that whilst government does act in most cases, it does not always follow the recommended course of action, particularly in respect of political office bearers. According to the PSC (2001: 20), where the recommendations concern actions against public officials, the office gets full backing from parliament – but where recommendations concern political office bearers, the majority party tends to close ranks. Although this does not happen often, it does tarnish the reputation of the office. It can be argued that anyone found to be corrupt or involved in conflict-of-interest situations must be punished, because this will have the desired consequence of, firstly, making recommendations of the public protector far more effective in curbing instances of conflict of interest and, secondly, promoting public confidence in the functioning of the office. 8.3.4 Special Investigating Unit The Special Investigating Unit and Special Tribunals Act 74 of 1996 provides the mandate for the functions of the Special Investigating Unit (SIU). The SIU carries out investigations as referred to it by the president through publication of a proclamation in the Government Gazette. The President of South Africa may refer a matter to the SIU for investigation only on the following grounds: 131

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Public Finance Fundamentals ■■ ■■ ■■ ■■ ■■ ■■ ■■

serious maladministration in public sector institutions improper conduct by elected officials unlawful expenditure of public funds unapproved transactions intentional or negligent loss of public money or damage to public property public sector corruption unlawful conduct which causes serious harm to public interests.

The functions and powers of the SIU are to investigate all allegations; to collect evidence regarding acts or omissions which are relevant to its investigation; to present evidence in proceedings brought before a special tribunal; and to refer any evidence which points to the commission of an offence to the relevant prosecuting authority. The SIU has broad powers, enabling it to act on allegations of maladministration and corruption. With the authority of a magistrate or a judge, SIU members may enter and search premises, and remove documentation on the basis of a reasonable suspicion that this would assist an investigation. The SIU may also summon anyone to appear before it and compel them to answer any questions asked. It has the power to order the return of money or property, and to issue an interdict to stop the potential loss of money or property. The SIU’s role is significant in that its functions cannot be performed by any other constitutional body; the SIU is the only public body that has as its focus area the application of civil law with the intent of recovering money and other assets, saving money and assets, and/or safeguarding money and assets belonging to public institutions. The SIU’s powers allow it to take a matter from the initial stages, when it is still mere allegation, through a full investigation and, ultimately, to engage in litigation to bring the matter to finality. 8.3.5 National Prosecuting Authority The NPA is a large and complex organisation that consists of several business units, namely: ■■ The National Prosecution Service (NPS) ■■ The Directorate of Special Operations (DSO also popularly referred to as the Scorpions) – disbanded in 2009 and replaced by the Directorate for Priority Crime Investigation (DPCI, also called the Hawks) ■■ The Asset Forfeiture Unit (AFU) ■■ Sexual Offences and Community Affairs (SOCA) ■■ The Specialised Commercial Crime Unit (SCCU) ■■ The Witness Protection Unit (WPU) 132

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Safeguarding ethics and accountability in the public sector The Priority Crimes Litigation Unit (PCLU) ■■ The Integrity Management Unit (IMU) ■■ Corporate Services (CS). ■■

The prosecuting authority has the power to institute criminal proceedings on behalf of the state, and to carry out any necessary functions incidental to instituting criminal proceedings. The National Prosecuting Authority (NPA) office is headed by: ■■ the national director who is the head of the prosecuting authority and is appointed by the president as head of the national executive ■■ directors of public prosecutions and prosecutors as determined by an act of parliament. The National Prosecuting Authority Act 32 of 1998 provides that: the national director shall, with the concurrence of the minister of justice, and after consulting the directors of public prosecutions, determine prosecuting policy and issue policy directives which must be observed in the prosecution process. The national director may intervene in any prosecution process when policy directives are not complied with, and review a decision to prosecute or not to prosecute, after consulting the relevant director of public prosecutions, and after hearing representations from the accused person, the complainant and any other person whom the national director considers to be relevant. At the discretion of the national director, any of the deputy national directors may perform any of the powers, duties and functions of the national director. It is critically important for the proper functioning of our democratic system of governance that the independence of the office of the Prosecuting Authority is safeguarded, such that it may implement national legislation and perform its functions without fear, favour or prejudice. In recent times, however, the impartiality of the office has been brought into question. This relates in particular to the disbanding of the highly successful Scorpions (in 2009) who enjoyed a conviction rate of well over 80%, and their replacement with the Hawks, who have been put under the authority of the South African Police Service (SAPS). The beginning of the end for the Scorpions came about as the result of fierce political lobbying within certain politically powerful circles that accused the Scorpions of targeting or singling out high-profile persons in the ruling ANC party. It is generally feared 133

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Public Finance Fundamentals that this reorganisation may result in a loss of independence in this corruption and crime-fighting organ of state, which will affect their ability to pursue cases against high-ranking police officials (and their political bosses in the executive). Another important business unit of the NPA is the Asset Forfeiture Unit (AFU). Focus areas of this unit include (PSC, 2001: 42–54): ■■ seizure of large amounts of cash associated with the drug trade ■■ seizure of property used in the drug trade or other crime ■■ corruption ■■ white-collar crime ■■ targeting of serious criminals ■■ violent crime. A typical example of the above is the case in which the Asset Forfeiture Unit was granted an order to seize assets worth R30 million from a Durban businessman who had been convicted of fraud and corruption (http://www.mg.co.za/articlesPage. aspx?). There is an argument to be made for the seizure of assets obtained through illegal means, since such drastic action is likely to serve as a deterrent to elected officials aspiring to accumulate wealth unethically.

Summary and conclusion From this chapter it is clear that the public sector is characterised by manifestations of unethical conduct, and that such conduct taints all in public office. To combat conflict of interest and corruption, the judiciary should consider harsher penalties, improve incentives of public officials, and increase the probability of being caught. The government should clarify discretionary powers and create an environment within which constitutional bodies may function effectively. Furthermore, the government cannot be seen to be dragging its feet when it comes to the recommendations of anti-corruption agencies, whoever may be involved. Failure to implement the recommendations of anti-corruption agencies damages the image of these agencies in the eyes of the public and is detrimental to public confidence in government systems.

Self-examination questions 1. Discuss the National Prosecuting Authority with specific reference to its role in combating corruption in South Africa. 2. Discuss the auditor general’s role in combating corruption in South Africa. 3. Discuss unethical conduct by way of definition and examples. 134

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R E T P A H C

9

Privatisation as a major reform in public sector management T Makondo

LEARNING OBJECTIVES By the end of this chapter, you should be able to: ■ define the term ‘privatisation’ ■ explain the rationale for privatising state-owned enterprises ■ explain approaches to privatisation ■ describe advantages and disadvantages of privatisation ■ discuss privatisation in South Africa’s post-1994 public sector.

Introduction In many developing countries, public enterprises form a large component of the country’s economic activities. Inefficiency within these enterprises has been reflected, among other instances, in high debt levels, low productivity and poor profitability. These failures can constrain the rest of the economy and act as a brake on economic growth and development. However, it is also important to note that sometimes public enterprises have successfully been utilised to provide much-needed public services to the majority of poor people, or to expand investment and industrial development. Controversially, the IMF and the World Bank have strongly advocated the privatisation of state-run enterprises for these poor and developing countries to reduce their levels of debt. This has often come at a price, as transformed public institutions have had to cut down on costs to be competitive, resulting in several negative outcomes, such as job losses. In this chapter the author seeks to provide an in-depth study of privatisation as a major reform in public sector management. The term ‘privatisation’ is defined,

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Public Finance Fundamentals followed by a brief overview of the history of state-owned enterprises (SOEs) in South Africa, the rationale for privatising SOEs, and a description of alternative privatisation methods/approaches. Some of the advantages and disadvantages of the concept of privatisation are also highlighted. Throughout this chapter, emphasis is placed on the escalating trend worldwide, of a shift from public provision of public services towards privatisation. The chapter concludes by taking a closer look at privatisation in the current South African public sector.

9.1 Defining privatisation Privatisation is the transfer of state-owned assets and/or managerial functions and activities to the private sector. Privatisation can also be understood in terms of its association with other important and related terms such as nationalisation, commercialisation, corporatisation and restructuring. Each of these is defined below and contrasted, whether directly or indirectly, with the concept of privatisation. 9.1.1 Nationalisation Nationalisation is the direct opposite of privatisation, and can be defined as ‘confiscation’, with or without compensation, of privately owned enterprises by government. Nationalisation is consistent with communist and socialist ideology and the belief that government is more competent than the private sector in making decisions about public needs. More specifically, nationalisation argues (as does socialism) that the efficient production of all goods and services in society can be accomplished only when the means of production (land, labour and machinery) are owned and controlled by the state. 9.1.2 Commercialisation Commercialisation entails the rendering of a service at a profit. It is essential for state-run services to be commercialised before they can be privatised. Commercialisation, in this regard, acts as a test of the viability of the service in private markets prior to the decision to privatise. The commercialisation of public enterprises could be significant in making improvements in the functioning of these enterprises without changing ownership (Staal, 1994: 25). 9.1.3 Corporatisation Corporatisation, within the South African context, is the process by which a stateowned enterprise becomes a formal company, on par with private enterprises and registered in accordance with the Companies Act 61 of 1973. The state, however, remains the sole shareholder. Corporatisation, according to Staal (1994: 25), 136

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Privatisation as a major reform in public sector management should happen after commercialisation (as discussed above) and before privatisation, if privatisation is to be deemed appropriate. 9.1.4 Restructuring Restructuring of public enterprises is a related concept, though far broader than privatisation, which refers to the matrix of options that includes the redesign of business management principles within enterprises, the attraction of strategic equity partnerships, the divestment of equity either in whole or in part, where appropriate, and the deployment of various immediate turnaround initiatives (Department of Public Enterprises, 2000: 3).

9.2 History of state-owned enterprises in South Africa Privatisation is ultimately concerned with the change in traditional modes of ownership and/or management of state-owned enterprises. In South Africa, SOEs have a long history, dating back to the early 1940s when the government established Iscor, Eskom and others, based on the realisation that the establishment of these industries was necessary for development. The South African government also realised that no private operators were in a position (or even willing to make the attempt) to survive the shortand medium-term start-up costs required to engage as producers in these industries, thus initially SOEs in South Africa were created to move the country into an accelerated trajectory of development, especially in the manufacturing sector. But SOEs also played a strategically significant role in keeping the system of apartheid intact for several decades. The effects of the international trade embargo and disinvestment campaigns of the 1980s were partly mitigated by the production and supply of primary goods and services by SOEs. Steel is a prime example of an important primary product produced by Iscor: not only was it used to extend the freight rail network in the country, but it was also used as an important input for secondary industries. By the mid-1980s, it had become clear to South African policymakers that SOEs had lost their effectiveness and needed to be considered for privatisation. The 1987 White Paper on Privatisation and Deregulation in the Republic of South Africa represented the government of the day’s first real intentions to privatise SOEs. Interestingly, before coming into power in 1994, the ANC party opposed privatisation, as it argued – along with the Congress of South African Trade Unions (COSATU) and the South African Communist Party (SACP) – that privatisation would lead to job losses and higher prices for public goods. An opinion often expressed by ANC party leaders at the time was that privatisation would simply result in the turning over of state assets to white capitalists. The second term of the ANC in government, however, was 137

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Public Finance Fundamentals marked by a turnaround in its policy on privatisation: favouring privatisation over nationalisation, a move that has seen perennial disagreements between the ANC and its alliance partners. Even with the coming to power of the Zuma administration in 2009, propped by the union federation, there had not been a considerable policy shift from the Mbeki administration. Yet the failure of public enterprises (such as Eskom, South African Airways and Transnet), often requiring government bail-outs, has resulted in more calls for privatisation of these entities.

