LOCAL GOVERNMENT REVENUE

Table of contents

1 Introduction .................................................................................................................... 3

2 Some general principles and conventional wisdom ....................................................... 3

2.1 Linking taxing and spending .................................................................................... 3

2.2 National government is best placed to ensure redistribution ................................ 3

2.3 Fiscal autonomy can threaten economic unity and/or macro-economic stability . 3

2.4 Some taxes are best placed with national government .......................................... 4

2.5 A fiscal gap/imbalance is inevitable ........................................................................ 4

2.6 Intergovernmental allocations must address the fiscal gap in an objective and
inclusive manner ................................................................................................................ 4

3 Basic features of South Africa’s IGR fiscal system .......................................................... 5

3.1 General sources of revenue ........................................................................................ 5

3.2 Understanding own revenue ...................................................................................... 5

3.3 Taxing powers in South Africa ..................................................................................... 5

3.4 Municipal own revenue .............................................................................................. 6

VIDEO: Municipal Revenue explained ............................................................................... 7

3.5 Municipal borrowing ................................................................................................... 7

3.6 Fiscal imbalance .......................................................................................................... 8

3.7 Intergovernmental institutions and forums for IGR fiscal relations ........................... 8

3.8 Intergovernmental transfers ....................................................................................... 8

3.9 Key concepts in the Division of Revenue Bill .............................................................. 9

3.10 Division of Revenue Bill ......................................................................................... 10

3.11 The process towards Division of Revenue Act ...................................................... 10

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3.12 Vertical division of revenue ................................................................................... 11

3.13 Allocations to local government: the equitable share .......................................... 11

3.14 Conditional grants to municipalities...................................................................... 13

VIDEO: Conditional grants explained ............................................................................... 14

3.15 Conclusion ............................................................................................................. 14

Glossary of key terms........................................................................................................... 14

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1 Introduction

Local government revenue is closely associated with the topic of intergovernmental fiscal
relations. The topic of intergovernmental fiscal relations is essentially about the following:
given that the Constitution allocates functions (i.e. expenditure responsibilities) to provinces
and municipalities, how are provinces and municipalities funded? In these notes, we will focus
on how municipalities are funded.

2 Some general principles and conventional wisdom

Intergovernmental fiscal relations is a comprehensive field of study that brings together a

number of disciplines including, at least, economics and constitutional law. It is built on the
experiences of many countries that wrestle with the issue as to how to fund the various levels
of government. There are number of general principles and some conventional wisdom that
has emerged. A number of them are briefly discussed below.

2.1 Linking taxing and spending

First, the authority to spend on a function, and the responsibility to raise revenue for it, should
ideally be located in the same level of government. This is good for accountability and it
enables that level of government to deal with the trade-offs that have to be made. If
subnational governments are dependent on the central government for funding, it makes
them accountable to the central government, instead of to their citizens.

2.2 National government is best placed to ensure redistribution

However, another conventional wisdom is that national government is generally better at

ensuring redistribution from wealthy regions to poorer regions. Not every region will be able
to extract the same level of resources from its citizenry because of demographic issues,
historical issues, the location of economic activity etc. Subnational governments can play a
role in redistributing resources from wealthy to poorer areas but are obviously limited to their
own jurisdiction. This means that the national government must collect the majority of
revenue and take responsibility for distributing it across the subnational governments. So this
points in a different direction, compared to the point made under 2.1.

2.3 Fiscal autonomy can threaten economic unity and/or macro-economic stability

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Furthermore, granting subnational governments a great deal of fiscal autonomy (i.e. the
power to levy taxes, borrow and spend according to its own priorities) can threaten macro-
economic stability and economic unity. If subnational governments impose taxes or borrow
excessively, this can affect the entire country’s economic stability. Economic unity and the
free flow of goods and services can be jeopardised if subnational governments use their taxing
authority to put up barriers to movement, or if they compete with one another with lowering
tax rates, resulting in a ‘race to the bottom’.

2.4 Some taxes are best placed with national government

There are also certain taxes that are best administered nationally. If the tax base (i.e. what is
being taxed) is mobile or highly unequal, the tax is best administered nationally. The taxation
of income (income tax) and the taxation of goods (VAT) are good examples of this. It is very
difficult to administer those taxes locally.

