Transfers and Tariffs for Municipal Water Services Water Research Commission Seminar on Tariffs, Costs, Revenue and Regulation Presenters: Steven Kenyon.

Transfers and Tariffs for Municipal Water Services

Water Research Commission Seminar on Tariffs, Costs, Revenue and Regulation

Presenters: Steven Kenyon and Kevin Venter | National Treasury | 14 June 2013

Presentation Outline

• General structure of the local government fiscal framework

Transfers• Summary of transfers to fund water and sanitation in local

government• Operational funding for water services

– New local government equitable share formula

Tariffs• Findings from National Treasury’s benchmarking engagements• Shortcomings in costing practices• Summary of National Treasury’s work to improve municipal

costing

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General principles for funding services in local government• The local government fiscal framework is made up of own revenues

(including service charges) and transfers• Municipalities should charge cost-reflective tariffs for the supply of water

for all users that can afford to pay• High levels of poverty mean that funds from national revenues are

needed to fund the delivery of services to poor households

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Structure of the Local Government Fiscal Framework

National Transfers

25%

Local Government Own Revenue

75%

HH in informal settlement Poor HH in RDP houseEmployed HH in RDP house with improvements

Middle to upper income HH

Rates and charges

Charges

Summary of the transfers available for water and sanitation in 2013/14

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MIGR14.4 billion

(over R7 billion for water and sanitation)

USDGR9 billion

(mainly for providing serviced land - including water and sanitation)

Regional Bulk Infrastructure Grant

R3.2 billion(indirect grant)

Rural Households Infrastructure GrantR107 million

Water Services

Operating Subsidy

R560 million

Municipal Water

Infrastructure Grant

R603 million

R16.1 billion in operations and maintenance funding for W&S in the Local Government Equitable Share

(Not to scale)Focus of this presentation is on operating funding

The new LG equitable share formula structure

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Basic Services

Institutional and Community Services

+Allocation for every poor household in the country to enable municipalities to fund the cost of free basic services (including maintenance costs)

Made up of three parts:

Institutional funding

Funding for Community

Services

Revenue Adjustment factorEnsures more funds go to the municipalities with

less own revenue capacity(Factor of between 0% and 100% applied)

Form

ula

How

it w

orks

+

Correct-ion &

Stability

Ensures guarantees are met and smoothes changes in allocations

±

LGES Allocation

1 2 3

A new LGES formula

The local government equitable share was reviewed through a consultative process during 2012 and a new formula, based on 2011 Census data is being phased in over 5 years from 2013/14

Schematic of how the new formula works:

In partnership with:

Review was undertaken by:

Detail on the basic services component

• Formula funds free basic services for every household below an affordability threshold of R2300 household income per month in 2011– Based on value of 2 state Old Age Pensions (as proposed by municipalities)

during the consultation process– 59% of all households in SA fall below this threshold

• Cost of services and number of households will be updated annually– Cost of water updated based on average water board bulk tariff increases

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Water: R86.45

Sanitation: R72.04

Energy: R56.29

Refuse removal: R60.39

Subsidy of R275.17 per month for a package of free basic services

Includes 10%

provision for maintenance

FBS funding allocated for each HH through the formula:

Summary of Local Government Equitable Share allocations for water• Total of R8.7 billion allocated for water through the LGES• This amount includes an allocation of R86.45 per household per month for free

basic water (includes 10% allocation for maintenance)• Amount for water will be increased annually based on weighted average increase

of water board prices (for bulk water costs) and inflation (for other costs)

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Amounts per basic service allocated through the Local Government Equitable Share

Operations Maintenance Total

Energy 50.66 5.63 56.29 5 719

Water 77.80 8.64 86.45 8 783

Sanitation 64.84 7.20 72.04 7 319

Refuse 54.35 6.04 60.39 6 136

Total basic services 247.65 27.52 275.17 27 957

Allocation per household below affordability threshold (Rands)

Total allocation per service(R m illions)

Costing water and sanitation services for the LGES formula

• During consultations, stakeholders wanted detailed costing in the formula that would account for local cost drivers (e.g. topography and density)

• This proved to not be technically feasible due to a lack of credible and agreed data on what factors drive costs (and by how much) and consistent measures of these cost drivers across all municipalities

Advantages of using a single subsidy per poor household:• Municipalities can use any excess funding on one service to

compensate for higher costs of another service• Recognises that municipalities have a responsibility to provide

alternative services for households without connections• Recognises that the provision of alternative services is not necessarily

any less expensive• Allows the formula to be updated based on an estimate of the growth in

the number of households

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The new formula and service delivery

• Section 227 of the Constitution says:

“Local government and each province is entitled to an equitable share of revenue raised nationally to enable it to provide basic services and perform the functions allocated to it.”