9.3 Rationale for privatisation Over the past three decades or so, privatisation has been the key economic and social reform undertaken by governments across the globe. Many contemporary academics are of the opinion that SOEs need to be privatised as they are seen to be inefficient organisational entities that could benefit greatly from exposure to free-market forces. This is because, all too often, SOEs have recourse to financial assistance from the government if they lose money – they do not face the hard budget constraints that require private businesses to make profits in order to survive. Profit maximisation implies lower costs and better quality for consumers due to competitive pressures, whereas cost minimisation (by itself) is internally focused and does not take account of competition. Proponents of privatisation also argue that, although privatisation may initially lead to job losses, this is simply a short-term manifestation of the process as, in the long run, privatisation should result in more efficient large-scale organisations and thus a more competitive economy, which in turn, should lead to the creation of more jobs than were initially lost. The caveat to be noted here is that the possible benefits of privatisation depend, in part, on the extent to which competition is allowed in the relevant industry. A privatised telecommunications company, for example, would not pass on lower costs to consumers unless it faced competition from other suppliers. This means that privatisation may need to be accompanied by deregulation of the industry, allowing private investors to enter and compete in industries traditionally reserved for SOEs. Alternatively, if the monopoly position is unavoidable, then the government may need to continue to regulate tariff setting by a privatised entity. Privatisation and deregulation go hand in hand: privatisation without regulatory reform is unlikely to lead to public benefits. Privatisation of telecommunications, transport and electricity networks, for example, leads to public monopolies being replaced by private ones, unless deliberate steps are taken to foster a competitive industry structure. Pitcher (2012) observes two key considerations for the post-apartheid South African government in their approach towards reforms. The first was that privatisation was 138

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Privatisation as a major reform in public sector management central in securing a marriage between the state and capital through the expansion of black ownership. The second consideration was that, due to concerns over employment equity, preferential procurement and unemployment, the state has had to depend on parastatals instead of full privatisation to drive the developmental project in South Africa. Hence, privatisation has not been seen as a panacea to the many economic ills facing the country.

9.4 Alternative methods or approaches to privatisation Forms of privatisation range from the least comprehensive to the most comprehensive, the latter being the wholesale selling of government assets or shifting of a function entirely out of government. In this case, the service ceases to be offered or controlled by government. Privatisation is not an end in itself, but seeks to restore market forces to a commercial activity that had previously been in the government domain and thus protected from competition. The argument put forward by exponents of privatisation is that the change of hands of ownership of assets, from public to private, may achieve public purposes on a competitive and more efficient basis than maintaining public ownership (Butler in MacAvoy et al, 1989: 18). Following the reasoning of Gildenhuys (1997: 26), there are several methods or approaches to privatisation, including commercialisation, denationalisation, depoliticisation, withdrawal or suspension, contracting out and deregulation. These approaches are dealt with below. Given the challenges related to privatisation, governments opt for various alternatives to provide a framework that manages both political and market (economic) concerns. The framework is critical as it offers more diverse options than the conventional dichotomy of government or market. 9.4.1 Commercialisation The first step towards privatisation is to commercialise such a service. What this entails is that the service must be removed from the public budget and be placed on its own, with its own profit and loss account in order to prove itself as a suitable candidate for privatisation. Commercialisation is seen as a market-oriented reform and a form of economic solution to scarce resources in which a service is rendered at a cost. The concept is based on the cutting of deficits or generating financial resources for such a service (Baylis & Kessler, 2006: 3). According to Staal (1994: 25) the commercialisation of public enterprises could be significant in making improvements in the functioning of these enterprises without changing ownership. The most common example of commercialisation is the reduction or termination of subsidies on a particular service, for example water or electricity provision. It should 139

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Public Finance Fundamentals be emphasised that these services must show signs of maturity towards privatisation before they can be privatised – that is, they must remain under the control and accountability of government until they have proved that they are suitable for privatisation within the competitive world of the free-market system. If the commercialised public service survives free-market competition, then it can be privatised. However, in the case where it fails, this might be a sign that there is no public demand for such a service (Gildenhuys, 1997: 27). 9.4.2 Denationalisation Denationalisation can be viewed as a way of moving back to a free-market economy. However, this should not mean the creation of private monopolies by preventing them (through legislation) from entering into competition. It may, however, be necessary, according to Gildenhuys (1997: 27), for government to lend initial financial support to these enterprises through subsidies if they cannot hold their own in the competitive market. 9.4.3 Depoliticisation Depoliticisation is a form of privatisation in that it ensures that services are rendered outside the party political milieu, making them less subject to party political manipulation and exploitation for vote buying. An example of a politicised SOE would be a case in which the SOE’s board of directors and senior managers are appointed on the basis of political control by the ruling political party. The idea is that when depoliticised, these types of service can be rendered more efficiently and effectively. Craythorne (1997: 461– 462) also identifies several methods for privatisation, some of which have been identified above. Other methods identified include transfer, partnerships and joint undertakings, concession, withdrawal, contracting out and vouchers, as discussed below. 9.4.4 Transfer This method of privatisation refers to the total sale of all assets, liabilities and personnel to the private sector. The government thus cedes the function of such institution to a private enterprise, which will thus start rendering the service at a profit. This is simply the transfer of a service from public to private hands. Transfers may take place through sales to outsiders, in which the title in equity is transferred to foreign and local investors. The main purpose of this type of privatisation, as Perlmann and Zarenda (1997) observe, is to bring in revenue and ensure that owners would have the expertise, knowledge and incentive to govern and raise the capital to restructure the entity. 140

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Privatisation as a major reform in public sector management 9.4.5 Partnership In a partnership, the government has a fixed shareholding in a private entity with which it is in partnership. This kind of undertaking may be limited for a specific period of time or may be permanent in nature. Large-scale development, such as mass housing areas or large industrial developments, are more suitable for this type of operation. As Hemson (1998) observes, involving private players in the form of partnerships in South Africa is a way of promoting black empowerment and improving service delivery. Partnerships ensure that public sector deficit is reduced, while creating new means for making profit, which could serve as a panacea to slow economic growth. Partnerships could take various forms, including concession agreements discussed below. 9.4.6 Concession Under this method, a private undertaking is authorised by the state to render a service based on a concession agreement for its own benefit. Concession arrangements, according to Guislain and Kerf (1995) are well suited for privatising sectors with monopolistic characteristics, in which the state cedes the responsibility to deliver a service while retaining some control through certain terms and conditions governing the project. Though not limited to these, some examples of this type of agreements include Build–Own–Transfers (BOT) and Build–Operate–Own (BOO) type of arrangements. In the case of the former, a private operator is responsible for building new infrastructure, which is returned to the state at the end of the concession agreement. While the latter is also similar, it does not involve the transfer of assets. 9.4.7 Withdrawal or discontinuation This form of privatisation involves the discontinuation of the provision of a particular service by the public sector, thereby creating an opportunity for a private entity to move in and render such a service at a profit. A good example of this could be services relating to public health or public safety. While this approach could improve efficiency and service delivery, it may be disadvantageous to low-income earners who may not be able to afford to pay for such services. It is important, therefore, that the state conducts a situational analysis in order to determine which services may be withdrawn. 9.4.8 Contracting out Contracting out is a form of privatising in which the public sector chooses to provide a selected service through a private service provider. When contracting out takes place, the public sector remains responsible for providing a particular service, but contracts with one or more private concerns to do the actual work for it at a specific 141

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Public Finance Fundamentals level. The government, through competitive tender processes, chooses a private contractor to provide the service. Most local government-level services, such as sanitation and refuse removal, are examples of this type of undertaking. 9.4.9 Voucher Vouchers may also be considered as a form of privatisation. Government provides recipients of services with funding in an earmarked form to use to shop around for services in the market. This method can be used effectively in a situation where market demand does exist and the only real problem is that certain individuals do not have the income to buy enough of the service. Vouchers thus allow the market to continue to operate with minimal government involvement, while also catering for low-income segments of the population. A good example could be food vouchers offered to the destitute and low-income earning groups. However, a number of concerns may arise from this type of system, including that the recipients of the vouchers are not adequately informed to make wise choices on the use of their income to obtain services (Craythorne, 1997: 461–462). It is imperative, having identified the different ways and means of privatising, to look into some of the advantages and disadvantages that accompany the concept.

9.5 Advantages and disadvantages of privatisation Exponents of privatisation justify its adoption by identifying certain benefits gained through the private ownership of key industries in an economy. Among these advantages are efficiency and effectiveness, as well as the easing of government overload. However, those against the process single out certain shortcomings, such as unaffordability – that is, citizens cannot afford to acquire the expensive services of the for-profit companies. 9.5.1 Advantages The benefits of privatisation are economic and social, but may also include benefits to the particular industry or organisation/firm. These benefits are briefly discussed below. Social benefits

Social benefits include wider participation in the economy, made possible by the fact that individuals are put in a position where, for example, they are able to own shares in enterprises. Also, sustainable employment may be promoted, directly or indirectly, through improvements in the economy (Department of Public Enterprises, 2000: 1). 142

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Privatisation as a major reform in public sector management Economic impacts

The sale of public enterprises eases the burden on government by reducing the public-sector borrowing requirement. The reduction of the level of state debt is also accelerated. Foreign direct investment (FDI) may be attracted, bringing technology and productivity improvements to formerly government-controlled parts of the economy. According to Perevalov, Gimadii and Dobrodei (2000), privatisation strengthens competition, which enforces the entity’s efficiency, while poorly performing SOEs slow down the growth of the private sector and increased competition. Benefits for industry

Benefits for industry include: ■■ the mobilisation of private sector expertise and capital ■■ the creation of effective market structures in the sectors dominated by public enterprises ■■ enhanced efficiency and effectiveness. With perceptions of government overload, fiscal stress and the maladministration pandemic worldwide, advocates of privatisation already view the privatisation of public enterprises as the only way forward for governments. Privatisation is thus regarded as amongst the best ways to end the inefficiencies and bureaucratic pathologies associated with public ownership (Durant & Ledge, 2002: 307). According to Gildenhuys (1997: 23), inefficiency and ineffective management of nationalised enterprises result in a lack of productivity and substantial financial losses, and privatisation is seen as a panacea to these economic ills. These ills contribute conspicuously to economic stagnation or even negative economic growth, which results in a shrinking tax base. Also, through privatisation – where market forces drive the economy – competition is enhanced, leading to decreased prices, which, in the end, benefits consumers. 9.5.2 Disadvantages Although exponents of privatisation have praised it as the panacea for most of the economic ills faced by governments worldwide, there are certain disadvantages associated with it: ■■ First, those against the ideology argue that there is no evidence that the public sector is less efficient than the private sector. Although there are certain instances where the public sector has failed to render services efficiently, it is also possible that complaints from the public arise even when the service is rendered by the private sector. In circumstances where a service is contracted to a private entity, and with politicians remaining politically accountable, it may be difficult for politicians to rectify problems until such contract runs out. 143

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Public Finance Fundamentals Secondly, government will need a relatively strong inspectorate to monitor the performance of the private entity to which services have been contracted in order to ensure that taxpayers get value for money. ■■ Thirdly, when a public service has been contracted out or discontinued, it could be difficult for the public sector to restart such a service or function at short notice in the event of the failure of the contractor (Craythorne, 1997: 463). ■■ Fourthly, the issue of job losses is the most critical when considering a policy shift towards privatisation. In a bid to become efficient, private entities would reasonably cut down on jobs. Despite the long-term benefits to the economy through efficient entities, which may include more jobs, any short-term and largescale job losses would not augur well for those concerned about South Africa’s already high unemployment rate. With an unemployement rate of above 25%, job losses are certainly a major concern for labour unions and the rest of the South African population. ■■

9.6 Alternatives to privatisation Supporters of privatisation contend that private enterprise can do a better job than the public sector. Their argument is based mainly on the fact that public bureaucracies are prone to failure. However, many opponents of privatisation, as indicated by Gormely (in MacAvoy et al, 1989: 7), argue that the performance of public bureaucracies can be improved through institutional redesign, involving, amongst other things, greater accountability to consumers, listening to workers, decentralisation and audits. Greater accountability to consumers: This entails ensuring a dramatic improvement in the performance of public bureaucracies, which are to be more accountable to the people whose interests they are supposed to serve. The idea behind this thinking is to improve the performance of public agencies through greater consumer choice or clientele feedback. ■■ Listening to workers: Workers in many public bureaucracies are brimming with ideas on how to improve their agency’s performance, but lack the platform to do so. The agency should therefore encourage workers to offer suggestions and participate in the planning process. This approach, it may be argued, could yield substantial benefits to public agencies. ■■ Decentralisation: In some instances, the improvement of services could entail radical measures, such as decentralisation. This process could empower lowerlevel employees to unleash their creative potential for the benefit of the institution. Decentralisation increases managerial autonomy, financial discretion as well as increased accountability. The devolution of such responsibility to lower■■

