Governance and Municipal Finance (Lessons from the Pandemic Series)
Danga Mughogho is Programme Manager for Well Governed Cities at South African Cities Network. We explore the State of City Finances 2020 report, impacts of the pandemic on city finances, trends in the affordability of municipal bills, lessons from the report, and implications for municipal finance in the future.
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This episode is brought to you in partnership with South African Cities Network (SACN).
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SACN’s Urban Governance Programme explained
- SACN’s governance programme understands governance as consisting of both governing (through bureaucratic systems and processes) and managing competing public and private interests and stakeholders through political processes.
- Well-governed cities are efficient, manage their finances prudently, are sustainable and are accountable to their citizens. Citizens in well-governed cities actively participate in democratic local government electoral process and decisions about local development. Governance in well-governed cities is therefore democratic, inclusive, and participatory.
- The efficacy of governance is measured by the quality of local services and institutions, the democratic participation of local citizens and communities in policy-making, and the accountability of elected and public representatives.
SACN’s Sustainable Municipal Finance Programme explained
- Crucial to any development of a city is a sustainable, stable financial base. One of the key areas of research is how municipalities generate income, collect revenue and budget for expenditure. Stable revenue and strategic expenditure are central to enabling growth and development in cities.
- The SACN tracks and analyses performance in the eight metros and Msunduzi. Every two years we produce a State of City Finances report targeted at senior municipal administrators and politicians, as well as officials in the national and provincial spheres of government with an interest in public finances and the intergovernmental fiscal framework. The State of City Finances is a flagship SACN publication.
- Accompanying the main report is a People’s Guide to the State of City Finances which distils the messages in the main report and is targeted to a broader, citizen and civil society, non-financial audience.
Reflection on the State of City Finances 2020 report
- In 2018, the last State of City Finances Report called for cities to be at the centre of development and for systemic problems to be addressed, but little has changed.
- Cities remain the drivers of the economy and home to most people in South Africa but continue to face challenges of inadequate finance for infrastructure and service delivery, and affordability of municipal services for consumers.
- Cities are finding it increasingly difficult to raise sufficient revenue to cover their mandates, mainly as a result of structural issues within the local government fiscal framework (LGFF) and the deteriorating macro-economic environment in which they operate – both matters over which cities have little control.
- Of course, cities could always improve their fiscal effort and expenditure efficiencies, but the fiscal space open to them has shrunk.
- The population of low-income groups continues to grow as urbanisation brings people to cities in search of jobs, which remain elusive due to the slow and decreasing rates of economic growth.
- Reduced margins on electricity and water sales, as a result of both rising unemployment and stagnating household incomes, and above-inflation increases in the cost of bulk purchases, mean that cities are less able to cross-subsidise the provision of basic services for lower-income residents.
- Faced with a shrinking fiscal space, cities have used the Local Government Equitable Share (LGES) to cover some of their expenditure obligations, a decision which is at odds with the original purpose of the LGES as envisaged in the 1998 Local Government White Paper.
- The report examines city financial performance over time, including the effects of Covid-19 on city finances; looks at the affordability of municipal bills; and provides an analysis of the LGES.
The changing state of municipal finances
- Cities have grown their revenues by an average of 5.7% per year, above operating expenditure growth of 5.5%.
- The average annual increase in operating surpluses was 4.2%, which is a positive development.
- A key trend over the period was the rising share of property rates as a proportion of own revenue. This is a result of revenue from service charges growing at a far slower rate than that of property rates.
- Between 2015/16 and 2018/19, transfers to cities grew by an average of 4.7% per year, dramatically lower than the 12% recorded for the period covered by the State of City Finances 2018.
- The slower growth in conditional transfers was partly responsible for the lower capital expenditure. Between 2015/16 and 2018/19, capital expenditure grew at only 1.5% per year on average.
- Cities did not make significantly more use of their own sources of finance, although borrowing contributed slightly more to total capital finance, and Cape Town, Ekurhuleni and Johannesburg issued new bonds.
- Between 2015/16 and 2018/19, combined cash collection rates for the cities declined from 91% to 87%. As a result, cash coverage ratios also declined, from 2.14 months in 2016/17 to 2.07 months in 2018/19.
How the Pandemic has affected city finances
- Reduced revenue from property rates and service charges (in particular non-domestic customers) as a consequence of reduced economic activity during lockdown, the closure of businesses and depressed property markets.
- Higher city expenditures, primarily on emergency water supplies, protective equipment, sanitation of public transport facilities, and food and shelter for the homeless.
- Increased non-payment for services, as household incomes are reduced, and affordability comes under pressure.
- Although the increased expenditures are likely to be temporary, lasting only for the duration of the pandemic, the revenue and payment impacts may persist, depending on how rapidly and extensively the economy recovers post-Covid-19.
Trends in the affordability of municipal bills
- In most cities, the price of municipal services packages has increased in real terms for most packages.
- Price increases have been highest for the lower-income packages and lowest for the higher income packages. For the cities as a group, prices of the services packages increased by 2.1% (Type A), 2.0% (Type B), 1.2% (Type C), and 1.1% (Type D).
- Price increases have been driven by higher water charges.
- On average, affordability for all packages has improved. The affordability has improved slightly for lower-income packages and remained stable or become progressively more affordable for higher-income packages.
- Services are not affordable for the poorest. Type A customers spend more than 10% of their household income on municipal bills in all cities, except for Ekurhuleni, while Type B to D customers spend less than 10% of their income on bills in all cities.