• The equitable share is unconditional, but it is intended to fund the delivery of basic services

• The new formula structure:– is more transparent about the funds available for

basic services– Has more realistic cost estimates– Will have its data updated annually– Includes more realistic levels of institutional and

community services funding • This will make it easier to hold municipalities

accountable for how they budget for and use LGES funds 9

Formula divides LGES allocation among 278 municipalities (like slicing a R34bn cake)

Formula determines size of each ‘slice’

Municipalities determine how funds are used to deliver services to their

residents

LGES DELIVERY CHAIN: From formula to services

Costing, tariff setting and managing sustainability

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Findings of benchmarking engagements (1)

• Basic accounting principles and costing methodologies are not applied to determine the ‘real’ cost of providing services

• Tariff determination is not informed by accurate costing that incorporates direct, indirect and hidden costs of services

• There is rarely a correlation between the annual tariffs in respect of basic services and the cost of providing such services

• The traditional approach of incremental tariff increases is widely applied• The financial imbalance of the basic services is becoming increasingly

greater with the costs exceeding the revenue generated by service charges

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Findings of benchmarking engagements (2)

• Decreased cash coverage and depleted cash backed reserves is a further concern

• In general municipalities are becoming more and more grant dependent• Cost efficiency does not seem a widely applied practice• Inadequate allocations for asset renewal & maintenance

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Elements of accounting for costs

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HiddenCost

•Secondary Cost•E.G. Donation recieved

for a clean-up project whereby community or private sector donate their time

Indirect Cost

•Secondary Cost•E.G. Labour, machine,

equipment, HR, Legal and IT services utilised from other departments

Direct cost

•Primary Cost•E.G. Sa laries, stationary

,telephone costs

Total Cost

Trade and Economicservices

Findings of benchmarking engagements (3)

• An analysis of the 17 non-delegated municipalities 2012/13 MTREF found that 8 municipalities budgeted for a cost reflective tariffs, others applied an incremental approach

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R thousand Surplus Deficit Surplus Deficit Surplus Deficit Surplus Deficit Surplus Deficit

MetrosCity of Johannesburg 316,093 468,649 (48,656) 736,086 City of Cape Tow n 579,618 54,464 218,202 (734,796) 117,488 eThekw ini 440,385 (152,613) 52,849 (209,244) 131,377 Ekurhuleni 207,820 76,730 325,611 146,406 756,568 City of Tshw ane 34,852 (329,966) 52,045 (468,760) (711,829) Nelson Mandela Bay (79,399) (15,388) (87,283) 14,901 (167,169) Mangaung (167,845) 43,385 138,117 (18,718) (5,061) Buffalo City (132,739) (86,916) (35,798) (26,098) (281,550)

Secondary CitiesMsunduzi LM 297,742 (276,613) 56,729 57,329 135,188 Rustenburg LM (45,247) 22,021 1,869 (6,549) (27,905) uMhlathuze LM 19,535 (60,207) 12,539 (23,046) (51,178) Mbombela LM 93,828 18,831 2,947 9,104 124,710 Polokw ane LM (56,281) (13,694) (8,193) (18,772) (96,941) Sol Plaatjie LM (8,748) 18,914 261 (1,924) 8,503 George LM (365) 18,833 33,749 58,833 111,052 OR Tambo DM (203,041) (203,041) Mafikeng LM (14,628) (5,239) (32,542) (52,408)

Total 1,989,872 (490,623) 721,829 (1,153,065) 894,920 (136,512) 286,574 (1,589,105) 2,120,971 (1,597,083)

NotesSecondary costs have been includedEquitable share for Free Basic Services has not been factored in

Trading Services Consolidated

2012/13 FY Electricity Services Water Services Waste Water Services Waste Management Services

Findings of benchmarking engagements (4)

• These deficits reflected on the table above mean that municipalities are:– Cross subsidising tariff services with property rates– Depleting the limited reserves available– Budgeting for deficits or adopting the mythical “balanced budget

approach”

• This is detrimental to financial sustainability and consequently places service delivery at risk

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Findings of benchmarking engagements (5)

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Findings of benchmarking engagements (6)

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– 10 000 20 000 30 000 40 000 50 000 60 000 70 000 80 000 90 000

100 000

R -

tho

usa

nd

s

Mafikeng Water Services

Revenue

Expenditure

Bulk Purchases

Primary + SecondaryCosts

• Engagements were held with the various financial system vendors in order to establish if their systems catered for internal cost recoveries (cost accounting).

• It must be noted that only 40 % of municipalities do apply some sort of cost allocation, but the manner in which they allocate direct and indirect costs is weak

• Where municipalities are attempting to cost for services, there calculations are usually limited to direct costs such as remuneration and bulk purchases, with little or no consideration for indirect costs

• The traditional approach of incremental tariff increases is widely applied• The financial imbalance of basic services is becoming increasingly

greater with costs exceeding the revenue generated by service charges.

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Shortcomings in costing practices

Progress to date

• Pilot study at uMhlathuze on costing;• Compilation of costing guidelines;• Accompanied DWA on their road shows;• Assisted various municipalities with costing and tariff setting;• Various training sessions to CFO forums & Provincial Treasuries; and• Inclusion of an additional segment (Management Accounting) in SCOA

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Conclusion

• Costs, cost management and a costing methodology should not be informed by a specific approach i.e. ABC, absorption costing etc., but should rather be a hybrid solution aimed at the specific requirement of LG in a South African context.

• The time, effort and cost should always be justified by the outcome. • Municipalities that work to a longer planning horizon and understand the impact

of cost drivers and cost management will be in a position to:– Test the likely impact of different income scenarios;– Seek out alternative models for sharing local resources more effectively;– Increase the impact of spending and influence;– Challenge the status quo of the design, management and delivery of

services;– Improve efficiency by streamlining business processes;’– Be in a position to decide on trade-offs in meeting the current challenges and

preserving capacity for the longer term; and– And start understanding the costs of specific service delivery i.e. agency

services, underfunded mandates etc

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