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Privatisation as a major reform in public sector management level employees certainly brings about a sense of ownership and commitment in the entity, which may translate to better performance and competitiveness of the entity. This method is more appropriate for medium and smaller-scale enterprises that are not widely geographically dispersed (Perlmann & Zarenda, 1997). ■■ Audits: Misspending of funds is a common characteristic of most public agencies. The introduction of stricter audits and the monitoring of expenditure could help to prevent the misappropriation of large amounts of funds (Gormely in MacAvoy et al, 1989: 6). Poor performance of SOEs can also be associated with poor accounting practices, since the assets of an entity cannot be accounted for. Additionally, weak auditing systems may open up the entity to corrupt practices, which may leave the entity seeking government bail-outs at the end of the day. 9.6.1 Intersectoral administration Apart from the means and ways of privatisation and the alternatives of privatisation outlined above, some scholars regard privatisation as passé. Instead, they focus on the change of that part in administration (public) caused by the forces of globalisation and devolution. These have resulted in an intersectoral network, caused by a configuration of laws, policies, organisations and institutions, cooperative agreements and formal agreements that control citizens and the delivery of public benefits. With these kinds of change, it is argued that the old term of ‘privatisation’ can no longer be relied upon; instead, Henry (2002: 377) prefers the term ‘intersectoral administration.’ ‘Intersectoral administration’ simply means the management and coordination of the relations among government agencies and the organisations in the private and non-profit sectors for the purpose of achieving specific goals. This process is thus a method of public policy implementation and government service delivery that is usually compatible with that environment, whereas privatisation is viewed as a subset of intersectoral administration that is designed to achieve public goals through government’s collaboration with profit-seeking companies (Henry, 2002: 377). 9.6.2 Public–private partnerships Public–private partnerships (PPPs) could be a very relevant example of intersectoral administration. PPPs can be defined as: ... a contractual agreement between a public sector and private sector entity whereby the private sector performs a governmental function in accordance with an output-based specification for a specified, significant period of time in return for a benefit, normally in the form of financial remuneration. It involves 145

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Public Finance Fundamentals a substantial transfer of all forms of project life cycle risk to the private sector. The public sector retains a significant role in the partnership project, either as the main purchaser of the services provided or as the main enabler of the project (National Treasury, 2000: 1). Within the South African context, PPPs are viewed as a way of enhancing the restructuring of state-owned enterprises by the involvement of the private sector in public service delivery.

9.7 Privatisation in South Africa Privatisation – which has often been referred to as ‘restructuring’ by the South African government – should be viewed in the light of a process of economic reform within a global environment. While most governments have utilised the term ‘privatisation’ in reference to their economic reforms, the South African government deliberately uses the term ‘restructuring’. Reasons cited for this are that restructuring is a much broader term that refers to a whole range of methods for economic reform. Unlike privatisation, which is rather narrow, restructuring deals with issues of economic reform, of which privatisation is one. Others are liberalisation and deregulation. However, the term ‘restructuring of state-owned enterprises’ is widely understood in South Africa to refer to the transfer of government ownership (either in whole or in part) of public corporations to the private sector. It should be emphasised that the rationale for privatising SOEs in South Africa has been aimed at increasing access to services by the historically disadvantaged as well as reducing costs and public debt. 9.7.1 The way forward for privatisation in South Africa Historically, the apartheid government used trends worldwide to justify its attempts to privatise. These attempts met with hostile rejection from the ANC and other opposition parties, together with COSATU. The ANC felt at the time that the National Party government would use revenue from the sale of public assets to finance its policies. Upon assuming power in 1994, the ANC government moved from the critical position it had held in the Reconstruction and Development Programme (RDP). As articulated in the Growth, Employment and Redistribution (GEAR) policy, the ANC shifted to a more positive approach towards privatisation, and then to the nuanced view expressed in the policy framework of 2000. The South African government earmarked certain enterprises within the energy, telecommunications and manufacturing industries for restructuring. These include the following key enterprises: Telkom, Denel, Transnet and Eskom, which are major players in the South African economy, as well as in the provision of public services and employment. 146

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Privatisation as a major reform in public sector management The ANC government’s position on privatisation has met with opposition from its alliance partners, the SACP and COSATU, who felt that privatisation would not benefit the poor. COSATU maintained that it is not opposed to the restructuring process, but that the state restructuring process forms part and parcel of the broader privatisation programme. This position has seen protest action by COSATU and likeminded groups; however, the government has continued with the process. Privatisation can take several forms, and restructuring is the approach that the ANC government seemed to prefer for its efforts at privatisation, though the debate (vis-à-vis nationalisation) re-emerged during the Zuma administration. Restructuring in this context means that SOEs are not simply sold off to private investors, but instead includes the reconfiguring of the organisational structures of SOEs to mirror private-sector operating methods and performance measures, comprehensive partnerships between public and private institutions, and contracting out specific activities to private sector organisations. The South African government expects privatisation to: ■■ increase the amount of foreign direct investment in the country ■■ raise capital from the sale of SOEs to reduce the public sector borrowing requirement ■■ increase opportunities for investment for the domestic private sector. But there is also the guarded realisation that ‘strategic’ SOEs – such as the SABC, Eskom and Denel – would not be considered for privatisation, as the White Paper on Privatisation and Deregulation, 1987 states, in paragraph 7.2.1, that ‘governmental functions which are so intimately related to the public interest that they require compulsory performance by public officials [eg defence of the country] will not be privatised.’ Although privatisation has proved to be a relatively controversial issue in South Africa in recent years, the South African government’s plans for restructuring SOEs gained prominence during the Mbeki administration. The Department of Public Enterprises, under instruction from the cabinet, during this period earmarked four of the largest SOEs, namely Eskom, Transnet, Telkom and Denel. All other SOEs were also being reviewed for restructuring and the major elements of the restructuring process had been expected to be completed by end of 2004, though this did not happen in the anticipated timeframe. Despite calls by the ANC Youth League for the nationalisation of mines, government policy remains unchanged since the Zuma administration. While Zuma had continuously stated that nationalisation was not 147

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Public Finance Fundamentals government policy, it was expected that the party and its alliance partners, especially its youth wing, would push for a move towards nationalisation of the mines. The emergence of new political parties, such as the EFF, with a more leftist agenda has put even more pressure against privatisation. Theirs is a more radical approach to transform the economy, calling for the nationalisation of state assets. The longstanding and ongoing financial crisis at Eskom (the nation’s energy supplier) has drawn special attention from the current administration of President Cyril Ramaphosa. As an attempt to save the ailing power utility, the president announced in his State of the Nation Address (SONA), that Eskom would undergo a process of unbundling. Unbundling is defined as a process by which a company with several different lines of business retains core businesses, and sells off assets, product lines, divisions or subsidiaries. Unbundling is done for a variety of reasons, but the goal is always to create a better-performing company or companies. Unbundling may also refer to offering products or services separately that had been packaged together. A crucial point made by President Ramaphosa in his SONA address is that separating Eskom’s divisions into separate units allows each entity to source funding on its own merits. This is important because it allows the transmission and distribution operations to deal with their future roles in the power sector independently and, most importantly, identify and deal with their own urgent needs without being overshadowed by the generation sector and its multiple challenges (https://www. gov.za/sona2019). Those who welcome this initiative simply see it as a restructuring exercise, whereas unions and other sceptics see it as a covert first step towards privatising the utility. Although a more detailed account is yet to be provided, the president has thus far stopped short of calling for privatisation. Yet, despite the unease about privatisation, the various alternative forms should be considered by governments. This would be necessary to create a balance between the failure of SOEs and the gains of privatisation. If the government does choose to privatise, it should be done correctly, by considering the best alternatives given the conditions of the country, including addressing public access to services, poverty and unemployment.

Summary and conclusion Politicians, exponents of privatisation and most countries all over the world see privatisation as a potent engine for development. For the politician, the shifting of government functions into the private sector has offered a solution to the 148

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Privatisation as a major reform in public sector management problems confronting most politicians – that is, reducing government spending. Undoubtedly, the option of providing a service to the public, efficiently and at a lower cost, would be worth a try for most legislators. In countries such as the USA and Britain, privatisation seems to have aroused much interest, as it is doing even in less-developed countries. This is evidenced by a shift towards the private provision of public services in most countries around the world. However, as much as privatisation brings about benefits such as increased competition and efficiency; it has its own shortcomings, including loss of jobs and income on the workforce in the short term. As such, privatisation should not be the sole panacea to societal, and particularly socio-economic, challenges. Public sector reform and alternatives adopted by governments should consider the local conditions of the country, including addressing public access to services, poverty and unemployment as in the case of South Africa.

Self-examination questions 1. Discuss privatisation in South Africa, in both a historical and a contemporary context. 2. Compare and contrast the South African union movements’ views of privatisation with those of the South African government and ruling political party.

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R E T P A H C

10

From procurement and tendering to supply chain management K Moeti

LEARNING OBJECTIVES By the end of this chapter, you should be able to: ■ define the term ‘public procurement’ ■ make the distinction between procurement and inventory management ■ present arguments for and against the decentralisation of procurement tendering ■ explain routine purchasing ■ describe the social goals of procurement ■ define supply chain management.

Introduction The goods and services acquired by a government represent, on the one hand, a substantial amount of public resources spent and, on the other, a substantial source of income to private service providers. Therefore it is required that measures be put in place to ensure that government institutions receive the best possible supply of goods and services at the most economical price, whilst at the same time ensuring that potential service providers are afforded the opportunity to compete for contracts on a fair and equitable basis – taking into account, in the South African context, the government’s intentions to redress past discrimination. This chapter focuses on, among other things, the procurement of goods and services by government. It has been noted elsewhere in this text, and is to some extent common knowledge, that most fraud and corruption in government occurs through

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From procurement and tendering to supply chain management poor procurement management and control. This being the case, reform of official procurement policy in the South African public sector was inevitable. The two key reforms in public procurement in South Africa relate to decentralisation of the process of procurement through tendering, and the introduction of supply chain management (of which procurement management forms a part). These two reforms anchor the discussion of this chapter. The chapter also deals with tendering as a process, routine purchasing, and the social policy goals of procurement.

10.1 Tendering as a process Diverse and plentiful inputs are needed by government before the provision of goods and services to the people can take place. These inputs include, among other things, office space, office furniture, office equipment (including computers, printers and telephones), stationery and the salaries of government workers. All of these, with the exception of salaries, may be acquired through procurement (ie the purchasing of goods and services). Public procurement: The purchasing of goods and services by government from the private sector. Two management decisions must be made prior to the decision to purchase (procure) goods and services. First, management must attach a weight to the benefits and costs of producing the desired goods in-house, and compare this to the (also weighted) benefits and costs of procuring the desired goods through private commercial vendors. Secondly, as the tendering process is a lengthy and complex one, it is not feasible to purchase everything needed by government through tendering. In fact, government policy dictates that all purchases of an amount of R30 000 or more require formal tender processes (Preferential Procurement Regulations 2017). The tender process includes: ■■ calling for tenders ■■ opening and assessing the tenders ■■ awarding tenders.

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Public Finance Fundamentals Note: There is an important distinction to be made between procurement and inventory management. Procurement is the purchasing/acquiring of goods, whereas inventory management occurs after goods have been purchased and includes, inter alia, such aspects as the maintenance of proper storage and accounting systems for acquired goods; determining the optimal amount of the good or service to keep in inventory/storage; determining the minimum level of inventory at which an order must be placed, and disposal of obsolete inventory. Supply chain management, discussed later in the chapter, combines procurement and inventory management into one seamless, integrated process.

10.1.1 Calling for tenders First and foremost in calling for tenders, a manager must ensure that the funds needed to conclude a tender contract are available, therefore budgeting is central to public procurement, in the sense that all procurement decisions must be made as approved on the public budget. Once budget funding for a given capital project or capital asset has been confirmed, the actual tendering process begins by informing the public of the opportunity to tender. In theory, the announcement of the invitation to tender should be publicised in such a way that no citizen or private institution is excluded from the opportunity to tender their bids. In practice, however, some invitations to tender may be placed in specialised industry publications so as to limit the selection process to those who are uniquely qualified. Regardless of where or how the invitation to tender is publicised, further standard requirements are that: ■■ the nature and specifications of the desired good or service must be clearly communicated ■■ information about the required attributes of potential suppliers must be communicated ■■ the closing date and time of the tender must be made clear ■■ the fact that no late tenders will be accepted must be communicated. Tender: A proposal to provide a good or service in competition with other potential suppliers.