- Structuring and setting tariffs is a delicate balancing act.
- Cities are facing a dilemma. Their populations and households are growing rapidly, especially for lower-income groups, economic growth is slow, unemployment is rising, and household incomes are stagnating for all but the wealthiest.
- Ultimately, cities can only provide affordable services within their overall financial ability. In this regard, cities may need to consider interventions, such as:
- Scaling back levels of service to make them more affordable.
- Increasing focus on core services.
- Avoiding unfunded or expanding mandates.
- Making better use of revenue sources other than property rates and tariffs.
- Now is perhaps the time to reopen the discussion about a new tax instrument for cities in order to ensure continued financial sustainability.
Report findings on the Local Government Equitable Share
- The data reported by the cities shows that, as a group, they are delivering free services to fewer households than envisioned in the allocation formula, and spending a significant portion of the grant to cover costs other than the provision of free services. Cities are entirely within their rights to spend the LGES on items other than free services because it is an unconditional grant. However, the data indicates that the intention of the grant, at least in so far as it is articulated through the LGES formula, is not in fact being fully realised.
- Cities are functioning in an environment of ever-increasing input costs and a sluggish economy, which constrains growth in revenue and leads to an increase in the number of low-income households requiring support. Cities are finding it increasingly difficult to raise sufficient revenues to cover their many (and expanding) expenditure obligations. As a result, they rely on the LGES to subsidise some of these obligations and are not able to use it only for free basic services, as intended. As their fiscal space closes, cities are forced to target subsidies ever more tightly, rather than expanding support.
- The growing funding gap in cities can be disaggregated into (SACN, 2018):
- An unfunded mandate gap: municipalities are incurring expenditure on services and functions that are not in their mandates and for which they do not receive revenues.
- An expenditure inefficiency gap: municipal expenditures are higher than the reasonable levels required to provide services.
- A transfer gap: transfers do not completely fill the structural gap.
- A fiscal effort gap: municipalities do not exert sufficient fiscal effort to collect all the own revenues implied by their fiscal capacity.
- The inefficiency and fiscal effort gaps are, at least in part, within the control of cities, and some have considerable space to improve in these areas – indeed, cities must continue to do so. However, the unfunded mandate and transfer gaps are largely structural.
- It is perhaps time for a complete review of the LGFF.
Main lessons of the report and implications for municipal finance in the future
- The State of City Finances 2018 makes the argument that the vision espoused in South Africa’s urban policy (the Integrated Urban Development Framework) for productive, sustainable, inclusive, and well-governed cities can only be achieved with a municipal fiscal framework that is fit for purpose.
- This argument, as well as proposed solutions to the systemic financing problems that cities face in meeting their developmental mandate, was also made in the State of City Finances published in 2015.
- The main argument is that cities must address the systemic problems that affect their ability to achieve the policy goal of developmental local government.
- Municipal budgets should be aligned to policy, and urban planning should reflect that orientation.
- Cities need to find ways to bridge the capital funding gap which prevents cities meeting the infrastructure requirements of a steadily increasing urban population.
- The case for fiscal transformation:
- The misalignment of policy, budgets, and planning
- Contradictions between the municipal revenue and funding model and local government’s mandate to promote spatial transformation and achieve desired developmental objectives
- The impact of fundamental changes within the energy sector
- The need to transition to a climate-resilient economy
- The pandemic has thrown into sharp relief the systemic problems affecting the ability of cities to achieve the policy goals of developmental local government and spatial transformation.
- Just as the shock of Covid-19 has prompted many countries to re-examine the way in which societies are organised, it is perhaps time to review the way in which cities and other municipalities deliver on their constitutional mandate to provide services to communities in a sustainable manner.
- Despite identifying and analysing reasons why cities are not currently able to finance themselves to transform urban space as envisaged in urban policy documents, SACN has not been able to insert these ideas into the policy space. SACN research is intended to inform urban policy and is an advocate for the metros.
- While some of the changes to municipal finances proposed in the publications require systemic changes, some are interventions that individual metros can implement given the political will.
- However, there has been limited adoption and uptake of the policy recommendations emerging from this research.
- This suggests that it makes the most sense at this stage of the project cycle to investigate the appetite for reform and strategise on how to influence the local government fiscal policy process.
About the Future Cities Africa and South African Cities Network Partnership
2020 has fundamentally changed the context in which South African municipalities govern and provide services. Future Cities Africa has partnered with South African Cities Network on a series of 4 episodes that look at how cities have fared during the pandemic and what fundamental lessons have been learned. We cover: Economic recovery, Climate Change, Governance & Municipal Finance and Built Environment.
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About Danga Mughogho
Twenty years of analysis, strategy, writing and communication in the private and public sector, in three countries, and on two continents. I am a cerebral humanist. I inspire action with my passion for democracy, human rights, and social justice. Malawi citizen. South African permanent resident. Visit LinkedIn
About The South African Cities Network (SACN)
The South African Cities Network (SACN) is an established network of South African cities and partners that encourages the exchange of information, experience, and best practices on urban development and city management. Since 2002 the SACN’s objectives are to:
- Promote good governance and management in South African cities
- Analyse strategic challenges facing South African cities
- Collect, collate, analyse, assess, disseminate and apply the experience of large city government in a South African context
- Encourage shared learning partnerships among spheres of government in order to enhance good governance of South African cities.