2.5 A fiscal gap/imbalance is inevitable

Depending on the interaction between taxing powers and expenditure responsibilities of

subnational governments, a fiscal gap or fiscal imbalance may occur. This means, in simple
terms, that the subnational government has more responsibilities than it can generate its own
revenue for. So there is a shortfall, which is called the fiscal gap/imbalance.

2.6 Intergovernmental allocations must address the fiscal gap in an objective and inclusive
manner

To fill this gap, intergovernmental allocations, i.e. grants from the central government to
subnational governments are necessary. The determination of the size and purpose of these
grants is a critically important exercise performed by the national government. It is important
that this power is not abused or neglected. Allocations must be determined objectively i.e.
preferably by means of a formula, based on reliable data. This formula must address the need
for (re)distribution. Also, the recipients of the grants, i.e. the subnational governments, must
be able to influence or at least have a say in the determination of these grants. There needs
be trust in the process. If subnational governments mistrust the process or feel excluded, this
can damage the relationship between levels of government.

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3 Basic features of South Africa’s IGR fiscal system

The essential features of South Africa’s intergovernmental fiscal system are set out in Chapter
13 of the Constitution. In essence, it is a system that is based on provinces and municipalities
collecting their own revenue, complemented by fiscal transfers to correct fiscal imbalances.
The integrated or centralised nature of South Africa’s multilevel government system come
through in the second feature, namely that there is an elaborate system of supervision, i.e.
intergovernmental monitoring of financial performance.

3.1 General sources of revenue

In general, the following sources of revenue are available for national, provincial and local
governments (subject to what is explained in 3.3 below):

1. taxes
2. user charges
3. surcharges
4. licensing fees
5. debt financing (borrowing)
6. agency and contract fees
7. intergovernmental transfers (conditional and unconditional)

3.2 Understanding own revenue

The first six can be considered ‘own revenue’. The degree to which a provincial government
or a municipality has access to own revenue is best understood by asking these three
questions:

1. What is the tax assignment, in other words: what powers does the provincial government
or municipality have to impose taxes, charges or fees? And does this power include the
determination of the rate or tariff?
2. What is the tax base in the province or municipality for that tax or charge? In other words,
what is there to tax or to charge?
3. What is the tax effort? If the province or municipality has the power to tax/charge and
access to a tax base, does it actually collect taxes or charges due to it?

3.3 Taxing powers in South Africa

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If one analyses Chapter 13 of the Constitution, it becomes clear that, in South Africa, the
national government collects almost all the taxes. Unlike federations that assign significant
taxing powers to states or provinces, South Africa’s Constitution reserves almost all taxing
powers for the national government. This is one of the most important manifestations of the
integrated or centralised system of multilevel government in South Africa.

3.4 Municipal own revenue

Section 229 of the Constitution provides that municipalities have powers to impose property
taxes and charge fees for the services they provide. This aligns with their constitutional
powers. The local government functions in Schedules 4B and 5B are exclusive to
municipalities. It is only municipalities that may perform these functions (even though they
are subject to national and provincial regulation. Furthermore, many municipal functions are
trading services where cost recovery is possible. Municipalities can charge individual users for
electricity, water, wastewater management and waste management. The municipal powers
to collect property rates and charge fees for services are constitutionally guaranteed: in
principle there is no empowering legislation needed. However, the national government
regulates how municipalities exercise these powers. For example, property rates are levied in
terms of the framework set out in the Municipal Property Rates Act of 2004, and the
Municipal Systems Act of 2000 regulates how municipalities must charge for services.

Municipalities are not limited those two own revenue sources. The Municipal Fiscal Powers
and Functions Act of 2007 provides for a procedure for municipalities to apply for further
taxing powers.

In practice, the extent to which municipalities raise own revenue varies greatly from one
municipalities to the next. First, the division of responsibilities between district and local
municipalities is important. While all metropolitan and most local municipalities perform the
‘trading services’ mentioned above, very few district municipalities do. Property rating is also
done by local municipalities. The result is that district municipalities raise very little own
revenue. Secondly, even if the tax assignment is there across the board for local
municipalities, the revenue base and tax effort can differ substantially, resulting in this wide
variation. In actual fact, most of the local government revenue is generated in the eight
metros: they account for almost two-thirds of total aggregated revenue raised by local
government.
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 VIDEO: Municipal Revenue explained

The above video, produced by the National Treasury contains an explainer of the
importance of municipal revenue: https://www.youtube.com/watch?v=GwvMI2GVwCg

The Municipal Fiscal Powers and Functions Act is not utilised much to grant municipalities
additional taxing powers. This may change in future when the chapter on development
charges (bulk infrastructure levies attached as conditions to land use management approvals)
is added and put in to operation.