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From procurement and tendering to supply chain management 10.1.2 Opening, assessing and awarding tenders To avoid the unfair selection of a tender bid, all tenders received in good time must be opened in public. Particulars of each tender must be made public and this information should be entered into an official tender register to be kept for auditing purposes. A well-qualified internal tender selection committee (or tender board) should compare the tenders against one another as well as against a set of predetermined criteria. The tender committee should then make its selection and prepare a contract for the successful bidder. All bidders should be invited to attend the opening and awarding of tenders, as this goes a long way towards mitigating claims by bidders and other interested parties of tenders having been unfairly awarded.

10.2 Decentralisation of tendering as a reform With the political regime change to the 1994 ANC-led government came a number of reforms in public service delivery. Key among these were efforts to reform what the government perceived as an inefficient procurement and tendering policy framework. In this regard, the ANC government channelled its reform efforts into two broad focus areas, namely: 1. the promotion of principles of good governance 2. the introduction of a preference system to address certain historically created racial and socio-economic disparities. Government’s efforts to draw the principles of good governance into the procurement and tendering processes focused on decentralisation as a means to achieving efficiency gains. The 1994 government inherited a model of procurement and tendering that was managed by the State Tender Board and fell under the ambit of the former Department of State Expenditure. Under this model, procurement and tendering processes were highly centralised, resulting in administrative delays and vast overhead expenses. Amongst the decentralisation reforms introduced by the PFMA, is section 38(1)(a)(iii), which places upon accounting officers, the full responsibility for ensuring the existence and maintenance of a procurement system in his/her institution. The reason for the government’s massive reform in the area of tendering may be better understood in the context of the following arguments made in favour of and against centralisation.

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Public Finance Fundamentals 10.2.1 Arguments in favour of centralised procurement tendering The key argument in favour of a state tender board relates to economies of scale. Where one institution (or group of people) is responsible for all matters of procurement, savings are experienced by government. There is no duplication of effort if government institutions do not each have their own tender committee and process. Some believe that central purchasing works efficiently, because all government institutions need more or less the same goods and services, and where these can be bought in bulk (for the entire public service), savings can be experienced. 10.2.2 Arguments favouring decentralised procurement tendering Arguments in favour of decentralisation relate mostly to the fact that in the previous procurement system, state tender boards were naturally far removed from suppliers. Procurement decisions were thus often made without a proper flow of communication between potential service providers and the government agents in need of their services. Proponents of decentralisation of government procurement maintain that managers in government are in much closer contact with existing and potential suppliers and as such are better placed to make decisions in which their own needs are appropriately balanced against what suppliers have on offer. Pauw et al (2002: 241–242) identify the following arguments in favour of decentralisation: ■■ Having greater authority over their spending will provide opportunities for managers to receive better value for money, make better product choices, and achieve better service from suppliers. ■■ If accounting officers have full responsibility, for which people hold them accountable, performance and accountability at the departmental level will be greatly enhanced. ■■ Transparency ought to be enhanced where purchasing and procurement transactions are conducted at an individual organisational level. ■■ There could be more appropriate internal controls, which would minimise procedural failings. From the above, it seems apparent that arguments in favour of decentralisation are more persuasive than those to the contrary. This is affirmed by the current worldwide trend towards decentralised government procurement.

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From procurement and tendering to supply chain management

10.3 Routine purchasing As previously discussed, it is not cost effective for all purchases of government to occur through the tendering process. For purchases up to R30 000, routine purchasing is the prescribed method of public procurement. The two basic steps of routine purchasing, namely ordering and receiving, are briefly discussed below. 10.3.1 Ordering for routine purchases To purchase goods and services that have been budgeted for, but for which the tender process is not required, the relevant steps to be followed in ordering are as follows (Pauw et al, 2002: 246): ■■ A purchase requisition must be completed by the public official authorised to make a given purchase. ■■ The relevant line manager authorises the purchase requisition and it is then sent to the buying section. ■■ The buying section, in consultation with the public official and the relevant manager, selects the supplier offering the best combination of price and quality. ■■ The buying section makes out a purchase order and sends it to the selected supplier. 10.3.2 Receiving for routine purchases ■■ ■■ ■■ ■■ ■■ ■■ ■■

The stores or user department receives the goods, together with a delivery note. The goods are checked against the delivery note and the original purchase order. A goods received note is made out. The supplies are taken into stock and the stock records are updated. The invoice (bill) is received and married up with the delivery note, the goods received note and the purchase order. The invoice then goes to the accounts department. Payment is processed when it becomes due.

It can be concluded from the above that routine purchasing is not a simple and unsophisticated process. Instead, a number of steps are involved, and various authorisations and documents are generated for each step of the process – these must be kept on file as a paper trail of all goods and services purchased. Each of the steps outlined above is critical if effective purchasing is to take place. In this regard, imagine what would happen if all paperwork were completed but the stock records were not routinely updated when goods received are placed in stock. With no stock record of the received goods, these goods could easily disappear and 155

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Public Finance Fundamentals no one would be the wiser. As a second example of the importance of the steps in the routine purchasing process, consider that, without a duly authorised (signed) purchase requisition, a public official could simply order computers, office furniture and other goods for his or her home at taxpayers’ expense. One can think of many problems, including theft and fraud, that may occur in purchasing if any of the above steps were omitted, or the relevant documentation for each step were not maintained. Even in computerised environments, it should be possible to trace transactions back through each step of the routine purchasing process.

10.4 Social policy goals of procurement Economic exclusion and marginalisation of black South Africans were effectively achieved by the previous regime’s policies of apartheid and job reservation for whites. These policies robbed the black majority of an opportunity to participate in and enjoy the fruits of the economy. Since the establishment of democracy in South Africa in 1994, however, the ANC, as the ruling party, has made the reversal of this situation a key policy objective. Indeed, it would be simplistic and perhaps even incorrect to say that the ANC sought simply to reverse discrimination. Instead of creating a situation of reversed discrimination, the ANC actually sought to bring equity into the way government conducts its business. Equity, as discussed in a previous chapter, is the assertion that all persons (black, white, Indian, coloured, women, the disabled, etc) deserve a fair share, which may not necessarily amount to an equal share. With respect to equity, one of the principal policies of government, in addition to social programmes, is what has come to be termed ‘preferential procurement.’ Preferential procurement has turned out to be a significant vehicle by which the government can provide economic opportunities to previously disadvantaged groups. The Preferential Procurement Policy Framework Act 5 of 2000, or alternatively the PPPFA, gives effect to Section 217 of the South African Constitution Act 108 of 1996. In Section 217, government institutions are mandated to procure goods and services ‘… in a manner which is fair, equitable, transparent, competitive and cost effective’. Section 217 further allows public institutions to structure their procurement policies and practices on the basis of preference for previously disadvantaged groups of persons. The PPPFA provides a framework, as prescribed by Section 217 of the Constitution, within which government institutions must procure goods and services. As per Section 2(1) of the PPPFA, this framework is based on a preference point system, as follows: 156

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From procurement and tendering to supply chain management ■■ ■■ ■■

■■

■■

■■

Contracts must be awarded to the bidder with the highest point score. Point scores are to be awarded for price, meeting social objectives specified in the Act, and quality. The social objectives specified in the Act include: ❏❏ contracting with persons, or categories of persons, historically disadvantaged by unfair discrimination on the basis of race, gender or disability; and/or ❏❏ implementing the programmes of the Reconstruction and Development Programme (RDP), as published in Government Gazette 16085, dated 23 November 1994. For contracts worth over R50 million, a maximum of 10 points can be awarded to a bidder for meeting social objectives, provided that bid is the lowest acceptable tender and as such scores 90 points for price. For contracts worth R30 000 to R50 million, a maximum of 20 points may be awarded to a bidder for meeting social objectives, provided that bid is the lowest acceptable tender and as such scores 80 points for price. The contract must be awarded to the tenderer (bidder) who scores the highest combined points for price and meeting social objectives, unless factors such as experience and expertise must also be considered for purposes of quality assurance.

In simpler terms, this means that the winner of a tender is the bidder who scores the highest points, out of a maximum of 100. For larger contracts above R50 million, there is less emphasis on meeting social goals and more on the lowest price, as only 10 points can be awarded for social goals and up to 90 points for price. With contracts of smaller amounts (under R500 000), the reverse is true – that is, there is greater emphasis on social goals (maximum 20 points) and less on price (maximum 80 points). A simple example may illustrate this: Imagine that a school has two prizes to give away to high achievers – one is an amount of R500 and the other R200. The learner with the highest mark wins. In the R500 competition, the maximum mark is 100, of which 90 is for academic achievement, and 10 is allocated for attendance and punctuality. So a learner could win the R500 if he or she gets at least 90% on the test. Ten percentage points may be added for the other criteria: attendance and punctuality. Here good behaviour, in the form of attendance and punctuality (worth 10%), is not as important as academic performance. For the prize of R200, the maximum mark is still 100, of which 80 is for academic achievement and 20 for attendance and punctuality. So a learner can win by scoring 157

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Public Finance Fundamentals at least 80% on the test and then earning up to extra 20 percentage points for attendance and punctuality. Here good behaviour (worth 20%) is given more weight than in the competition above, and academic performance is a little less important, whilst the payout is also a bit less.

10.5 Supply chain management In keeping step with international best practice, Treasury is in the process of implementing a new system of procurement and asset disposal based on supply chain management principles. Supply chain management is ultimately concerned with maximising affordability and value for money in the processes of procurement and disposal of the assets of institutions. This system is to be applied uniformly throughout the three spheres of government (see Figure 10.1). Supply chain management

Acquisition management

Logistics management

Disposal management

Government’s preferential procurement policy objectices

Infrastructure (systems)

Demand management

Supply chain performance database(s)

Figure 10.1 Supply chain management, a system for the procurement and disposal of assets

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From procurement and tendering to supply chain management The supply chain management model being used by Treasury works within a systems framework that integrates: ■■ demand management (determining future needs and critical delivery dates and matching these to the institution’s budget) ■■ acquisition management (taking account of preferential policy objectives in procurement, and bid and contract processes and documents finalised) ■■ logistics management (receiving, coding and distribution of goods purchased) ■■ disposal management (planning for the sale of obsolete assets at fair market value) ■■ supply chain performance evaluation and control (assessing cost variances, compliance with treasury norms and standards, and the achievement of institutional goals). The principle benefit of supply chain management lies in its overarching and coordinating function, whereby all aspects of acquiring, maintaining and disposing of assets are accounted for. The faulty argument is often made that supply chain management forms part of procurement management. This argument can easily be dispelled when one considers the true nature of supply chain management as prescribed by the national treasury and outlined above. In 2003, Treasury issued a framework document of regulations to be followed by accounting officers in the supply chain management process. These regulations entail, among other things, the requirement that each public institution establish a supply chain unit within the office of that institution’s chief financial officer. This unit is charged with the responsibility of implementing the institution’s supply chain management system.

Summary and conclusion Many governments spend a substantial amount of public money on procuring goods and services from the private sector. This chapter introduced the concept of tendering in procurement. Tendering refers to the purchasing of goods and services through competitive processes, creating an opportunity for qualified suppliers to compete for provisioning contracts. The result of this competitive process is that the state is able to acquire goods and services of the highest quality at the lowest cost. The chapter also highlighted the issue of the South African government’s efforts to redress past racial discrimination by empowering designated groups of persons to receive preference in government tendering. The relevant legislation in this regard 159

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Public Finance Fundamentals is the Preferential Procurement Policy Framework Act 5 of 200, which is commonly referred to as the PPPFA. For smaller purchases (purchases of an amount that does not require tendering) the procurement of goods and services is referred to as routine purchasing, and the formal processes used in purchasing (regardless of the size of purchases) in order to avoid losses through inefficient process or fraud still apply. The last section of the chapter dealt with supply chain management, which in many respects is one of the key reforms in South African public financial management. Supply chain management effectively integrates procurement (both through routine purchasing and tendering) with the systems and processes for receiving, storing, retrieving and disposing of these goods.

Self-examination questions 1. Write an essay on the Preferential Procument Policy Framework Act 5 of 2000. 2. Discuss decentralisation as a reform in tendering for state contracts in South Africa. 3. Compare and contrast routine purchasing to tendering in the South African context.

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R E T P A H C

11

Local government financial management in South Africa N Nkuna M Sebola

LEARNING OBJECTIVES By the end of this chapter, you should be able to: ■ understand the financial affairs of municipalities ■ mention and explain the aspects involved in municipal finances ■ understand the structures involved in municipal financial management ■ understand municipal budgeting and reporting on financial matters.

