Another Reason Why Eskom Is The Bull In The Fiscal China Shop
We have seen many headlines over the past two years highlighting the negative effects of Eskom on the national fiscus. Billions of rands have been allocated to the national utility to try and shore up its fragile balance sheet. The total amount of money handed over to Eskom for this purpose currently stands at about R132-billion, with plenty more to come. The minister of finance has repeatedly highlighted the dangers that the power utility poses to the national fiscal framework because of these huge financial demands. The more money that goes to prop up Eskom, the lower the amount available for critical socioeconomic developmental needs. The enormous fiscal cost of the coronavirus pandemic — both direct, through new expenditure demands, and indirect, through a collapsing tax-revenue base — makes the price of supporting Eskom from our limited national resources even higher.
But there is another way in which Eskom is undermining our national fiscal framework. It doesn’t get much attention, but the long-term effects may be even more calamitous than those created by its constant need for bail-out cash.
The national fiscal framework effectively determines how much money is available to all parts of government. The key component of that national framework is the equitable division of revenue among the three spheres of government (national, provincial and local). During the negotiations for South Africa’s new Constitution, there was considerable debate around the decentralisation of the tax-raising authority.
Local government already had some own-revenue-raising capacity (property taxes and service charges being the main items), but provinces had hardly any. All income, value-added and related taxes were levied at a national level. In order to counter demands for a federal fiscal system (where provinces would have greater own-revenue-raising capacity), an agreement was reached on a system for the equitable distribution of nationally raised revenue in order to attain a fiscal balance between the available revenue and expenditure of the three spheres of government.
Under the current system, national revenue is allocated among the three spheres (the vertical allocation) and then among the various parts of those three spheres (the horizontal allocation of each vertical allocation) on the basis of a detailed formula. This is reviewed and revised periodically by the Financial and Fiscal Commission and is contained in the annual Division of Revenue Act (DORA).
Under the current revenue-sharing arrangements, local government receives by far the smallest share of nationally raised revenue — less than 10% of non-interest allocations in the original 2020/21 budget estimates. At the same time, municipalities have a wide range of responsibilities that are essential to achieving the state’s developmental mandate, most notably the roll-out and maintenance of basic services infrastructure, and the provision of those basic services.
The reason for this apparent mismatch between share of national revenue and expenditure demands lie in the assumptions made in the 1998 White Paper on Local Government about the revenue-raising capabilities of municipalities. The White Paper proceeded on the assumption that, in aggregate, local government could fund 90% of all its operating expenditure requirements from its own revenue. Operating expenditure includes not just operating overheads such as salaries, but the costs of service provision such as payments to bulk service providers and infrastructure maintenance.
What would be the main sources of this own revenue? Property rates (which under the new wall-to-wall system of municipalities would be extended to many more households than before) and service charges — electricity, water, sewerage and refuse removal being the major items — were forecast to be sufficient to finance 73% of total operating expenditure requirements (with the balance coming from other licensing income, rentals, etcetera).
Income from services would comprise the difference between bulk purchases of items such as electricity and water, and the price charged to consumers. The assumptions in respect of the contributions of these different services to municipal revenue and operating expenditure are set out in the table below.
By far the most important source of margin income to local government was assumed to be electricity — in aggregate, some 38% of local government’s total operating expenditure requirement was going to be financed by buying power from Eskom and on-selling it to consumers.
But that was not the only way in which electricity was going to be central to the local government fiscal framework: the White Paper was also clear that in order to meet these revenue-raising projections, two critical factors had to be in place. The first was that there had to be effective revenue management; municipalities had to be able to collect revenue from customers.
And the critical tool to ensure that they were able to do so, according to the paper: “It is fundamentally important that local government is able to retain the power to cut off electricity to consumers as a credit-control measure”.
This was even more the case after the Constitutional Court effectively ruled that water could not be disconnected because of an outstanding municipal account, although the pressure could be reduced.
The second critical factor was that municipal charges were to be set at a rate that households could actually afford to pay. Not only was this a key part of the developmental goal of ensuring that all households could access basic services, but affordable charges would increase the likelihood that revenue could actually be collected.
The reality has been very different, in large part because of events at Eskom. Electricity bulk charges have increased sharply, in order to service debt costs and the huge construction cost overruns of Medupi and Kusile. These rising bulk charges have resulted in consistent above-inflation price increases that municipalities charge their customers. The effect has been that millions of households simply cannot afford to pay for electricity. Rising electricity bills also means that households have less money to pay for the other items that are intended to finance local government, notably property rates and taxes, and water.
At the same time, where customers are able to pay for charges such as rates and taxes, the ability of local government to collect that revenue has been greatly reduced by an inability to use electricity disconnections as a credit control measure, as envisaged in the White Paper.
This is because Eskom directly supplies power to just over half of all South African households, and a large portion of commercial users, and will not use disconnection of their customers as a means of assisting local government to collect outstanding revenue.
Total debt owed to the local government as at March 31 was just over R181-billion. Most of that debt (about R130-billion) was owed by households, and more than 80% of that had been outstanding for more than 90 days. Despite the media attention on the amount of money that municipalities owe Eskom, the pressure that national treasury has brought to bear means that most municipalities have been collecting and paying electricity costs to a much greater extent than other services. But the inability to collect other sources of revenue is having a debilitating effect on the municipal balance sheet. Municipalities in aggregate are owed about R22-billion for electricity, but more than double that — just over R50-billion — in unpaid rates and taxes, and some R36-billion in water charges.
According to the Auditor General of South Africa (AGSA), only about 60% of the revenue on local government’s balance sheet will ever be collected. This has serious implications for the ability of local government to operate as a going concern, and to fund critical items such as infrastructure maintenance (the unfunded portion of which we have estimated to currently be around R15-billion per annum). The AGSA’s latest report (for the 2018/19 fiscal year, and thus a picture of events before the effects of the coronavirus) indicated that 79% of municipalities had a financial health status that was “either concerning or requiring urgent intervention”. About one third were considered to be “in a particularly vulnerable financial position”. Thirty-four per cent of municipalities ended the year with a deficit — they had spent more than they had collected.
Whereas mismanagement of funds is certainly an issue that negatively affects the financial status of municipalities, we should not make the mistake of thinking that it is the only problem. The 2018/19 AGSA report for local government indicated that three of the municipalities and municipal entities that received a clean audit, and 27 of those that received an unqualified audit ended the year in deficit. In terms of current liabilities exceeding current assets, two that received a clean audit and 35 with an unqualified audit ended the year in such a state of technical insolvency.
The bulk of the state’s programme to deliver basic services and to maintain local infrastructure depends on the integrity of the local government fiscal framework. In addition, the ability of local government to largely self-fund operating expenditure is not just critical to the local government fiscal framework, it is a foundation stone of the entire national fiscal framework. The assumption that almost 100% of nationally raised revenue can be allocated to national and provinces is directly related to the assumption of how much money local government can raise. And that assumption is, in turn, directly influenced by what happens at Eskom.
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