3.5 Municipal borrowing

Municipal borrowing is generally permitted only for capital expenditure (i.e. expenditure on
infrastructure). Borrowing for current expenditure (e.g. salaries) is only allowed if the loan is
repaid within the same financial year. The Municipal Finance Management Act contains a
borrowing framework. Municipalities are given more discretion to borrow than provinces (for
example when it comes to the choice of whom to borrow from). Borrowing is also much more
common in local government than it is in provincial government. This is in part because
(many) municipalities can offer a revenue stream (property rates, service fees) as security for
debt. They are thus more attractive for financial institutions. Some cities have even issued
bonds to finance capital expenditure.

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3.6 Fiscal imbalance

When comparing the constitutional responsibilities of municipalities with their own revenue,
it becomes clear that the fiscal imbalance for municipalities varies from one municipality to
the next, but is often also significant.

Addressing these fiscal imbalances requires intergovernmental fiscal transfers, which will be
discussed below. Before discussing the process and substance of intergovernmental fiscal
transfers, the most important institutions and forums will be briefly discussed.

3.7 Intergovernmental institutions and forums for IGR fiscal relations

The Finance and Fiscal Commission is an independent constitutional body, tasked with
advising government in intergovernmental fiscal relations. It comprises nine members,
appointed by the President. The Minister of Finance nominates members to the FFC with the
involvement of the Premiers and SALGA. So while it is not an intergovernmental institution
per se, all three spheres of government play a role in selecting its leadership. The FFC plays a
particularly important role in the process towards the annual division of revenue (see further
below). The Budget Council is an IGR Forum (see also Theme 3) that brings together the
Minister of Finance and the nine MECs for finance. The Budget Forum is also an IGR Forum
that brings together the Minister of Finance, the nine MECs for finance and SALGA. These two
forums are platforms for information sharing and consultation surrounding
intergovernmental fiscal transfers. The Minister of Finance, the FFC, the Budget Council and
the Budget Forum are the most important actors in the process of determining the
intergovernmental fiscal transfers.

3.8 Intergovernmental transfers

The vast majority of intergovernmental transfers involve the national government as the
transferring authority. While provincial governments (and district municipalities) may
transfer grants to municipalities, this does not happen often and usually involves relatively
small amounts of money. The national government generally pursues two key objectives with
intergovernmental transfers:

1. To address the fiscal imbalances (discussed above) and ensure fair distribution of
resources across the entire country; and
2. To drive special policy priorities.

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Importantly, intergovernmental fiscal transfers complement a provincial government’s or a
municipality’s own revenue but they are not there to compensate for failures to collect
revenue.

Intergovernmental transfers are decided annually in the Division of Revenue Act (DORA)
which is passed as part of the annual budget. It is important that the transfers are decided in
an Act of Parliament, and not decided solely by the Minister or Cabinet. This ensures a
transparent process and Parliamentary involvement. The Intergovernmental Fiscal Relations
Act of 1997 determines a process of intergovernmental consultation on the Division of
Revenue Bill, which is repeated annually.

3.9 Key concepts in the Division of Revenue Bill

A number of concepts are critical in understanding the mechanism of the Division of Revenue
Act.

First, there is the difference between the vertical division and the horizontal division of
revenue. The vertical division of revenue determines how all nationally generated revenue is
split three-ways, between the national, provincial and local spheres. This division thus results
in one overall allocation to national government, one to provinces and one to local
government. The horizontal division determines how the share of one sphere of government
is then distributed among the governments in it. In other words, how much of the provincial
share, will each of the nine provinces receive? And how much of the local government share
will each municipality receive?

Secondly, the Constitution puts forward a set of principles to guide decision making with
respect to the vertical and the horizontal division. They are set out in section 214 of the
Constitution and deal with issues such as the national interest, the need to service national
debt, the need to ensure that provinces and municipalities can deliver basic services,
economic disparities, fiscal capacity and efficiency, stability and predictability etc. etc.