Introduction Good financial management is crucial for the success of municipalities, especially in the area of service delivery. It goes without saying that almost all strategies and objectives of municipalities can only be implemented through the spending of money. The manner in which municipalities go about managing their finances will determine, to a large extent, if and how objectives and mandates will be achieved. South African local government sits in a very unenviable position in relation to satisfying the basic needs of the citizenry. This is because this sphere of government is regarded as the one that is closest to the people and is thus charged with delivery of basic yet critical services. At the same time, due to factors such as non-payment by recipients and a low tax base, financial resources are severely constrained in many municipalities. This chapter presents an introduction to financial management in the context of South African local government. In so doing, the need for financial management within local government is outlined. That need is cascaded down from the democratic principles of South African government that have given shape to public

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Public Finance Fundamentals administration and public management, and their related sub-disciplines. The nature and role of the various structures and stakeholders involved in local government finances are also discussed. The chapter also takes note that the core of local government financial management revolves around budgeting. Budgeting itself comprises a range of activities that, if properly adhered to, build up to effective and efficient financial management. To ensure the principle of accountability as discussed in the previous chapter, financial reporting and auditing in local government rounds off the discourse on proper financial management within local government.

11.1 Background to local government challenges in South Africa The statement is often made that we need not blame our apartheid past for all that is wrong in society today. However, one clear example of the daunting legacy left behind by apartheid separationist legislation and policy lies in the development of local communities across the country. Apartheid created distortions in settlement patterns on the basis of race, designed to bring about an uneven distribution of municipal capacity in favour of white urban areas to the detriment of mostly black peri-urban and rural municipalities. The Group Areas Act 41 of 1950, with its establishment of forced removal of blacks, spatial separation of races and influx control, was the principle instrument used by the apartheid government to disenfranchise the majority black population whilst simultaneously creating pockets of white privilege (1998 White Paper on Local Government). Today, many so-called townships and rural municipalities are far removed from access to industrial development, employment opportunities and a tax base that is sufficient for providing services to residents. Scores of South African municipalities are thus operating from a weakened position of inherited and widespread poverty and under-development.

11.2 The need for financial management in local government Local governments are required through their constitutional establishment to render services to citizens residing within their municipal boundaries and jurisdiction. In rendering these services, substantial amounts of financial resources are required in one form or another (own revenue, equitable share grants, etc). In terms of its establishing ideal for South African local government, unlike the other spheres of government, local government is expected to raise over 90% of its own revenue to render the required services. The raising of such revenue and expending it for the delivery of basic services require municipalities to have efficient and effective financial management systems in place. An additional concern is that the finances being dealt with in local government are part of public money. Public money belongs to the people (Pauw et al, 2009: 15) and therefore it must always be used 162

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Local government financial management in South Africa in ways that are in the public interest or that are of public benefit. This requires accountability (as discussed in Chapter 8 of this book). The processes involved in collecting public money and spending it for public interest is complex to the extent that a set of management ideals first has to be put in place. This management ideal is present in the 1996 South African Constitution, as well as in various theories that inform the management of local government finances.

11.3 Democratic principles and local government finance Democratic South Africa has its founding through the Constitution of the Republic of South Africa of 1996. The Constitution provides for the rights of all citizens in the country, including the right to basic services that are provided by municipalities as the part of government closest to the people. In providing these basic services, municipalities must encapsulate the basic principles of democratic governance that are enshrined in the Constitution. Literature provides various conceptualisations of democratic principles in public administration. In this book the democratic principles of public administration and management in South Africa are as provided for in section 195 of the Constitution. Of these principles, the ones that relate to effective financial management are that: ■■ a high standard of professional ethics must be promoted and maintained ■■ efficient, economic and effective use of resources must be promoted ■■ public administration must be development oriented ■■ services must be provided impartially, fairly, equitably and without bias ■■ people’s needs must be responded to, and the public must be encouraged to participate in policy making. The principles are applicable to every sphere of government, state organs and public enterprises. The principles as outlined above form the basis of the practice of South African public administration, and must inform local government financial management.

11.4 Legislative framework for municipal financial management in South Africa Municipal financial management takes place within a policy framework that is regulated by law in South Africa. As mentioned elsewhere in the text, this legislation must be in line with the provisions of the Constitution. Other than the Constitution, a number of other acts and policies have come into effect, closing out the final phases of local government transformation in South Africa. A summarised exploration of legislation and policy pertaining to local government financial management in South 163

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Public Finance Fundamentals Africa follows, with a brief summary of the provisions of each in terms of purpose (see also Pauw et al, 2009: 256): 11.4.1 Local Government Municipal Demarcation Act 27 of 1998 The Local Government Municipal Demarcation Act was enacted by parliament to provide for criteria and procedures for the determination of municipal boundaries by an independent authority, and to provide for matters connected thereto. The independent authority here is the Municipal Demarcation Board that is established to, from time to time, determine categories and size of municipalities. Such category and size of a municipality will therefore have a bearing on the extent to which it manages its finances in that the boundaries that cover the municipal area are to a large extent a determinant of spatial planning for such municipality. 11.4.2 Local Government Municipal Structures Act 117 of 1998 The Local Government Municipal Structures Act was enacted by parliament to provide for the establishment of municipalities in accordance with the requirements relating to categories and types of municipality. It establishes the criteria for determining the category of municipality to be established in an area that has been determined by the Municipal Demarcation Board. It further provides for an appropriate division of functions and powers between categories of municipalities as well as regulating the internal systems, structures and office bearers of municipalities through provision for appropriate electoral systems, and for matters in connection therewith. The conditions within which the municipality is established determines the delegation of functions and responsibilities for financial management in terms of the category of that municipality. 11.4.3 Local Government Municipal Systems Act 32 of 2000 The Local Government Municipal Systems Act was promulgated to provide for the core principles, mechanisms and processes that are necessary to enable municipalities to move progressively towards the social and economic upliftment of local communities, and ensure universal access to essential services that are affordable to all. It defines the legal nature of a municipality as including the local community within the municipal area, working in partnership with the municipality’s political and administrative structures established in terms of the Local Government Municipal Structures Act. The Local Government Municipal Systems Act provides for the manner in which municipal powers and functions are exercised. Fundamentally, it calls for community participation through the establishment of a simple and enabling framework for the core processes of planning, performance management, resource 164

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Local government financial management in South Africa mobilisation and organisational change, each of which underpins the notion of developmental local government. The act puts emphasis on empowering the poor and ensuring that municipalities put in place service tariffs and credit control policies that take their needs into account. In addition, the act also calls for the establishment of a framework for support, monitoring and standard setting by other spheres of government in order to progressively build local government into an efficient, frontline development agency capable of integrating the activities of all spheres of government for the overall social and economic upliftment of communities in harmony with their local natural environment. Lastly, the act further provides for legal matters pertaining to local government; and for matters incidental thereto. Local Government Municipal Planning and Performance Management Regulations of 2001

The Local Government Municipal Planning and Performance Management Regulations are put in place to regulate provisions of the Local Government Municipal Systems Act wherein such is required. In implementation of the act, provision is made for certain sections to have further regulations that give effect to the implementation of such sections. In terms of these regulations, provision is for planning and performance management. 11.4.4 Preferential Procurement Policy Framework Act 5 of 2000 The Preferential Procurement Policy Framework Act is assented to give effect to Section 217 (3) of the Constitution of the Republic of South Africa 1996 by providing a framework for the implementation of the procurement policy contemplated in Section 217 (2) of the same constitution, and to provide for matters connected therewith. Section 217 of the Constitution provides for the procurement of services within government and other public entities. It indicates that when an organ of state in the national, provincial or local sphere of government, or any other institution identified in national legislation, contracts for goods or services, it must do so in accordance with a system which is fair, equitable, transparent, competitive and cost effective. 11.4.5 Preferential Procurement Regulations of 2001 Preferential Procurement Regulations of 2001 is enacted pertaining to the Preferential Procurement Policy Framework Act 5 of 2000. The regulation provides for the preference point system, evaluation of tenders, awarding of tenders not scoring highest points, cancellation and re-invitation of tenders. It further regulates the following – duty to plan, general conditions, principles, declarations, penalties, tax clearances and tender goals within local government and other government entities. 165

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Public Finance Fundamentals 11.4.6 Local Government Municipal Finance Management Act 56 of 2003 The Local Government Municipal Finance Management Act (MFMA for short) seeks to secure sound and sustainable management of the financial affairs of municipalities and other institutions in the local sphere of government. It does this through establishing treasury norms and standards for the local sphere of government, and providing for matters connected therewith. The act is the core for local government financial management. Each municipality as a local government has to adhere to the provisions of the act while dealing with financial management. 11.4.7 Local Government Municipal Property Rates Act 6 of 2004 The Local Government Municipal Property Rates Act is enacted to regulate the power of municipalities to impose rates on property for revenue generation. Certain properties that are for national interest are excluded. In implementing the provisions of the act, municipalities are required to be transparent and apply a fair system of exemptions as well as reductions and rebates through their rating policies. The act further makes provision for an objections and appeals process whereby property owners may make submissions. 11.4.8 Intergovernmental Fiscal Relations Act 97 of 1997 The Intergovernmental Fiscal Relations Act seeks to promote cooperation between the national, provincial and local spheres of government on fiscal, budgetary and financial matters through prescribing a process for determining equitable sharing and allocation of revenue raised nationally. Local government has a share in the revenue raised nationally, and it is through this legislation that cooperation among the spheres of government is regulated vis-à-vis sharing such revenue. 11.4.9 Division of Revenue Act (differs from year to year) The Division of Revenue Act is passed before the beginning of each government financial year to determine the allocation of the state revenue to all government entities including local government. The act stipulates the amounts of revenue allocated to each government entity per category, and is adopted by parliament through the minister of finance’s budget speech. 11.4.10 Intergovernmental Relations Framework Act 13 of 2005 The Intergovernmental Relations Framework Act is enacted to establish a framework for the national government, provincial governments and local governments to promote and facilitate mechanisms and procedures to facilitate the settlement of 166

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Local government financial management in South Africa intergovernmental disputes. This legislation is put in place to ensure that mechanisms are in place to deal with intergovernmental relations issues as they arise. 11.4.11 Public Audit Act 25 of 2004 The Public Audit Act is enacted to give effect to the provisions of the Constitution of the Republic of South Africa of 1996 by establishing and assigning functions to an auditor general to provide for the auditing of institutions in the public sector and to provide for accountability arrangements of the auditor general. All monies that are utilised in the public sector are subjected to public audit as a means of accountability within the society. 11.4.12 Municipal Fiscal Powers and Functions Act 12 of 2007 The Municipal Fiscal Powers and Functions Act is enacted to regulate the exercise by municipalities of their power to impose surcharges on fees for services provided under Section 229(l)(a) of the Constitution of the Republic of South Africa 1996. The act also provides for the authorisation of taxes, levies and duties that municipalities may impose under Section 229(l)(b) of the Constitution. 11.4.13 Municipal Supply Chain Management Regulations of 2005 The Municipal Supply Chain Regulations are put in place to give effect to the implementation of the provision of supply chain management as provided for in the Local Government Municipal Finance Management Act 56 of 2003. The regulations are meant to synchronise the implementation of the act as specified in relevant sections as well as ensuring uniformity in application. 11.4.14 Municipal Investment Regulations of 2005 The Municipal Investment Regulations are enacted to provide for criteria to be followed by municipalities in terms of dealing with investment as provided for in the Local Government Municipal Finance Management Act 56 of 2003. Each municipality has to adhere to the provisions when dealing with matters of investment. 11.4.15 Municipal Public Private Partnership Regulations of 2005 Municipalities as local government have due regard for the fact that delivering services may require partnership with other public and/or private entities. Such process is within the scope of local government financial management, and is provided for in the Local Government Municipal Finance Management Act 56 of 2003. The Municipal Public Private Partnership Regulations provide for the effect of such implementation to ensure that proper guidance is in place for municipalities. 167

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Public Finance Fundamentals 11.4.16 Local Government Municipal Performance Regulations for Municipal Managers and Managers Directly Accountable to the Municipal Manager of 2006 The Local Government Municipal Systems Act provides for the employment of municipal managers and managers accountable to the municipal manager to be on contractual basis. The Local Government Municipal Performance Regulations for Municipal Managers and Managers Directly Accountable to the Municipal Manager of 2006 regulates for such appointment to assist municipalities in giving effect to the provisions of the legislation. 11.4.17 Local Government Municipal Finance Management Circulars issued by the National Treasury from time to time The national treasury, from time to time, issues circulars that guide and assist in managing public finances. This is done in terms of the national treasury being the custodian of the state’s fiscus and having the mandate to regulate public finance management as it relates to the country’s economy.

11.5 The cycle of local government financing Municipal financial management needs to be understood as a revolving cycle that moves within the stages of the local government financial year. The local government financial year in South Africa begins on 1 July and ends on 30 June of the following calendar year. Thus local government finance refers to the period of 12 months which municipalities expend on its approved budget before the start of the next budget cycle. That cycle moves in line with other municipal planning processes like the Integrated Development Planning (IDP) that serves as the master plan for the municipality during the municipality’s elected term.

11.6 Structures involved in local government finance Local government finance involves various structures, in addition to communities and community organisations, in the form of political representation and administrative components. The structures can be classified into internal and external categories. The internal structures are those that are within the structural establishment of a municipality as a local government. Those structures are the elected municipal council, the municipal council’s executive committee, the mayor, the accounting officer, the chief financial officer, the heads of departments, and the general administrative staff of the municipality. External structures are those that are outside the structural establishment of the municipality. These structures include the Office of the Treasury in the form of the National Department of Finance, as well as the 168

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Local government financial management in South Africa auditor general. The nature and role of each of these structures is discussed in the following paragraphs. 11.6.1 The elected municipal council Each municipality has an elected municipal council that is comprised of councillors elected per the electoral system of the country. The electoral system in South African local government currently provides for the election of ward councillors and proportional councillors. Ward councillors are elected by the electorate to represent the delimited ward within the municipal council, while proportional councillors are elected to represent (proportionally) political parties that participated in local government elections of that municipality. Table 11.1 Structures and role players involved in local government financial management

INTERNAL STRUCTURES

INTERNAL ROLE PLAYER

Municipal council

Mayor Municipal council’s executive committee Mayoral committee

Finance Portfolio Committee

Chairperson and members

Office of the municipal manager (MM) Risk management unit Internal audit unit

Municipal manager Chief risk officer (CRO) and staff Internal audit manager and staff

Departments

Heads of departments with other staff members with financial responsibilities

Budget and treasury office Supply chain management unit Bid committees Disposal committees

Chief financial officer (CFO) Head of expenditure (supply chain management) Asset management Head of revenue (income)

EXTERNAL STRUCTURES

EXTERNAL ROLE PLAYERS

Auditor general

External auditors

Provincial treasury

MEC for finance

Department of Local Government

MEC for local government

Source: Adapted from Pauw et al (2009: 275)

11.6.2 The municipal council’s executive committee Each municipality (depending on its nature and category of establishment in South Africa) elects, from among its councillors, the municipal council’s executive committee. This committee is delegated matters that are required by law for the council to deal with. In circumstances where the municipality has in terms of its category of establishment had an executive mayor, such municipality will instead have a mayoral council. 169

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Public Finance Fundamentals 11.6.3 The office of the mayor Each municipality has a mayor who is the political head of the municipality depending on the category and type of the municipality. There are municipalities that, in terms of their establishment category, have executive mayors and there are those that have a mayor but without an executive mandate. The Local Government Municipal Finance Management Act 56 of 2003 provides for the roles of the mayor in relation to local government financial management. Those roles are that the mayor of a municipality must provide general political guidance over the fiscal and financial affairs of the municipality. In providing such general political guidance, the mayor may monitor and, to the extent provided for by law, oversee the exercise of responsibilities assigned in terms of law to the accounting officer and the chief financial officer, but may not interfere in the exercise of those responsibilities. He or she must take all reasonable steps to ensure that the municipality performs its constitutional and statutory functions within the limits of the municipality’s approved budget. The mayor is also required by law to submit a report to the municipal council on the implementation of the budget and the financial state of affairs of the municipality within 30 days of the end of each quarter. He or she must exercise the other powers and perform the other duties assigned to the mayor in terms of the relevant legislation, or as delegated by the council to the mayor. 11.6.4 The municipal manager The municipal manager is the administrative head of the municipality. As the administrative head of the municipality he or she also holds the title of the accounting officer of the municipality. The accounting officer of a municipality is responsible for managing the financial administration of the municipality, and must take all reasonable steps to ensure that the resources of the municipality are used effectively, efficiently and economically. In terms of the Local Government Municipal Finance Management Act 56 of 2003, the municipal manager must ensure that: ■■ full and proper records of the financial affairs of the municipality are kept in accordance with any prescribed norms and standards ■■ the municipality has and maintains effective, efficient and transparent financial systems that provide for financial and risk management and internal control ■■ unauthorised, irregular or fruitless and wasteful expenditure and other losses are prevented ■■ disciplinary or, when appropriate, criminal proceedings are instituted against any official of the municipality who has allegedly committed an act of financial misconduct or an offence in relation to financial mismanagement ■■ the municipality has and implements a tariff policy and a rates policy as may be required in terms of any applicable national legislation. 170

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Local government financial management in South Africa 11.6.5 The chief financial officer For the municipal manager to exercise an accounting role in local government finances there is a need for a chief financial officer. The chief financial officer (CFO) is a financial expert appointed by the municipality to advise the municipal council and the municipal manager on financially related matters. The chief financial officer serves as the internal consultant for the management of finances within the municipality. There are specific functions or roles that he or she must perform in terms of legislation. The functions are as follows, as provided for in terms of the Local Government Municipal Finance Management Act 56 of 2003: ■■ The chief financial officer of a municipality is administratively in charge of the budget and treasury office of the municipality. ■■ He or she must advise the accounting officer on the exercise of powers and duties assigned to the accounting officer in terms of the relevant legislations that regulate local government financial management. ■■ He or she must assist the accounting officer in the administration of the municipality’s bank accounts and in the preparation and implementation of the municipality’s budget. ■■ He or she must advise senior managers and other senior officials in the exercise of powers and duties assigned to them in terms of Section 78, or delegated to them in terms of Section 79. ■■ He or she must perform such budgeting, accounting, analysis, financial reporting, cash management, debt management, supply chain management, financial management, review and other duties as may, in terms of Section 79, be delegated by the accounting officer to the chief financial officer. The chief financial officer of a municipality is accountable to the accounting officer for the performance of the duties referred to above. 11.6.6 The heads of departments Municipalities organise themselves into departments to allow for more effective service delivery. In public administration such organising is referred to as departmentalisation. Departmentalisation might take various forms depending on the needs and policy aspirations of the municipality. Departmentalisation is normally complemented by specialisation, whereby within departments, functions that are related to each other are put together into specialised units, and these specialised units then work together and support each other in the form of a department. Such departments are then managed by appointed officials who are accountable to the municipal manager. Each senior manager of a municipality and each official 171

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Public Finance Fundamentals of a municipality exercising financial management responsibilities must take all reasonable steps within their respective areas of responsibility to ensure that the work of the municipality is carried out diligently, effectively, efficiently, economically and transparently. In doing so, the heads of departments must ensure that: ■■ there is a system of financial management and internal control established for the entity and that its work is carried out diligently ■■ the financial and other resources of the municipality are utilised efficiently, effectively, economically and transparently ■■ any unauthorised, irregular or fruitless and wasteful expenditure and any other losses are prevented ■■ all revenue due to the municipality is collected ■■ the assets and liabilities of the municipality are managed effectively and that assets are safeguarded and maintained to the extent necessary ■■ all information required by the accounting officer for compliance with the provisions of legislation is timeously submitted to the accounting officer ■■ the provisions of legislation to the extent applicable to that senior manager or official, including any delegations in terms of Section 79 of the MFMA, are complied with ■■ he or she performs the functions referred to in terms of relevant legislation subject to the directions of the accounting officer of the municipality.

11.7 Budgeting process in local government For a municipality to spend its money there must be a budget drawn in terms of processes regulated by law. In the case of South Africa, such procedures are informed by the provisions of the Local Government Municipal Finance Management Act 56 of 2003. Drawing of such a budget requires a consultative process that is in line with the democratic principles discussed in section 11.3 of this chapter. The main reason for having a budget that is drawn in consultation with communities is to ensure that the municipality spends public money on goods and services that address the needs of communities. The processes and procedures that are followed to get the municipality’s budget approved is called budgeting process, while the aspects related to budgeting from the planning process until the reporting stage is called budget cycle (Pauw et al, 2009: 294). A municipality may, except where otherwise provided for by law, incur expenditure only in terms of an approved budget, and within the limits of the amounts appropriated for the different votes in an approved budget. The council of a municipality must for each financial year approve an annual budget for the municipality before the start of that financial year. An annual budget of a municipality must: 172

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Local government financial management in South Africa ■■ ■■ ■■ ■■ ■■

be a schedule in the prescribed format setting out realistically anticipated revenue for the budget year from each revenue source appropriate expenditure for the budget year under the different votes of the municipality set out indicative revenue per revenue source and projected expenditure by vote for the two financial years following the budget year set out estimated revenue and expenditure by vote for the current year detail actual revenue and expenditure by vote for the financial year preceding.

An annual budget must generally be divided into capital and an operating budget. The paragraphs that follow elaborate on the differences between the capital budget and operational budget. 11.7.1 Capital budget A municipality may spend money on a capital project only if the money for the project (excluding the cost of feasibility studies conducted by or on behalf of the municipality) has been appropriated in the capital budget. Such a capital project must be approved by the municipal council after determining that the sources of funding have been considered as available and applicable to the project without being committed for other purposes. Before approving of a capital project in terms of law, the municipal council should consider the projected cost covering all financial years until the project is operational, as well as future operational costs and revenue. 11.7.2 Operational budget The operational budget provides for operating expenses and operating revenue for a municipality. It involves the development of financial plans for the organisation, typically for a year or less. While annual budgets need not be subdivided into shorter periods, monthly or quarterly budgets are especially useful for anticipating cash needs and for comparing actual experience with the plan. Operating budgets are carefully crafted budgets that focus on managing current expenses. This is different from other types of budgeting strategies that may include provisions for future transactions or the creation of additional expenses that are outside the scope of the basic budget. The focus of an operating budget is to ensure there are funds to maintain the continued operation of a business, and that those funds are distributed in the most cost-efficient manner. Just about any type of organisation drafts and follows an operating budget. Companies of all sizes require this type of budgeting as a means of understanding how much income they need to receive in order to continue operating at current 173

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Public Finance Fundamentals levels. Non-profit organisations also must function with an annual budget that reflects the anticipated amount of donations and other revenue sources that will ultimately be used to cover daily or routine expenses that are essential to the functioning of the entity. Even households benefit from drafting a reasonable budget of this type, since the process makes it much easier to identify and settle expenses each month. 11.7.3 Importance of the budget for local government financial management The budget remains an important tool for ensuring effective and efficient management of public finances. In local government the budget has to be drafted in consultation with local communities and has also to be aligned with the municipality’s Integrated Development Plan (IDP). As municipalities are expected to raise a significant amount of their own revenue (approximately 90%), they do not draft their budgets based on the actual amounts of money available, but instead they budget based on the potential revenue to be collected.

11.8 Local government financial reporting and auditing It was outlined at the beginning of this chapter that the money that municipalities spend to ensure the delivery of services to local communities remains public money. To ensure the principle of accountability within the fields of public administration and management, it is important for each municipality to report on its annual finances, and subject such reports to auditing. To fulfil that obligation, municipalities compile annual reports and annual financial statements. These assist the auditor general in making a determination on the soundness of financial management within all publicly funded entities. Reports of the auditor general are mandated by law to be presented to the relevant legislative authority and are also required to be made public (Constitution of South Africa of 1996: Chapter 9). 11.8.1 Annual reports The council of a municipality must, within nine months after the end of a financial year, produce an annual report for the municipality and for any municipal entity under the its sole or shared control. The purposes of an annual report are: ■■ to provide a record of the activities of the municipality or municipal entity ■■ to provide a report on performance against the budget or standards ■■ to promote accountability to the local community for the decisions made during the financial year to which the report relates. In terms of the Local Government Municipal Finance Management Act 56 of 2003, the annual report of a municipality must include, among others, the following: 174

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Local government financial management in South Africa ■■

■■ ■■

■■ ■■ ■■

■■ ■■ ■■ ■■

the annual financial statements of the municipality, as well as consolidated annual financial statements, as submitted to the auditor general for audit in terms of Section 126 (1) of the Local Government Municipal Finance Management Act 56 of 2003 the auditor general’s audit report on those financial statements the annual performance report of the municipality prepared by the municipality in terms of Section 46 of the Local Government Municipal Systems Act 32 of 2000 the auditor general’s audit report in terms of Section 45(b) of the Local Government Municipal Systems Act 32 of 2000 an assessment by the municipality’s accounting officer of any arrears on municipal taxes and service charges an assessment by the municipality’s accounting officer of the municipality’s performance against the measurable performance objectives for revenue collection from each revenue source and relevant vote in the municipality’s approved budget for the relevant financial year particulars of any corrective action taken or to be taken in response to issues raised in the audit reports any explanations that may be necessary to clarify issues in connection with the financial statements any information as determined by the municipality any recommendations of the municipality’s audit committee as well as any other information as may be prescribed by law.