Thirdly, there are important differences between unconditional grants and conditional grants.
Unconditional grants are allocated with ‘no strings attached’: the provincial government or
the municipality determines in its own budget how the funds will be spent and there is no
application necessary. The rules pertaining to prudent financial management apply but the
province or municipality decides what the spend the money on. Conditional grants, however,

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come with strings attached: they are specifically earmarked for certain purposes and are
subject to conditions and monitoring. Often (but not always), the province or municipality
must apply for the grant. Conditional grants are paid from the national government’s share
of nationally generated revenue.

3.10 Division of Revenue Bill

The Division of Revenue Bill is an annual Bill with –

1. a set of rules on how intergovernmental grants are going to be distributed and managed;
2. a determination of the vertical division of revenue;
3. a determination of the unconditional grants to provinces and municipalities; and
4. a determination of the conditional grants to provinces and municipalities.

The Bill contains determinations of the vertical and horizontal division of revenue mentioned
above under 2-4 for the upcoming budget year, but also for the two ‘outer years’. This is in
line with the government’s Medium Term Expenditure Framework, which is government’s
three-year policy framework and budget.

For year 1, the Bill contains a definite allocation. For years, 2 and 3, the Bill contains estimates
which can be adjusted in the following years. However, the estimates are usually close to
accurate. This enables provinces and municipalities to plan their expenditure over at least a
three-year period, as they are reasonably sure as to how much they will receive.

3.11 The process towards Division of Revenue Act

The process towards the annual DORA is tightly regulated in the IGRFA. It starts at least 10
months before the beginning of the financial year with a report by the FFC in which it makes
recommendations on (1) the vertical division of revenue and on (2) the allocations to
provinces and municipalities. The National Treasury then prepares the Division of Revenue
Bill. It consults with provinces in the Budget Council (see above), and with provinces and local
government in the Budget Forum (see above). The FFC is consulted as well. The National
Treasury must respond to the recommendations by the FFC and usually does that in the
Explanatory Memorandum to the Division of Revenue Bill.

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The diagram below depicts the annual division of revenue process.

4. Parliament 1. FFC submits

adopts Division of technical
Revenue Act as recommendations
part of national on division of
budget revenue

annual process

3. Min of Finance
consults 9 2. National Govt
provincial prepares Division
counterparts and of Revenue Bill
local government

The process is designed to include provincial and local government input into the process of
designing the intergovernmental fiscal system. The engagements in the Budget Council and
Budget Forum, in particular, serve that purpose. It is not without its challenges. One issue that
has been raised is the challenge that the entire local government sphere is represented
through SALGA, and that metropolitan municipalities do not have their own voice in the
Budget Forum. There are also those who argue that, by the time the process starts in earnest,
the die is cast in that the vertical division has been decided.

3.12 Vertical division of revenue

DORA will set out the vertical division of revenue. This division is determined by the Cabinet.
Importantly, before allocations to provincial and national government are determined, the
national government takes the ‘top slice’ out of the National Revenue Fund. The ‘top slice’
comprises predetermined allocations, such as the debt service costs (interest the national
government pays on its loans), contingency reserves, salaries of Member of Parliament and
the judiciary and a few other costs. After those have been deducted, the vertical split is
decided and inserted into the Bill.

3.13 Allocations to local government: the equitable share

Every municipality is entitled, in terms of the Constitution, to an equitable share of nationally

raised revenue. The main objective of the equitable share for municipalities is to enable
municipalities to deliver basic services. Like the equitable share for provinces, the equitable
share for municipalities is determined according to a formula.

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 The formula is as follows:

LGES = BS + (I + CS)xRA ± C.

Its five elements are set out in the table below.

Formula element Calculation

BS: Basic Services, a subsidy for providing free basic subsidy x number of poor
services (water, electricity, sanitation and refuse) for households
poor households

I: Institutional component, subsidises basic municipal base allocation + allocation per

administrative costs council seat

NTS/CS: Non-trading or community services Health and related services x

component, funds services that benefit community number of households + other
rather than households such as health, fire services, services X number of households
roads, cemeteries, planning, stormwater management,
street lighting and parks

RA: Revenue adjustment, adjusts for revenue capacity looks at:

so that municipalities least able to raise their own
• total income of individuals and
revenue, benefit the most.
households
• property values
• no of households on traditional
land
• unemployment rate
• % of households that are poor

C: Correction and stabilisation guaranteeing a certain percentage

of the current allocation in year 2

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The equitable share allocation is an unconditional grant, which means that the municipality
decides, in its budget, how it spends the money. This discretion is not completely unbounded,
though. The Constitution compels the municipality to ensure the delivery of basic services,
and the municipality must of course adhere to financial management rules when spending
the money.