11.8.2 Financial statements In the private sector, financial statements are normally prepared on an annual and/or quarterly basis to ascertain whether a profit has been made and whether the financial position of the entity is sound (Fourie & Opperman, 2007: 440). A municipality is a non-profit undertaking that provides a wide range of services to the local communities but, to ascertain the sound financial viability of local government, the law states that every municipality must, for each financial year, prepare annual financial statements which fairly present the state of affairs of the municipality. Such financial statements should reflect: ■■ its performance against its budget ■■ its management of revenue, expenditure, assets and liabilities ■■ its business activities ■■ its financial results ■■ its financial position as at the end of the financial year.

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Public Finance Fundamentals The statements should disclose the information required in terms of Sections 123, 124 and 125 of the Local Government Municipal Finance Management Act 56 of 2003 (MFMA). These sections provide for: ■■ disclosures on intergovernmental transfers and other allocations that the municipality might have received from other sectors ■■ disclosures concerning councillors, directors and officials (the salaries, allowances and benefits of political office bearers and councillors of the municipality, whether financial or in kind) ■■ other disclosures that are compulsory in terms of legislation. These disclosures are discussed in further detail in the paragraphs that follow. A municipality which has sole control of a municipal entity or which has effective control, within the meaning of the Local Government Municipal Systems Act 32 of 2000, of a municipal entity which is a private company, must in addition prepare consolidated annual financial statements incorporating the annual financial statements of the municipality and of such entity. Such consolidated annual financial statements must comply with any requirements as may be prescribed. Both annual financial statements and consolidated annual financial statements must be prepared in accordance with generally recognised accounting practice (GRAP), or alternatively, generally accepted municipal accounting practice (GAMAP) as GAMAP replaced GRAP for municipalities (see Scott, 2008). Fourie and Opperman (2007: 441) list what are regarded as the main purposes of preparing and analysing financial statement of a municipality. Such purposes are: ■■ to determine the extent planned objectives of a municipality have been reached and the cost involved in rendering each service ■■ to determine if the level of tariffs for economic and trading services are such that those services are sustainable ■■ to determine the extent to which the level of accumulated surplus at the end of an accounting period is too high, acceptable or too low ■■ to determine whether the loan debt of a municipality, in comparison with other comparable municipalities, is too high or acceptable ■■ to determine if the operating capital is sufficient to meet short-term commitments ■■ to determine if the credit control policy is achieving its objectives ■■ to determine whether consumer deposits are sufficient to prevent losses as a result of non-payment.

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Local government financial management in South Africa Disclosures on intergovernmental and other allocations

In terms of the Local Government Municipal Finance Management Act 56 of 2003, the annual financial statements of a municipality must disclose information on any allocations received by the municipality from: ■■ an organ of state in the national or provincial sphere of government ■■ a municipal entity or from another municipality ■■ any other organ of state. The disclosure must reflect the way those allocations were spent, per vote, excluding allocations received by the municipality as its portion of the equitable share. The MFMA also requires disclosure of any allocations made to the municipality other than by national organs, as well as reasons for any non-compliance with Section 214 of the Constitution of South Africa of 1996, which stipulates an equitable sharing of revenue raised nationally, by all three spheres. The annual financial statement must also disclose whether funds destined for the municipality in terms of the annual Division of Revenue Act (DORA) were delayed or withheld, and the reasons advanced to the municipality for such delay or withholding. Disclosures concerning councillors, directors and officials

The Local Government Municipal Finance Management Act 56 of 2003 also provides that the notes to the annual financial statements of a municipality must include: ■■ the salaries, allowances and benefits of political office bearers and councillors of the municipality, whether monetary or in kind, including a statement by the accounting officer as to whether or not those salaries, allowances and benefits are within the upper limits of the framework envisaged in Section 219 of the Constitution ■■ any arrears owed by individual councillors to the municipality or a municipal entity under its sole or shared control, for rates or services and which at any time during the relevant financial year were outstanding for more than a few days, including the names of those councillors ■■ the salaries, allowances and benefits of the municipal manager, the chief financial officer, every senior manager and such categories of other officials as may be prescribed.

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Public Finance Fundamentals Other compulsory disclosures

The notes to the financial statements of a municipality must include: ■■ a list of all municipal entities under the sole or shared control of the municipality during the financial year, and as at the last day of the financial year. For these entities, disclosures should include: ❏❏ the total amount of contributions to organised local government (SALGA) for the financial year ❏❏ the amount of any contributions outstanding as at the end of the financial year ❏❏ the total amounts paid in audit fees, taxes, levies, duties, and pension and medical aid contributions ❏❏ whether any amounts were outstanding as at the end of the financial year ■■ disclosure, in respect of each bank account held by the municipality or entity during the relevant financial year, the name of the bank where the account is or was held, and the type of year-opening and year-ending balances in each of these bank accounts ■■ a summary of all investments of the municipality or entity as at the end of the financial year ■■ particulars of any contingent liabilities of the municipality or entity as at the end of the financial year ■■ particulars of any material losses and any material irregular or fruitless and wasteful expenditures, including in the case of a municipality as well as any material unauthorised expenditure, that occurred during the financial year – and whether these are recoverable ■■ any criminal or disciplinary steps taken as a result of such losses or such unauthorised, irregular or fruitless and wasteful expenditures, and any material losses recovered or written off. 11.8.3 Audit reports In terms of the Local Government Municipal Finance Management Act 56 of 2003, the accounting officer of a municipality must submit the annual financial statements of the municipality to the auditor general within two months after the end of the financial year to which those statements relate. The accounting officer must, in addition, submit consolidated annual financial statements in terms of the relevant prescription within three months after the end of the financial year to which those statements relate. These statements must also be submitted to the auditor general for auditing.

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Local government financial management in South Africa Similarly, the accounting officer of a municipal entity must prepare the annual financial statements of the entity and, within two months after the end of the financial year to which those statements relate, submit the statements to the parent municipality of the entity; and also to the auditor general, for auditing. The auditor general will then submit an audit report on those statements to the accounting officer of the municipality or entity within three months of receipt of the statements. If the auditor general is unable to complete an audit within three months of receiving the financial statements from an accounting officer, the auditor general must promptly submit a report outlining the reasons for the delay to the relevant municipality or municipal entity and to the relevant provincial legislature and parliament. Once the auditor general has submitted an audit report to the accounting officer, no person other than the auditor general may alter the audit report or the financial statements to which the audit report relates. The accounting officer of a municipal entity must, within six months after the end of a financial year, or on such earlier date as may be agreed between the entity and its parent municipality, submit the entity’s annual report for that financial year to the municipal manager of the entity’s parent municipality. The mayor of a municipality must, within seven months after the end of the financial year, table in the municipal council the annual report of the municipality and of the municipal entity under the municipality’s sole or shared control. If the mayor, for whatever reason, is unable to do this, a written report setting out the reasons for the delay, together with any components of the annual report that are ready, must be submitted to the council as soon as possible. The auditor general may submit the financial statements and audit report of a municipality directly to the municipal council and the national treasury. The accounting officer of the municipality must in accordance with Section 21A of the Local Government Municipal Systems Act 32 of 2000 make an annual report public and invite the local community to submit representations.

Summary and conclusion This chapter has attempted to provide learners with introductory basics of understanding local government financial management in the South African context. This was done through a brief outline of the need for local government financial management that takes place within the context of democratic principles enshrined in the Constitution of the Republic. Such need for local government financial management necessitates the provision of a legislative framework to be adhered to by all municipalities found within the Republic.

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Self-examination questions 1. Compare and contrast operational budgets and capital budgets in local government in South Africa. 2. Write an essay on the legislative framework for municipal financial management in South Africa by way of summarising key acts and policy. 3. Compare and contrast the roles of the chief financial officer and the mayor in relation to municipal financial management in South Africa.

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Endnotes Chapter 1 1. Monetary affairs in the current context refers to the amount of money the organisation has, needs or is expected to have or need for its effective functioning, profitability and growth. This contrasts to the usage of the term in later chapters, where monetary policy refers to controlling inflation by managing the amount of money in circulation in the economy. 2. For details on money standards, see Klein, J J. 1986. Money and the Economy, 6th edition. Orlando, FL: Harcourt Brace Jovanovich Publishers.

Chapter 2 3. The amount of money in circulation is also quite often referred to as the money supply. In this book, the two terms are used interchangeably. 4. When it comes to protecting the value of the rand, however, the South African Reserve Bank tries to limit intervention in currency markets and instead focuses on other measures (such as interest rate changes) for keeping inflation within its targeted range. The thinking is that low and stable inflation will keep the value of the currency stable as well. 5. ‘Repos’ refer to repurchase agreements between the central bank and commercial banks, in which commercial banks borrow at the discount window on the basis of such an agreement. More specifically, commercial banks tender offers to borrow from the central bank through the issuance of various securities, which the commercial banks can then repurchase from the central bank when liquidity conditions change. 6. A synonym for government spending is the term ‘expenditure.’ These terms are used interchangeably in this book.

Chapter 3 7. Generally in the literature, public goods are defined according to a number of characteristics, as has been done in this book, whereas pure public goods have only two characteristics – ie non-rival and non-excludable. The authors of this book feel that little, if any, benefit is gained by distinguishing between the terms ‘public goods’ and ‘pure public goods’.

Chapter 4 8. The Public Finance Management Act 1 of 1999 (as amended by Act 29 of 1999). 9. Local Government: Municipal Finance Management Act 56 of 2003. 10. Under the now defunct apartheid regime in South Africa, parliament was actually constituted of three houses of parliament, one for whites, one for coloureds and one for Indians. 11. The factor that determines this separation is the fact that the position of minister of a public department is a political appointment and is thus classified as executive, whereas the director general (who reports to the minister) and all other positions in a department are appointments made in terms of the normal human resource recruitment and selection practices, and are therefore classified as administrative.

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Legislation included in support material 2004 Annual Budget Review Agricultural Vote Annual Appropriation Act (AA) Annual Division of Revenue Act (DORA) Auditor General Act 12 of 1995 Borrowing Powers of Provincial Governments Act 48 of 1996 Companies Act 61 of 1973 Constitution of the Republic of South Africa – Interim Constitution Act 200 of 1993 Constitution of the Republic of South Africa 108 of 1996 Executive Members’ Ethics Act 82 of 1998 Financial and Fiscal Commission Act 99 of 1997 Intergovernmental Fiscal Relations Act 97 of 1997 Intergovernmental Relations Framework Act 13 of 2005 Local Government Municipal Demarcation Act 27 of 1998 Local Government Municipal Finance Management Act 56 of 2003 Local Government Municipal Finance Management Circulars issued by the National Treasury Local Government Municipal Performance Regulations for Municipal Managers and Managers Directly Accountable to the Municipal Manager of 2006 Local Government Municipal Property Rates Act 6 of 2004 Local Government Municipal Structures Act 117 of 1998 Local Government Municipal Systems Act 32 of 2000 Municipal Fiscal Powers and Functions Act 12 of 2007 Municipal Investment Regulations of 2005 Municipal Public Private Partnership Regulations of 2005 Municipal Supply Chain Management Regulations of 2005 National Prosecuting Authority Act 32 of 1998 Organised Local Government Act 52 of 1997 Preferential Procurement Policy Framework Act 5 of 2000 Preferential Procurement Regulations of 2001 Promotion of Access to Information Act 2 of 2000 Public Audit Act 25 of 2004 Public Finance Management Act 1 of 1999 (as amended by Act 29 of 1999) Public Protector Act 23 of 1994 Reporting by Public Entities Act 93 of 1992 South African Revenue Service Act 34 of 1997 Special Investigating Units and Special Tribunals Act 74 of 1996 Special Tribunals Act 74 of 1996 State Tender Board Act 86 of 1968 Treasury Regulations The full version of the Acts listed here are available online at www.jutaacademic.co.za in the Support Material Catalogue.