3.14 Conditional grants to municipalities

Both provinces and the national government can transfer conditional grants. In practice, the
vast majority of conditional grants come from the national government with provinces only
very occasionally transferring grants to municipalities.

There are basically two broad categories of conditional grants to municipalities. The first
category comprises capacity building grants, aimed at assisting municipalities in building
capacity in key areas of municipal governance. Even though the National Treasury expects
municipalities to find funds in their own revenue streams for capital expenditure, most
municipalities do not raise sufficient revenue to fund capital expenditure. This is why the
second category of conditional grants comprises infrastructure grants, aimed at assisting
municipalities with pro-poor capital and infrastructure investment.

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 VIDEO: Conditional grants explained

The above video, produced by the National Treasury contains an explainer of conditional
grants to municipalities: https://www.youtube.com/watch?v=bXL3p5khtio

3.15 Conclusion

All in all, the intergovernmental fiscal system reflects the integrated / centralised system of
multilevel government. The national government has a virtual monopoly on all taxation, but
responsibilities are spread across the three spheres of government. This then necessitates an
intricate system of intergovernmental fiscal transfers that seeks to follow that division of
responsibilities. The system for deciding on intergovernmental fiscal transfers is predictable,
formula-based and backed by excellent data (Statistics SA). It is also transparent and includes
input by provinces and local government. The question can be asked what the impact and
influence is of provinces and municipalities.

Intergovernmental fiscal relations do not just concern the raising and distribution of revenue
by and across spheres of government. This is complemented by a system of vigorous
monitoring of legal compliance, financial performance and service delivery performance.

Glossary of key terms

Budget Council An intergovernmental forum, comprising the Minister of Finance and

the nine MECs, responsible for Finance. It is provided for in the
Intergovernmental Fiscal Relations Act.

Budget Forum An intergovernmental forum, comprising the Minister of Finance, the

nine MECs, responsible for Finance and a representative of organised
local government. It is provided for in the Intergovernmental Fiscal
Relations Act.

conditional grant An intergovernmental transfer that comes with strings attached,

specifically earmarked for certain purposes and subject to conditions
and monitoring. Often (but not always), the province or municipality
must apply for the grant. Conditional grants are paid from the
national government’s share of nationally generated revenue.

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cost-recovery Recovering the costs of a service from those that receive the service

Divison of Revenue Each year, Parliament passes this Act, which provides for the division
Act of revenue between national, provincial and local government.

Finance and Fiscal A constitutional body, comprising experts nominated with

Commission involvement of all three spheres of government. Its role is to advise
government on intergovernmental fiscal relations.

fiscal autonomy The extent to which a province or municipality has powers to raise its
own revenue and decide how to spend its budget

fiscal capacity The revenue that a municipality (or a province) can potentially
collect, if one looks at its (1) the revenue raising powers and (2) the
tax base.

fiscal gap / Provinces and municipalities have more responsibilities than they can
imbalance generate own revenue for. So there is a shortfall, which is called the
fiscal gap/imbalance.

horizontal division The division of each sphere’s allocation among the governments in
of revenue that sphere, i.e. the allocations to each province and each
municipality

intergovernmental When the national (or provincial) government transfers funds from
allocation/transfer revenue that is generated nationally, to a province or a municipality.

property tax/rates A tax on property, levied by municipalities.

redistribution pursuing social equity by re-allocating wealth and resources from

richer areas to poorer areas

South African Local South African Local Government Association, an association of local
Government governments that is recognised in terms of the law as the official
Association voice of local government in intergovernmental relations.

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surcharge an additional tax, levied on an already existing tax

tax assignment the distribution of powers to tax across the three spheres of
government

tax base the total value of assets, activities and resources that are liable for
taxation, for example in a municipality.

tax effort The degree to which a government collects the taxes that is due to it

unconditional grant An intergovernmental transfer that comes without conditions, i.e.

the national or provincial government may spend it according to its
own budget decisions.

user charge The fees that a municipality charges for services it provides, such as
water, sanitation, sewerage and refuse collection.

vertical division of The division of revenue between the three spheres of government,
revenue i.e. three amounts, one for each sphere of government.

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