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Index Page numbers in italics refer to figures and tables

A

historical perspective 103–106

acceptability of money 6

introduction 101–102

accountability to consumers, greater 144

line-item budgeting 106–107

accounting and finance

modern budget reforms 106

balance sheet 65–67

multi-year programme budgeting 114

cash flow management 73–77

performance budgeting 107–109

GAMAP for local government in South Africa 71

post-budgetary era 106

generally accepted accounting principles (GAAP) 68–71

pre-budgetary period 103–105

income statement 67–68

uses of budgets 117

Standard Chart of Accounts (SCOA) 71–73

zero-based budgeting (ZBB) 114–117

acid-test ratios 76–77

programme budgeting 110–114

budgets

administrative authority 57–59

cash flow management 74

aims, objectives, programmes and directorates of budget reform 110–114

continuousness of 104

allocation of resources 50

definition and basic types 102–103

allocation of revenue sources, factors necessitating 89–91

managing 48

decentralisation 104

privatisation of 104

annuality of budgets 105

unity of 105

annual reports from municipal councils 174–175

uses of budgets 117

appropriation of budgets 105–106 Asset Forfeiture Unit 134 auditing 106 auditor general 52–53, 130–131 audit reports from municipal accounting officers 178–179 audits as alternative to privatisation 145

C cabinet 54–55 capital budgets for muncipalities 173 cash flow management budget 74 financial ratios 76–78 statement of sources and uses of funds, 74–75

B balance sheets 65–67

cash reserve requirement 15

benefit-based taxes 40

centralised procurement tendering, arguments for and against 154

bilateral and multilateral aid 42–43

chief financial officers 171

budgetary era 105–106

circulars issued by National Treasury about local government financial management, 168

budgeting process in local government 172–174 budget reform aims, objectives, programmes and directorates 110–114

classification of services provided by the government 31–33 collective goods 26–28

budgetary era 105–106

commercialisation 136, 139–140

budgets, definition and basic types 102–103

conceptual properties of money 4–5

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Index concern about unethical and unaccountable conduct 121–123

Asset Forfeiture Unit 134

concessions 141 conditional grants to provinces 95–96

concern about unethical and unaccountable conduct 121–123

conflict of interest 123–128

conflict of interest 123–128

consistency concept 71

gift-giving traditions and entertainment 127–128

Auditor General 130–131

constant returns to scale 23

government property, using 125

consumer tariffs 42

inside knowledge and influence, using 123–124

consumption tax 38–40

institutional bodies for combating unethical conduct 128–134

continuousness of budgets 104 contracting out 141–142

introduction 119–121

corporatisation 136–137

moonlighting 125–126

corruption 104

National Prosecuting Authority 132–134

coverage ratios 77–78

outside employment 125–126

current ratios 76

post-employment 126–127

customs duties 40

Public Protector 131

cycle of local government financing 168

Public Service Commission 129–130 self-dealing 124–125

D debt, money as a means of paying off 4 decentralisation 144–145 decentralisation of budgets 104

Special Investigating Unit 131–132 excise duty 39 executive authority 54–57 exemptions from tax 37–38

decision units and packages 115

expediency 104

decreasing returns to scale 22–23

externalities 25–26

democratic principles and local government finance 163 denationalisation 140 depoliticisation 140

F finance and accounting see accounting and finance

direct taxes 35

finance, money defined in relation to 3

disclosures in municipal financial statements 176–178

Financial and Fiscal Commission Act 99 of 1997 88

discontinuation of a service by the public sector 141

financial capacity, determining 90–91

discount window 15

financial needs, determining 90

Division of Revenue Act (DORA) 88

financial ratios 76–78

donor agencies 43

financial reporting and auditing by local government 174

E

financial resources, collecting 50

economic impacts of privatisation 143

financial statements 175–178

efficiency 107

fiscal equalisation 94–96

efficiency of a tax system 34

fiscal policy 16–19

elected municipal council 169

institutions responsible for 19

equity of a tax system 34–35

Phillips curve, theoretical reality 18

ethics and accountability in the public sector, safeguarding

see also monetary policy forms of government 82–86

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Public Finance Fundamentals

G

listening to workers 144

GAMAP for local government in South Africa 71

local government 85–86

generally accepted accounting principles (GAAP) 68–71

local government financial management in South Africa annual reports 174–175

gift-giving traditions and entertainment 127–128

audit reports 178–179

going concern concept 70

background to local government challenges in South Africa 162

government property, using 125

budgeting process 172–174

H

capital budgets 173

heads of departments 171–172

chief financial officer 171 cycle of local government financing 168 and democratic principles 163

I importance of budgets 174

disclosures 177–178

import duties 40

elected municipal council 169

income statements 67–68

financial reporting and auditing 174

increasing returns to scale 22, 24–25

heads of departments 171–172

indirect taxes 35–36

importance of budgets 174

inside knowledge and influence, using 123–124

municipal council’s executive committee 169

institutional bodies for combating unethical conduct 128–134

municipal manager 170

intergovernmental fiscal relations (IGFR) 93–96

office of the mayor 170

Constitution of the Republic of South Africa Act 108 of 1996 86–87 forms of government 82–86 introduction 79 legislative framework for revenue collection and allocation 86–89

need for 162–163 operational budgets 173–174 structures involved in local government finance 168–169 local government financial management, legislative framework 163–168 circulars issued by National Treasury 168

local government 85–86

cycle of local government financing 168

national government 83–84

Division of Revenue Act 166

provincial government 84–85

Intergovernmental Fiscal Relations Act 166

Intergovernmental Fiscal Relations Act 97 of 1997 89 intergovernmental transfers 95

Intergovernmental Relations Framework Act 166–167

international credit ratings agencies, influence 43–45

Local Government Municipal Demarcation Act 164

intersectoral administration 145

Local Government Municipal Finance Management Act 166

L

Local Government Municipal Planning and Performance Management Regulations 165, 168

legislative framework for revenue collection and allocation 86–89 leverage ratios 77–78

Local Government Municipal Property Rates Act 166

line-item budgeting 106–107

Local Government Municipal Structures Act 164

liquidity 6–7

Local Government Municipal Systems Act 164–165

liquidity ratios 76–77

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Index Municipal Fiscal Powers and Functions Act 167

monopolistic public goods 27

Municipal Investment Regulations 167

moonlighting 125–126

Municipal Public Private Partnership Regulations 167

multilateral and bilateral aid 42–43

Municipal Supply Chain Management Regulations 167

municipal council’s executive committee 169

Preferential Procurement Policy Framework Act 165

N

Preferential Procurement Regulations 165 Public Audit Act 167 local government, sources of revenue 92–93 luxury excise taxes 39

multi-year programme budgeting 114

national government 83–84 national government, sources of revenue 91–92 nationalisation 136 National Prosecuting Authority 132–134 negative externalities 26

M M1, M2, M3 categorisations of money 6–7 mandate, ownership and independence of the reserve bank 59–61 market failure 22, 30–31 matching concept 70–71

no direct quid pro quo 28 non-apportionable public goods 27 non-excludable public goods 27 non-rival public goods 27

mayors 170

O

medium term budget policy statement (MTBPS) 89

office of the mayor 170

minister of finance 55–57

open market operations 14–15

modern budget reforms 106

operational budgets 173–174

monetary policy 12–16

Organised Local Government Act 52 of 1997 89

discount window 15

outside employment 125–126

institutions responsible for 19

ownership of reserve bank 61

open market operations 14–15 quantitative easing 16

P

reserve requirement 15

Pareto efficiency criterion 34

and the South African Reserve Bank 13–15

particular goods 28–29

traditional instruments, compared 15–16

partnerships 141

see also fiscal policy money

performance budgeting 107–109 Phillips curve 18

acceptability 6

physical properties of money 5

defining as M1, M2, M3 6–7

positive externalities 26

as a means of paying off debt 4

post-budgetary era 106

as a medium of exchange 4–5

post-employment 126–127

physical properties 5

pre-budgetary period 103–105

public benefit 9–10 public interest 8–9

Preferential Procurement Policy Framework Act 5 of 2000 156–158

public money 8–10

president’s role in public financial management 54

in relation to finance 3

privatisation

as a store of value 5

advantages and disadvantages 142–144

as a unit of account 4

alternative methods or approaches 139–142

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Public Finance Fundamentals alternatives 144–146

particular goods 28–29

audits 145

public goods 26–28

benefits for industry 143

quasi-collective goods and services 29

of budgets 104

returns to scale 22–25 scarcity factor 21–22

commercialisation 136, 139–140 concessions 141

prudence concept 71

contracting out 141–142

Public Finance Management Act 1 of 1999 87–88

vs corporatisation 136–137

public goods 26–28

decentralisation 144–145

public money 8–10

defining 136–137

public-private partnerships 145–146

denationalisation 140

public protector 53, 131

depolicitisation 140

public sector borrowing 28

discontinuation 141

Public Service Commission 129–130

economic impacts 143 greater accountability to consumers 144

Q

history of state-owned enterprises in South Africa 137–138

quantitative easing 16

intersectoral administration 145

quid pro quo 28

quasi-collective goods and services 29

introduction 135–136 listening to workers 144 vs nationalisation 136

R resource scarcity, managing 47

partnerships 141

restructuring 137

public-private partnerships 145–146

returns to scale 22–25

rationale for 138–139

Revenue Service Act 34 of 1997 89

vs restructuring 137

revenue sharing 94–95

social benefits 142

role players in public financial management

in South Africa 146–148

activities, monitoring and controlling 48

transfers 140

administrative authority 57–59

vouchers 142

auditor general 52–53

withdrawals 141

budgets, managing 48

procurement vs inventory management 152 social policy goals 156–158

cabinet 54–55 efficiency, effectiveness and economy, dealing with 48

programme budgeting 110–114

executive authority 54–57

property tax 41

financial advice, providing 48

provincial government 84–85

key role players in financial management 48–53

grants 95–96

legislature 49–52

sources of revenue 92

minister of finance 55–57

provision of goods and services by the state 20–21

president 54

classification of services 31–33

public financial management, defined 46–47

externalities 25–26

public protector 53

market failure 22, 30–31

reserve bank 59–61

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Index resource scarcity, managing 47

T

Standing Committee on Public Accounts (SCOPA) 51–52

taxes, types benefit-based taxes 40

routine purchasing 155–156

consumption tax 38–40 customs duties 40

S

direct 35

scarcity factor 21–22

excise duty 39

self-dealing 124–125

import duties 40

simplicity and low administrative cost of a tax system 35

income tax 37–38 indirect 35–36

social benefits of privatisation 142

luxury excise taxes 39

social policy goals of procurement 156–158

property tax 41

sources of government revenue

sumptuary excise taxes 40

bilateral and multilateral aid 42–43

value-added tax 38–39

classification of taxes 35–36 consumer tariffs 42 donor agencies 43

see also sources of government revenue tendering calling for tenders 152

international credit ratings agencies, influence 43–45

decentralisation as a reform 153–154 opening, assessing and awarding tenders 153

nominal levies 41–42

as a process 151–153

sundry charges 42

see also routine purchasing; supply chain management

taxation, fundamental principles 34–35 taxes and taxation 34 user charges 41

see also taxes, types sources of revenue for spheres of government 91–93 South Africa history of state-owned enterprises in 137–138 privatisation 146–148 South African Reserve Bank and monetary policy 13–15 Special Investigating Unit 131–132 Standard Chart of Accounts (SCOA) 71–73 Standing Committee on Public Accounts (SCOPA) 51–52 statement of sources and uses of funds, 74–75 state-owned enterprises in South Africa 137–138 structures involved in local government finance 168–169 sundry charges 42 supply chain management 158–159

see also tendering

traditional instruments of monetary policy compared 15–16

U unconditional grants to provinces 95 unethical and unaccountable conduct, concern about 121–123 unity of budgets 105 user charges 41

V value-added tax 38–39 vouchers system 142

W withdrawal of a service by the public sector 141

Z zero-based budgeting (ZBB) 114–117

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